Good morning. My name is Jennifer, and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter and year-end results for 2014 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. If you would like to ask a question during this time, you may simply press star and the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you, Mr. Erik Helding, you will begin your conference.
Thanks, operator. Good morning, thank you for joining us on CNO Financial Group's fourth quarter 2014 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 Chris Nickele, Chief Actuary, and Bruce Baude, Chief Technology and Operations Officer, 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 on the investors section of our website and was filed in a Form 8-K earlier today. We expect to file our Form 10-K and post it on our website by February 23rd.
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'll be making performance comparisons, unless otherwise specified, any comparisons made will be referring to changes between fourth quarter 2013 and fourth quarter 2014. With that, I'll turn the call over to Ed.
Thanks, Erik, good morning, everyone. CNO posted another strong quarter, our businesses performed well as we continued to grow sales, collected premiums, annuity account values, and earnings. Consolidated sales were up 1% in the quarter, led by 6% sales growth at Colonial Penn. Sales at Bankers Life and Washington National were flat for the quarter. We completed our detailed year-end assumption review, I am pleased to report that overall testing margins remain strong while long-term care margins continue to be thin. LTC margins incorporate a comprehensive claims cost study covering 12 years of our claims data. Fred will discuss this in more detail later in the presentation. Our financial position remains strong, our key capital ratios are at investment-grade levels. Consolidated RBC increased further to 434%. Leverage decreased to 17.1%, holding company liquidity was $345 million.
We continue to return capital to shareholders through dividends and repurchasing $75 million of common stock in the quarter, bringing us essentially to the midpoint of our guidance at just over $376 million for the year. Turning to slide six. For the quarter, operating earnings excluding significant items were up 8%, while operating earnings per share increased by 21%. We continue to effectively deploy capital via our securities repurchase program. This has resulted in a 9% year-over-year decrease in average shares outstanding. Let me now briefly discuss the strategic partnership we announced last night. CNO and Cognizant have entered into a comprehensive multi-year agreement in which Cognizant will deliver technology services to CNO. After a brief transition period, Cognizant will assume CNO's application development, maintenance, testing, select IT infrastructure, and all India-based operations.
This partnership provides CNO with access to scalable resources and capabilities and should allow us to accelerate information technology process improvements and innovation. In addition, this partnership delivers immediate run rate expense savings and reduces the cost of future IT delivery services. As a result of this agreement, we expect to incur a modest charge to earnings of approximately $6 million in the first half of 2015. We expect to realize $10 million in annualized expense savings beginning in the second quarter. Turning now to slide eight. For the full year, 2014 was another year of progress for CNO. We continued to grow the business even with overall sales results below our expectations. The sales results were due to specific acute issues that we are actively addressing to regain momentum.
We significantly reduced the go-forward risk profile of the company through reinsurance and the sale of closed blocks of business that were part of the former Other CNO Business segment. We met and exceeded the earnings growth, return on equity, and financial strength targets that we set back in 2012. We continued to return capital to shareholders. Since the beginning of 2011, we have returned nearly $1.3 billion via securities repurchase and common stock dividends. We also achieved a 20% dividend payout ratio one year earlier than we had guided to. We have been able to simultaneously invest in our business, build capital to withstand stress conditions, and return capital to shareholders. We have a strong business model and investment-grade financial strength. We received an additional four upgrades from the rating agencies during the year, bringing the total number of upgrades over the past three years to 10.
With that, I'll now turn it over to Scott.
Thanks, Ed. Beginning with Bankers Life, sales in the quarter were flat, putting us up 1% for the year. Life sales continue to be strong, with an increase of 11%, and annuities were up 4% for a combined increase of 8% in the quarter. This was offset by an 8% decrease in health sales, mostly made up of a decline in MedSup. Primary driver of the sales shortfall relates the challenges in recruiting we faced during the early part of 2014, which led to a contraction in our overall agent force, despite continued improvements in agent productivity. This has had a particular impact on MedSup sales. We have responded to our recruiting challenges by implementing tactical adjustments, we are seeing positive results from those actions, with a 9% increase in new recruits in the quarter.
This is an improvement over the 11% decline we saw at the end of the third quarter. The average producing agent count, which is impacted by recruiting, was down 4% from the prior year, but is up 1% versus the third quarter. Recognize that due to the onboarding process, it will take time to regrow our agent count to prior year levels, we expect a positive impact throughout 2015. Agent productivity continues to be strong, with a 5% increase in NAP per agent for the quarter. Collected premiums at Bankers Life grew by 3%, primarily due to an increase in life premiums resulting from higher sales as we continue to gain traction with interest-sensitive life, as well as larger premium per policy overall, and growth in the size of the block, partially attributable to the recapture of a block of business previously reinsured.
This increase is partially offset by a continued decline in long-term care as new sales, which are primarily short-term care, and the runoff of more comprehensive nursing home policies, gradually changes the mix of our in-force. Turning to Washington National, sales were flat in the quarter but up 6% for the year. PMA, which makes up 80% of total sales, was up 6%, and our average agent force at PMA was up 10%. Our independent channel was down 17%, with sales adversely impacted by an increased focus on the quality of submitted business and organizational restructuring of a large independent partner. Although the impact to fourth quarter sales results was larger than anticipated, the situation was isolated, the changes position 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 5% in the quarter and overall sales were up 6%. For the year, Washington National sales were up 9% on this basis. Lastly, supplemental health collected premiums were up 5% due to continued growth in our in-force. Moving on to slide 11. Colonial Penn posted 6% sales growth in the quarter and a 4% increase for the year. Results in the quarter were driven by strong sales in web and digital-generated activities, new simplified issue term and whole life products, and double-digit growth in GBL direct mail sales. Collected premiums were up 5% due to higher levels of sales and continued growth in the block. EBIT for the year was just above break even, this represented a significant increase over 2013.
This improvement was driven by growth in in-force earnings, increased marketing effectiveness, and a modest increase in the deferral of acquisition costs as we continue to shift to a higher percentage of direct mail-based lead generation activities. For full year 2015, we expect EBIT in the 0 to $3 million range, but because of the seasonality of advertising spend, we expect a loss in the $7 million range in Q1 of 2015. Slide 12 provides our outlook for 2015. From a consolidated standpoint, we expect sales to increase 3%-6%. At Bankers Life, we expect sales to increase 3%-5%. We continue to face headwinds in the sale of annuities as a result of low crediting rates given the low interest rate environment. As previously mentioned, it will take time to regrow our agency force to prior year levels.
We will continue to sharpen our focus on recruiting and increase the number of first-year agents, which is key to growing our overall agent force and also to increasing sales of MedSup. Additionally, we will continue to focus on increasing productivity of our veteran agents, leading to improved retention levels, which, combined with recruiting results returning to historical levels, will lead to a larger and more productive agent force. At Washington National, we are expecting sales growth of 5%-7%, along with continued growth in our PMA agency force of 8%-10%, 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 OneSource benefit enrollment and servicing platform, both of which were introduced on a limited basis late in 2014.
For Colonial Penn, we expect full year 2015 sales growth in the 6%-8% range. The key drivers of this growth will be a continued diversification of sales generated through direct mail and digital marketing activities, growth in simplified issue term and whole life products, and continued enhancements to our various marketing campaigns and lead generation and conversion activities. I'll now turn it over to Fred to discuss CNO's financial results. Fred?
Thanks, Scott. We recorded a solid quarter on the earnings and capital front. If you adjust for the significant items in our press release, we recorded operating earnings of $0.34 per share, up 21% over last year. The majority of our insurance earnings drivers performed in line with our expectations, and core capital ratios strengthened in the quarter. We spent down some of our holding company liquidity, returning $87 million to our shareholders in the form of stock repurchases and dividends. We completed our annual review of actuarial assumptions and loss recognition testing, which overall had little impact on the quarter's results, but did impact individual segments. In Bankers, we have about $500 million of interest-sensitive life reserves, where model refinements, mortality, and interest rate adjustments netted to a $6 million EBIT positive in the period.
In Washington National, we have a small block of runoff payout annuities and loss recognition, where we unlocked interest rate and mortality assumptions, driving the majority of their $10 million negative EBIT impact. Separately, we adopted a new mortality table published by the Society of Actuaries with respect to our deferred compensation liabilities. We take a mark-to-market approach to accounting for this liability, which resulted in a $15 million EBIT charge in the quarter. Going forward, we will be adjusting our definition of operating earnings to exclude these periodic adjustments as they are non-core and result in non-economic GAAP volatility. Turning to slide 14 and our normalized segment earnings. Bankers' EBIT benefited from continued strength in annuity margins, with life insurance benefiting from sales growth these last few years and the recapture of the Wilton Re block midyear.
Long-term care margins were a bit stronger than expected and medsup a bit weaker, both within the normal range of quarterly movement. Washington National's normalized EBIT was in line with our expectations. The elevated supplemental health claims experienced in the third quarter fell back in line at normal levels. Colonial Penn reported solid earnings and sales growth driven by cost-effective marketing spend. As noted earlier, we anticipate GAAP profitability in 2015, with normal seasonality resulting in an estimated EBIT loss in the $7 million range for the first quarter. Corporate segment results tend to move in accordance with our holding company investment performance. We actively invest approximately $200 million of our available liquidity and overall performance track the quarter's market volatility. Turning to slide 15, we profile our health margins.
Bankers Medicare Supplement results were weaker than what we have experienced in recent quarters, but still solid and in line with our expectations. With a pattern of favorable results in hand, we are seeing the pace of rate increases naturally slow, premium refunds increase, and persistency improve. Our benefit ratio guidance is stable in the 70% range in 2015, with continued steady increase in collected premium. In the case of long-term care, we are working on various initiatives designed to positively impact claims trends. We are in the early days of execution. This quarter is another example of claims experience falling in line with our expectations. We continue our long track record of actual to expected results supporting the quality of our claims reserves. We are calling for a modest increase in our interest-adjusted benefit ratio in the 81% range.
This increase is somewhat the result of our refreshed modeling and the build of future loss reserves on certain older and more comprehensive benefit blocks of business. The more comprehensive policies continue to run off, and collected premium is expected to decline absent the impact of rate increases, thus dollar margin's a headwind to our GAAP earnings. Washington National supplemental health benefit ratios fell back to just above 54% in the quarter. We are maintaining our benefit ratio guidance of 54% range for 2015. Turning to slide 16 and investment results. While rates traveled lower throughout 4Q, we defended new money rates by remaining tactical in our investment strategy. Lowering turnover creates a manageable flow of assets to invest, allowing us to be selective in finding enhanced yields without sacrificing credit risk. We did experience favorable prepayment income in the quarter.
This tends to be a natural result of lower rates and favorable spread conditions for issuers. Impairments in the quarter were limited to one legacy equity investment for which we now have very little book value remaining. There has been understandable focus on energy portfolios in the industry. We have included a slide in the appendix of our earnings deck that profiles our portfolio. You will find our exposure to be roughly in line with others in the industry, with around 87% investment grade and limited exposure to oil field services and refineries. We see credit losses as unlikely, but downgrades possible as market volatility persists. Turning to slide 17 and the results of our actuarial work in the quarter. We tested virtually all of our $23 billion of liabilities, and our overall margins were healthy and actually improved in aggregate over last year's results.
The net impact of freshly priced new business and the natural runoff contributed positively as we would expect. Policyholder experience overall offset the impact of adjusting our long-term ultimate new money rates down 50 basis points across the board. I mentioned payout annuities earlier as an area of loss recognition impact this quarter. This is specifically a block of only $200 million in reserves in Washington National, but serves to point out just how sensitive a closed block with thin margins can be when adjusting long-term assumptions. Fortunately, we sold or reinsured the majority of our interest-sensitive closed blocks during 2014, in part motivated by lowering our overall long-term interest rate exposure. Obviously, we're focused on long-term care, which I'll turn to in a moment.
Before moving off this slide, it's worth noting that we did not record any meaningful statutory asset adequacy or premium deficiency reserve increases as a result of cash flow testing this year. Turning to Slide 18 and a deeper dive into long-term care testing results. Before I get started, it's extremely important to understand that our long-term care business is unlike most in the industry, and that influences our testing results and sensitivities. A simple example is depicted by the pie chart, where roughly 72% of our active life reserves are on policies with benefit periods under four years. This is not a product design decision, rather a result of selling into the middle market. There are many other examples that make comparisons more complicated and often not as relevant. We have a lot of information on this slide, but I can summarize as follows.
Our overall testing margins reduced by approximately $150 million and are thin at roughly 2% of net GAAP liabilities totaling $4.4 billion. Margins were impacted negatively by rates, but not severely, as we are ALM matched, have a shorter overall duration, and only a modest need to reinvest in this low interest rate environment. The overall impact on our margin was negative $50 million. Morbidity had a more severe impact on our margins. We conducted a significant study covering over 12 years of claims data with a focus on strengthening our older age claims cost estimates. This resulted in a $460 million reduction in our loss recognition testing margins, and we believe is a more appropriate estimate based on our experience. We do not assume any improvement in morbidity or mortality.
Related to our new morbidity estimates, we are filing a new round of rate increases, which had a $230 million positive impact on loss recognition testing margins. Our estimate is conservative, reflecting only rate actions to be filed in the next six months, focused primarily on our older blocks with measured increases averaging 30%, and then a success rate applied of only 40%, recognizing uncertainty in the regulatory process. In aggregate, our assumption equates to a 9% increase or roughly $50 million in annualized premium. It's worth noting we have considerable direct experience to support our best estimate. We modestly adjusted our persistency assumption based on our experience study and excluding periods impacted by rate increases, it had a $125 million positive impact on margins.
Finally, we have several initiatives underway that we believe will improve our claims experience over time, but have not included any specific provisions in our margins. While we remain concerned over our thin margins, overall, we are pleased with the results in that we have a much more comprehensive understanding of our claims experience and have reflected that experience in our margin estimates. Turning to Slide 19 and drilling into new money rate assumptions. Our estimate involves a year-end process that incorporates our then view of the capital market conditions together with our planned investment and ALM strategy. As noted earlier, overall impact to our loss recognition testing margins was 3% decline or $110 million, including the impact recognized in our fourth quarter earnings on payout annuities. However, our reserve and capital exposure to interest rates is fundamentally concentrated in our long-term care block.
As a result, we show only our long-term care new money investment assumption here and the associated stress tests on actuarial margins. Holding new money rates flat for several years, then recovering, results in a modest impact to our margins and no isolated loss recognition. Down and flat forever has a more material impact on margins and holding all else equal, would result in loss recognition event. The implied earnings and capital hit would be to first eat through your existing margin, then write down intangibles, causing roughly a $100 million GAAP earnings impact. This is a bit more severe an impact than in past tests for the simple reason that we have less margin supporting our long-term care business. On a statutory basis, the stress test impact is to premium deficiency reserves, where the margins and the outcome are similar.
The estimated impact is much along the lines of what we have discussed in the past, roughly 25 to 35 points of consolidated RBC ratio impact. Something to be mindful of is highlighted on the bottom right of this slide. Our ability to duration match and slow turnover means we have only to invest approximately $35 million of cash flow a quarter to support the new money rates in this business. We have very little internal competition for longer duration investment opportunities, and our ability to tactically manage the portfolio is quite flexible. While we feel good about the adjustments we've made, we will need to monitor conditions closely as we move through 2015. Turning to Slide 20 in capital, it's important to come away from this discussion on loss recognition, long-term care, and interest rate risk, knowing that we come at this challenge from a position of strength.
We ended the quarter with an RBC ratio of 434%, a nine-point increase from the third quarter. Statutory earnings in the quarter of $108 million came in strong and as expected. You may have noticed we disclosed our Bankers Life legal entity RBC at 411% in the press release. This is up from 393% in the third quarter and important on a couple of fronts. First, Bankers Life houses our long-term care business and is understandably more exposed to low for long rates. So it's simply good risk management to keep their capital ratios robust. Second, Bankers Life is the flagship legal entity for CNO and drives most of our cash flow to the holding company. In our quest to upgrade our insurance company ratings profile, we target conservative capital levels for this legal entity.
Leverage held steady in the quarter at 17% despite continued capital deployment, and we ended the quarter with $345 million of liquidity and investments at the holding company. Our overall outlook for 2015 is for consolidated RBC at 425%, leverage reducing to 16% absent any recapitalization, and holding company liquidity of approximately $315 million. While weighing down somewhat on ROE progression, we think it's important to maintain caution with respect to current interest rate environment and our tight LTC actuarial margins. We, however, continue to generate very strong free cash flow and are setting our 2015 repurchase guidance in the range of $250 million-$325 million, recognizing we may alter this range as the year proceeds and alternative opportunities present themselves. Turning to slide 21 in ROE development and outlook.
Our normalized operating ROE came in at the high 8% range for the year, supported by strength in core earnings and a more material jump in capital return to shareholders. We discussed at a high level our three-year plan at this past June's investor conference and potential operating variables, including new money investment rates and long-term care performance. We have finalized our new three-year forecast and have essentially bumped out and flattened our ROE trajectory, driven by the following key variables. The current low interest rate environment and a more muted recovery expectation, refreshed long-term care actuarial work and associated GAAP build of reserves, installing our three-year sales plan and associated growth rates. Finally, we built into our forecast a bit more excess capital in recognition of the low rate environment and LTC actuarial margins.
These are all variables that can improve over time and give rise to more aggressive ROE build, but represents our best estimate given current conditions. We are as focused on the quality of ROE as we are the growth rate and are committed to continued ratings improvement and lowering the beta of our company driving long-term valuation. We continue to monitor markets and weigh the value of recapitalizing the balance sheet as leverage would be down to 15% come 2017. Markets continue to be constructive for strong double Bs, provided we remain disciplined on the capital front and are tactical in our execution. Most likely timing is around the call date of our bonds, but we are monitoring conditions closely. With that, I'll hand back to Ed for some closing comments.
Thanks, Fred. CNO will continue to be focused on a few key priorities. First, we'll continue to increase the size and productivity of our agent force and grow our franchise. We'll continue to enhance the customer experience to better serve middle-income Americans. Our strategic partnership with Cognizant is expected to accelerate the pace of increasing operating effectiveness. Furthermore, we will continue to effectively manage risk and deploy capital to increase profitability, return on equity, and shareholder value. We'll now open it up for questions. Operator?
At this time, I would like to remind everyone, if you would like to ask a question, you may press star then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Our first question comes from the line of Erik Bass with Citi.
Good morning. Thank you. I guess first, one question on long-term care is, how much additional are you accruing for long-term care reserves on a stat and GAAP basis going forward to reflect the lower assumed interest rates?
I guess, would that imply that if rates were to remain or follow your plan, that all else being equal, your reserve margin would increase year-over-year?
Two ways to answer that question, one GAAP and one stat. I would not isolate interest rates. In fact, in most cases, the future loss reserve from a GAAP standpoint is driven an awful lot by your claims expectations and the morbidity comments we made. Let's separate the two. Let's start with GAAP. Under GAAP, we are building a future loss reserve to reflect certain portions of the business that are in future years in negative cash flow. Again, the build of that FLR is influenced by our study and our new projections for morbidity, as well as our ability to achieve some of the near-term rate increase actions that we're taking in increased premiums. We are building the FLR more aggressively.
We've been building it now for quite a while at around $22 million a year. We would expect that build to climb kind of in order of magnitude of 10 to maybe as much as $15 million annually of additional FLR build as we go through the financial plan. This is, of course, an estimate, and it's based on a number of moving parts but weighs down on our GAAP results. Separately is statutory. Under statutory, we're not in a position from a cash flow testing where we're required to put up either premium deficiency reserves or asset adequacy reserves on our long-term care block. However, as an abundance of caution, we have been building a modest level of asset adequacy reserves in Bankers Life, and we've been building that at about $9 million a quarter on a statutory basis.
Today, as we sit here, that asset adequacy reserve, which again is not required, is up around $55 million or so, or think of it as roughly 15 points of RBC build in Bankers Life, the legal entity. This was not required, but as an appointed actuary representing that legal entity, we felt it prudent as the margins are thinner on long-term care when tested on a standalone basis. Hopefully that helps answer your question.
That does. I guess maybe to your last point, you don't mention specifically aggregating long-term care with Med Supp, which I believe you may have the ability to do in Bankers.
Yep.
The $100 million is a standalone long-term care block reserve. Is that correct?
I'm not sure what you mean by the $100 million, but let me answer your question.
Just roughly the 2% of the reserves test, I guess, was around $100 million margin, it looked like on a GAAP basis.
Yes. That is the margin from a loss recognition testing standpoint on the GAAP basis. On the statutory basis, the margin is roughly the same, and that is on all of our long-term care business housed in Bankers Life. We have a very small amount of business in New York. It's sort of a rounding error, quite honestly. It has not affected our results really GAAP and stat basis. Then the $55 million of asset adequacy build was on that block of business. You are right. We are able to borrow from Med Supp excesses for the purposes of cash flow testing. Remember, premium deficiency reserves are tested on a standalone basis. That's where you would still find some RBC effect related to stress testing.
Got it. Maybe just the final question is how should we think about capital generation in 2015? I mean, it looked like from just kind of triangulating the math on your slides that it would imply sort of free cash flow in the maybe $275 million-$300 million range. Is that kind of the right ballpark to think about?
I think that's about right. Our overall capital generation, which we would generally describe as the statutory pre-tax, because we don't pay a significant amount of cash taxes at the moment, pre-tax statutory earnings across the company, before the monies we send up to the holding company in the form of management fees and surplus notes. That's been traveling over several years around the half a billion dollar mark. That continues to be the case, if not building gradually over time. When I think about free cash flow up to the holding company, your numbers are approximately correct when it comes to 2015. For example, we would expect to have statutory dividend pace in and around the $60 million-$65 million a quarter range, absent any disruption.
You think about those statutory dividends as being pretty close to our free cash flow, recognizing we send $130 million up to the holding company through surplus note interest payments and management fees. That is more than enough to service our debt and cover holding company expenses, et cetera.
Got it. Thank you.
Our next question comes from the line of Randy Binner with FBR Capital Markets.
Hey, good morning. Thanks. I missed a little bit of the call, but I just wanted to, and this is kind of a follow-up to what Erik was just asking on the kind of free cash flow that comes out of the company on a prospective basis. I wanted to look back at what came up last year and just understand better, I guess, why there was not an upstream to the holdco in the fourth quarter, and I guess what the thinking is in leaving a higher RBC down at the insurance company. It seems like a very robust level of RBC downstairs, and wondering if there's any kind of shift in the plan of bringing up dividends to the holding company on more of a quarterly basis because you missed the fourth quarter.
Yep. Yeah. The fourth quarter dividend decision was extremely tactical. In other words, there's no messaging content in it as it relates to our forward ability to generate free cash flow. What was tactical about it was real simply 2 things. We left a significant amount of capital down in Bankers specifically, and that was to do really 2 things. One is absorb the liability adjustment we made to the deferred comp plan. That $15 million GAAP charge that I mentioned in terms of adopting the new Society of Actuaries table, that is both a GAAP and statutory impact, and that is an agent deferred comps program, i.e. Bankers' agent deferred comp program. It actually hit the Bankers legal entity. We wanted to absorb that by leaving a commensurate amount of capital down in there.
More importantly than that is we drove the RBC in Bankers from 393 up to 411. That is arguably higher than it needs to be. I would tell you that our long-term target for Bankers is really more around 400 flat. Part of the reason we're doing that is what I said on my prepared remarks, which is one, it is in fact just good risk management. That is now where we have the concentrated interest rate risk as we look forward. It's also where, as I mentioned, we capture all of our long-term care liabilities. If you're ever going to have a robust capital structure down in a subsidiary, it's going to be in Bankers. It's just good risk management. The other dynamic is it's also a flagship legal entity for the purposes of driving our insurance ratings as a company.
If you were to talk to particularly AM Best, where we are heavily focused because we are very close to moving into the A category, if we can continue to operate and be diligent in our capital management. That is really important to drive a good RBC in that entity. Frankly, if you talk to all four rating agencies, they will tell you that their ratings basis and basis for positive outlook and upgrade starts with the RBC formula. For CNO, it starts with what's going on in Bankers and then travels from there. It will moderate over time. You should not view any more than a tactical move in the fourth quarter. No messaging content as to the quality of our free cash flow.
All right. So that's helpful. I guess if your buyback guidance is approximating the capital generation for what you talked about with Erik Bass there, then in Bankers is, I guess, I'll call it stabilized with all the comments you made about reserve testing being benign, then it would seem like that's a lot of cash to keep at the holding company. That's just in reserve for whatever scenario you see as most advantageous. I guess, how would that not be buyback at the current stock price?
Really, it's a matter of keeping our options open, if you will, relative to the highest and best use for that money. If the marketplace hands us a buying opportunity, we might take advantage of that. If we have other opportunities that come around, then that's a good use of that money. We're trying to be balanced in it, balanced with our dividend trajectory, common stock dividend trajectory, balanced in buying back our stock, which we believe to be good value over the long run. Some risk management, yes, also making sure we're open for non-organic opportunities or more strategic investments in our platform. Honestly, it's really just balancing, and I wouldn't overread it. Again, in 2015, I expect relatively stable capital generation. Obviously, no change in the roughly $130 million we send up to the holding company through surplus note and management.
As I had mentioned earlier, you could expect something in the neighborhood of $250 million plus or minus of dividends up to the holding company. A little bit of spend down in liquidity, our share repurchase guidance range is out there. Recognizing we're early in the year, it's not uncommon for us to have a wider repurchase range, we start to refine it as we learn more throughout the year and guide a little more specifically.
All right. That's super. Hey, since I got in so fast, I'll ask one more, and this goes over to sales and to Scott Perry. I guess the question is, this is kind of a theme that we've been following with a bunch of companies, is the thing that is changing in the U.S. economy, I guess, is there's lower unemployment, there's lower gas prices. I think that if I could describe the kind of the sales setbacks that CNO's had over the last years, particularly in Bankers, is it was maybe some of the hiring and retention processes weren't as robust as they could be, and it sounds like you're making progress there.
Just on a basic level, it seems like the folks you're selling to should have more money in their pocket, and the folks who are driving around trying to sell these products should be able to have a lower gas price to support that activity. The bottom line is it ready to think that intuitive conclusion is right, that those are good things, lower unemployment, lower gas prices will help kind of drive this better sales guide we have for Bankers? I guess it's Washington National Bankers in particular.
Yeah. Sure, Randy. I think certainly an improving economy helps the consumer, the middle-market consumer benefits from some of the things that you were saying, and that can benefit our opportunities to sell them products. I think I've talked about this in the past. The improving unemployment picture doesn't necessarily help us from a recruiting perspective. It means there's more salaried or hourly opportunities out there than straight commission opportunities, and that can work against us. I would say, generally, sure, the consumer benefits and to the degree that our agents can get in front of them, it may make for an easier time making a sale than in a tougher economy. The recruiting kind of works against us, given the employment market picking up.
The last thing I'd say, it's also kind of an environmental issue that in particular is going to hit Bankers, and I mentioned in my prepared notes, the annuity interest rate environment. Crediting rates being held at these historically low levels, it looks like for another year, certainly are providing a headwind. Now, the agency force will shift to other products, but that's going to be a headwind that we'll face, we're projecting, throughout 2015.
All right. That's helpful. Thanks for the color.
Yep.
Your next question comes from the line of Colin Devine with Jefferies.
Good morning, gentlemen.
Good morning.
First of all, thanks for the increased disclosure on the agents and the roll forwards. Also I'd appreciate your color on how you're setting reserves for long-term care and not assuming rate hikes for the next 15 years in a different investment strategy. We certainly appreciate that. In looking at this though, Fred, I want to follow up on a couple things. All right. First off, on long-term care, where do I find the testing that was done on the block in Washington National? Obviously, page 17 discloses it for Bankers. What happened to the Washington National block? Then also, I'm not sure you directly answered Erik's question. Did you aggregate supplemental health and long-term care together for your cash flow testing, or did you not?
First question. Washington National, the legal entity and the reporting segment, doesn't have long-term care. Once upon a time, the legal entity itself had a closed block of long-term care business, but that was part of what we reinsured away last year this time under that transaction.
Okay.
We don't have that in that segment. It's really all in Bankers. Then in terms of the answer to the question from a cash flow testing perspective, okay, realize that work is still being finalized because it's part and parcel to filing your final statements. As we sit here today, there would be a need for the long-term care business in Bankers to borrow, if you will, somewhat of the excess cash flow testing reserves in Med Supp. They're able to do that.
Realize though, that's somewhat mitigated by what I said earlier, in that we've been building to the tune of about $9 million a quarter for the better part of a year and a half now. This continues, about a $9 million asset adequacy reserve, which again, is not required, but it's really been helpful in mitigating that need to borrow from an active life reserve perspective, if you will, from cash flow from Med Supp. There is a level of that that's happened in the past. Last year, it was relatively neutral. We didn't need to do that. This year, I think we would be a bit negative on a standalone basis and require some of the Med Supp excess margin, if you will, from a cash flow testing. Again, mitigated somewhat by our steady build of this asset adequacy reserve.
Okay. Fred, let's go a little bit further with this. Given how thin the margin is, I guess the two questions, one, why not a closed block on the older piece? Also, tell me if this is incorrect. Really, even with this narrow margin you've got now, that's reflecting the benefit of the most recently sold policies that you've priced with hopefully much higher margins. If we backed out the benefit for, let's say, the 2014 premiums or the 2013, does that block go negative? Just how dependent is it on the assumptions of the business that you sold the most recently?
Yeah. It's a good question. Let me kind of answer it in a couple different ways and may invite other commentary on it. First of all, what have we been selling in recent years? Be mindful that probably for the better part of 10 years now, the majority of what we've been selling has been very short duration, short benefit product, which actually doesn't do too much to contribute to your margin. Why? Because it's a more narrow tail, less risky, shorter duration. It's got all the great risk profile, but as a result, doesn't really build much in the way of reserves and doesn't really build much in the way of replenishing your margins. Said differently, Colin, we haven't been attempting to sort of sell our way out of a problem, if you will.
We just sell what we sell. The shorter benefits is really what the middle market needs. Having said that, it doesn't sort of add layers of enhanced margin over the years. You are right. The older, more legacy business, which is where we are really stressing our analysis and where the pricing increases, the rate increase action has been taking place. That is in fact the blocks of business that weigh more on our margin. It's also the more volatile blocks of business that tends to be more sensitive to these assumptions. The issue of somehow carving it out as some kind of different sort of a block doesn't really fit with the way in which we are managing the business. That's really where you have to start when discussing the idea of sort of isolating a piece of your block.
Right now, you have to sort of remember, and I know you do, but for everybody on the phone, you have to remember that once upon a time, we had $3 billion of reserves that were in fact carved off, did have different characteristics, were sold differently, were not open, and we took the hits and carved it off. It was $3 billion in reserves, and it's gone. More recently, we moved $600 million of reserves off our balance sheet, which was actually a closed block, similar characteristics, reinsured under the Beechwood Re transaction. What we are now left with is what we would call an active and open block. Every single day, we have a long-term care policy with a client out there where potentially a Bankers field agent is still working with that client and that client's family actively cross-selling and working with them.
In other words, we're not managing it like a closed block, so we should be having our financial reporting and our analysis consistent with how we're managing the block. It's one block. As you know, and as everybody knows, there isn't a block in the insurance industry of any kind of business where I couldn't cohort it in a way to where there's negatives somewhere offset by positives. That's how it works. It's a good question, and it's a fair observation, particularly because so many people in our industry have gone the route of closed blocks. This happens to be an open block managed that way, and so we collect it together and test it that way.
Okay, Fred, perhaps for the next quarter, you can look into how many new policies you're actually selling to these old existing policyholders to substantiate that case as to these are still active clients. If I think about it, they're probably much older clients. Really how much new business are you selling them? Maybe that's something we can go into next quarter.
Colin, this is Ed. We may or may not provide that kind of detail, but also our view of the customer isn't just the policyholder, it's their spouse, their household. We don't look at it so myopically as simply the policyholder when we're serving our customer base.
Okay. Fair enough. Thank you.
Yeah, this is Chris Nickele. Let me just add a little bit and answer one of your questions, Colin. With regards to what does the new business add to the margin, our 2014 new business in long-term care added $36 million to margin. It's not like a substantial contributor margin, as Fred said. The other thing, when it comes to our stat margins versus our GAAP margins, as Fred said, we're adding to our asset adequacy reserves electively. To the extent that those asset adequacy reserves build faster than we're building our future loss reserves, that adds to the margin on the stat side, and we'll begin to have our stat margin pull away, if you will, from the GAAP side.
Further, with regards to loss recognition testing and our current margin of $100 million, I'll just point out that we don't have any morbidity improvement in that analysis. We don't take any credit for shock lapses that might occur as rate increases are put in place. As Fred mentioned, we have a number of claims initiatives, claims management initiatives, which we have been testing. On the basis of those tests are actually rolling them out broadly in 2015. Based on the preliminary testing that we've done, we believe these initiatives will add north of $100 million of margin. That's something that will show up as we implement them and reflect them in later loss recognition testing work.
Okay. If we use that figure you just gave us of the $36 million, is it then fair to conclude that really the $100 million has come from what's been sold the last three years?
No.
Roughly.
No.
Okay.
Your next question comes to the line of Daniel Bergman with UBS.
Hi, good morning. I guess starting with buybacks, when we think about your guidance for 2015 share purchases, is there any assumed benefit from a potential recapitalization factored into this guidance? Or should we just think about any such benefit if a recap is done this year as kind of being incremental upside to the $250-$325 range you gave?
That's correct. There is no recapitalization assumed in the buyback guidance. If we were to recap, that's a decision that we would have to make, including working with our board on the use of proceeds. What is implied in the ROE pickup, if you look at the ROE slide and you see a little margin in there for pickup in ROE related to recap, is basically the mechanical exercise of increasing the leverage, and with the net proceeds, doing a buyback to jump the ROE. In our guidance is no assumed recap in terms of repurchase.
Great, thanks. Maybe shifting gears to sales. Given that the year-over-year kind of consolidated sales growth has slowed down kind of steadily during the course of 2014, I think it was up 4% in the first quarter and came down to 1% growth last quarter. I just wanted to see if you could provide some incremental color on the factors you're seeing to give you confidence that sales growth can re-accelerate from current quarter levels up to that 3%-6% range you're talking about this year.
Sure. This is Scott. I think it's as Ed mentioned in his comments, we experienced some acute setbacks, I guess I'd refer to them, in 2014. At Bankers Life, it was very specifically around recruiting. What we'd experienced is a slowdown and a sluggishness in recruiting that resulted in an average agency force that was smaller than the previous year, and therefore, even though we had growth in agent productivity, fewer total average agents, it resulted in the flat and sluggish sales. We've seen in the fourth quarter, with some targeted efforts, improvements, and we expect those improvements to continue in 2015. Those improvements are coming from a number of tactical moves that were made that we believe are sustainable to get us back to historical levels.
Again, we don't have to drive significant growth because the productivity and the retention improvements in the developing and veteran agency force are occurring. We do need to get back to historical levels at Bankers. Those two things will get us to that 3%-5% range for 2015. At Washington National, strong three quarters. The fourth quarter was really negatively impacted by the one instance that I mentioned, the partner that went through some reorganization restructuring. That will be a bit of a drag in the first half of this year. That drag is assumed in our forecast. We expect the second half of that year will be kind of out of that. The continued strength that we've seen at PMA, both in the individual market and the worksite market will continue throughout the year.
I will, even though it seems like a long time ago, if you recall, in 2014, we did experience a real tough start to the year at Colonial Penn. The rest of the year was strong, and we finished at 4%. If you back out to January, I think our total year results are closer to the 6% that we saw in the fourth quarter. That was kind of an acute situation that we recovered from. That's why we're comfortable with expecting sales ranges closer to the 6% range that we're forecasting.
Great. Thanks. I guess, just finally, I wanted to see if you had any updated thoughts around more your medium and long-term sales growth goals post-2014. Is that still kind of a mid to high single digit type of level that you're looking for?
I think it's mid to high single digit. At this point, a lot of it will hinge at Bankers on the interest rate environment and our ability in the annuity market. We're confident that all three of our segments are targeting a growing market, and there's growth opportunities that should get us into the mid to higher single digit rate.
Great. Thanks so much.
Sure.
Your next question comes from the line of Erik Bass with Citi.
Hi. Thank you for taking the follow-up. I guess one thing just to clarify first, I think at Investor Day, you had showed about 100 basis point lift from a recap on the ROE versus 50 basis points now. Just was curious as to what's changing that.
Yeah. Essentially, one, it's sort of redialing in kind of the borrowing cost estimates that we would have in today's market and spread environment and trying to do our best to also be a little bit conservative in what we could actually get in the way of yield. A little bit of redialing also of what we would expect to issue. I'll give you an example, and that is, I think it would be to our benefit if we do go to market to think in terms of bonds and longer duration and non-callable in nature, which is a bit more investment grade in its profile. It's a little bit to do with what we would issue and the cost of that. Also, when we did do our test this last time, we had a range of 75 basis points to 100 basis points.
Quite honestly, that range of benefit for recap had everything to do with exactly what leverage we would dial in and for how long. For example, last time we recapped, we levered up to 22.5% and then quickly brought it down through amortization to 20%. This time around, we could do something like that as well, which would help boost the range of the ROE over time. We're just kind of dialing in a more conservative approach for upside 20% leverage, assuming sort of market rates, longer duration, which is going to have more cost or weigh down more on interest expense, and just being more tactical in that way.
Got it. That's helpful. Thanks. Then maybe if I could just ask one bigger picture question on long-term care. I guess, is there a framework that you would think about for calculating the intrinsic value of a long-term care block? I guess I'm wondering if there's an approach similar to what companies did with variable annuities a few years ago with things like the MCV analysis that could shed more light on the cash flows and the value of a long-term care block under different scenarios.
Yeah.
It's interesting. It's sort of along the lines of an embedded value.
Some companies would characterize it as kind of an economic capital approach. Most companies do have a dynamic ability to do that, not so much that they want to walk around with those values necessarily as meaning anything, but rather, it's really the stressing of those values up and down for a given variable, and that can lead to you hedging away some of the risk or what have you. One of the things that I think is a good fact pattern for this company is that there's a reason why we're one of the few, if not maybe even still the only company to do a substantial reinsurance deal on long-term care, is because part of doing a reinsurance deal requires precisely what you're saying, which is essentially calculating an embedded value or an appraised value on the block of business and all the cash flows.
More importantly, having a buyer and seller be close enough on those estimates to where a deal can get done. I think I've said this before to people, but we take the same sorts of approaches to our reserving practices and assumptions on our Bankers Life block as we did on those closed blocks of business, and we think that lends some credibility, if you will, to our approach to the reserving and the value being real in how we think about it. We don't have a published embedded value calculation on our long-term care business only. Something I would relate to that Ed mentioned, which is kind of important about us, and that is we're not a product-driven company.
It's not as if we have a long-term care division that sells through long-term care independent distribution, and we monitor the economics and profitability on a standalone basis because that's how we sort of incent our managers and talk to the value creation. This is one of a number of products that is either going to be in favor, out of favor, or satisfy a solution on behalf of our households or clients, and that's how we look at it. We have much more information around Bankers and Bankers' legal entity valuation than we do the carve-out of long-term care.
Got it. No, that's helpful, and appreciate the thoughts. I just think given some of the market concerns about the product, I think an embedded value type analysis, particularly with your block, where it is more, as you said, you have more history and would have more kind of credibility in the cash flow outlooks under different scenarios, would certainly be something I think that would be helpful or be interesting to see to the extent you could share more.
I think what is safe to say from a valuation perspective is there's no question that our long-term care business obviously weighs down on our ROE, and considerably. I would say, in general, something to the tune of 200 basis points of weight placed on our ROE relative to what it would be without the business, and that's for the simple fact of carrying a fairly good amount of capital to support that business with very little in the way of GAAP earnings once you fully load expenses and everything else. I would say our basic message is we're obviously trying to, over time, change the profit profile of that business through what we're selling, through what's running off, and aggressive in-force management where we have the ability.
We're doing everything within our management power to turn that tide and create more of a contribution. Look, there's no question that it's weighing down. What we are focused on, though, is having it not hurt the balance sheet capital quality, and effectively lowering the beta of our long-term care business means we lower the beta of CNO, and that should create value.
Got it. Appreciate the comments. Thank you.
We have no further questions. Thank you at this time, and I would like to turn the conference back over to our presenters.
Thank you, operator, and thanks to everyone on the call for your interest in CNO Financial Group.