Afternoon. My name is Kim. I will be your conference operator today. At this time, I would like to welcome everyone to the CNO Financial Group second quarter 2018 earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Adam Auvil, you may begin your conference.
Good afternoon. Thank you for joining us on CNO Financial Group's second 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 releases. You can obtain the releases by visiting the media section of our website at 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 August 6th.
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 the presentations, we'll be making performance comparisons. Unless otherwise specified, any comparisons made will be referring to changes between second quarter 2017 and second quarter 2018. With that, I'll turn the call over to Gary.
Thanks, Adam. Good afternoon. Beginning on slide six, I am pleased to announce that CNO has entered into an agreement with Wilton Reassurance Company to cede approximately $2.7 billion of long-term care reserves through 100% indemnity coinsurance. The ceded blocks include 100% of Bankers Life legacy comprehensive and nursing home policies and represent 51% of CNO's statutory long-term care reserves. Bankers Life will pay an $825 million ceding commission as part of the agreement, which will be funded through existing capital resources. Erik will go into greater detail on the specifics of the transaction during his comments. This transaction represents a material risk reduction to CNO's balance sheet in stress scenarios. It also considerably reduces the possibility of a future reserve strengthening charge.
The execution of this agreement is the culmination of a multi-year process to identify a solution that is both fairly priced and enables CNO to realize material risk reduction. We are confident both objectives were achieved with this transaction. Additionally, we accomplished our goal to transact with a credible onshore counterparty. A subsidiary of Canada Pension Plan Investment Board, Wilton Re is an established, highly rated, and well-capitalized partner with whom we have a strong relationship, having previously executed three transactions together. The trust built through these mutually beneficial transactions contributed to the ability to execute on this agreement. We expect the transaction to close in 2018, subject to regulatory approval. Finally, de-risking marks a step forward in achieving investment-grade ratings by satisfying a consistently referenced catalyst that would lead to an upgrade.
On that point, we were very pleased to see the positive actions already taken by Moody's and Fitch in response to the announced transaction. I'll now turn the call over to Erik to discuss specifics of the transaction. Erik?
Thanks, Gary. The transaction announced yesterday encompasses $2.7 billion of legacy nursing home and comprehensive long-term care business in the Bankers Life and Casualty legal entity. You may recall that in our 2017 Investor Day event, we noted that it was these blocks of business that were potentially the most volatile from an earnings and capital perspective. More to come on this in a moment. The $825 million ceding commission will be funded by approximately $260 million of asset adequacy reserve releases that are no longer required, and approximately $150 million of tax benefits as a result of a loss generated by the transaction.
$175 million of capital is released as a result of no longer holding the assets and liabilities associated with the blocks, and the remainder will be funded by a $275 million capital contribution from the holding company in order to maintain a 400% RBC ratio at Bankers Life. It is important to note that the $275 million contribution represents less than one year of free cash flow generation for CNO. In conjunction with this announcement, we will move the ceded blocks of business to the LTC and runoff segment starting in the third quarter of 2018. We expect to record an after-tax GAAP loss of approximately $650 million before year-end. Slide eight details some of the key terms and conditions of the transaction. Upon closing, Bankers Life will transfer assets backing the statutory liabilities of the ceded blocks, plus the ceding commission to Wilton Re.
A domestic comfort trust will be established to hold the assets backing the statutory liabilities, as well as an additional $500 million of overcollateralization. The overcollateralization amount is subject to step downs of $62.5 million every five years. As the ceded block is in runoff, it is our expectation that the overcollateralization as a percentage of the reserves will increase over time. The comfort trust will be subject to strict investment guidelines as well as oversight and reporting requirements.
CNO will continue to administer the business for the next 36 months before transitioning over to a third party to be designated by Wilton Re. Slide nine is a graphical depiction of the risk reduction that is achieved with this transaction. The graphs depict projected future cash flows of the in-force block on a pre- and post-transaction basis under the following scenarios. Best estimate, which reflects CNO's current assumptions. Current assumptions adjusted to reflect an immediate and permanent 15% increase in lifetime morbidity. Current assumptions adjusted to reflect an immediate and permanent decrease in the investment portfolio rate from 5.8% to 5.25%. A compound scenario, which reflects current assumptions adjusted for both the impact of increased morbidity and decreased investment returns. Some key observations. First, recognize that CNO's historical reserve performance has been solid, having not ever taken a charge in this block.
That, coupled with no assumption for future rounds of premium rate increases, no assumed morbidity improvement, adds significant credibility to our best estimate assumption. Next, volatility or the spread of potential outcomes as a result of adverse deviations and assumptions is materially reduced in all scenarios on a post-transaction basis. Lastly, post-transaction, in the compound scenario, the model decline in cash flows relative to best estimate can be absorbed without materially impacting free cash flow generation. Slide 10 highlights the risk reduction achieved with respect to potential loss recognition charges under the stress test scenarios. Focusing on the compound scenario, on a pre-transaction basis, CNO would recognize a $1.4 billion reduction in margin, which would result in an $850 million GAAP charge.
On a post-transaction basis, the margin impact, while still material, decreases by more than 50% to $640 million and results in a $325 million charge, which approximates one year of free cash flow. We view the reduced range of potential impacts as manageable. Important to note that as a result of the transaction, our Bankers Life loss recognition testing margin as a percentage of net GAAP liabilities doubles from 7%-14%, and that future sales will continue to add positive margin to the retained block. These factors decrease both the probability and the impact of any potential future charges. Slide 11 details how we expect the transaction to impact our key capital measures, assuming a third quarter 2018 closing. We expect the Bankers Life legal entity to have standalone RBC of approximately 400% after giving effect for the capital contribution from the holding company.
Consolidated RBC is expected to be approximately 435%. Holding company cash and investments are expected to decrease to $150 million as a result of the contribution to Bankers Life. As a result of the GAAP loss, operating return on equity will improve on an annualized basis by 150 basis points, debt to total capital will increase to approximately 23%, and book value per diluted share will decrease to $19. We expect minimal impact to GAAP earnings in the near term, as ceded profits are not significant and will be partially offset by fees paid by Wilton Re to CNO for transition services and administration. Over the longer term, we expect GAAP income to improve as a result of ceding blocks of business that had declining future earnings.
As a result of no longer needing to accrue asset adequacy reserves for the ceded blocks, we expect annual free cash flow generation to increase from $300 million to $350 million. We expect to manage consolidated RBC in the 425%-450% range, maintain minimum holding company liquidity of $150 million at all times, and manage leverage in the 22.5%-25% range. We are committed to maintaining a strong balance sheet, and we feel that our capital ratios are dialed in appropriately and are reflective of the reduced risk profile of the current business. With that, I'll turn the call back over to Gary.
Thanks, Erik. Long-term care continues to be a significant healthcare and retirement challenge for middle-income Americans. Regulators and government officials continue to wrestle with an appropriate public solution. In the private sector, options are contracting and forcing those in need to turn to an already strained public system. CNO remains committed to offering long-term care insurance, and we will continue to focus on providing affordable, high-quality insurance designed with the needs of our middle-income consumers in mind. Looking at long-term care at CNO moving forward, let me start with our in-force business. The retained business represents a materially reduced risk to the balance sheet. Post-transaction, policies with benefit periods of less than one year will represent over 50% of the in-force. Policies with lifetime benefits will fall to under 3%, approximately 5,000 policies down from 11,000 policies.
Additionally, long-term care reserves will comprise only 13% of our reserves post-transaction, down from 25%. Turning to new business, CNO will focus on products offering shorter benefit periods. It is clear these are the products that resonate most with our customers, as the average benefit period across new sales is currently 10 months. Given current customer preference and our desire for products offering shorter benefit periods, we will discontinue sales of long-term care products with benefit periods longer than three years. It is important to note that we expect future sales to contribute to earnings and reserve margins. Additionally, we continue to reinsure 25% of new LTC business, which provides a valuable outside perspective on product design and pricing.
Finally, the transition of the administration of this business allowed CNO to undertake a more comprehensive review of our middle and back-office infrastructure to identify potential ways to increase operating efficiencies and better serve our customers. Moving to slide 13. I'll close this section of our call by highlighting the key benefits and takeaways for this transformative risk reduction transaction. This transaction successfully reduces CNO's long-term care exposure by ceding the older and more comprehensive business. The retained business has a much better risk profile, which reduces potential future volatility in earnings and reserves. CNO's differentiated long-term care business enabled us to execute a transaction at reasonable economic terms while attaining the necessary risk reduction. We were able to transact with a highly rated and well-capitalized counterparty in Wilton Re. The reduction of tail risk significantly enhances the go-forward balance sheet strength of CNO.
De-risking marks a step forward in achieving investment-grade ratings by addressing a key rating agency concern. Again, we are pleased to see the positive actions already taken by Moody's and Fitch. Lastly, removing this overhang will allow management to focus its time on accelerating profitable growth and serving the needs of the fast-growing and underserved middle-income market. I'd now like to move on to our second quarter earnings results. Beginning with slide 15, second quarter 2018 was another strong quarter for CNO. We posted solid earnings and capital results that again demonstrated the strength of our franchise. Operating earnings per share were $0.49, up 9%, reflecting benefits from tax reform. Book value per diluted share was $22.62, up 3% sequentially. Five of the seven metrics on the CNO growth scorecard are up this quarter.
Although we are pleased with the result, our goal remains to have all seven metrics grow in a consistent and sustainable way. I'll go into more details on the drivers of this quarter's strong growth later in the presentation. The expansion of several strategic initiatives from the pilot phase to deployment at scale has yielded encouraging early results. We are confident that we are on the right path to achieve steady and sustained growth across the enterprise. As exciting as these results are, it will take several more quarters of positive results until we will comfortably call it a trend. Our commitment to deploying capital into its highest and best use over time remains unchanged. We returned $77 million in capital to shareholders in the quarter, including $60 million in common stock repurchases. Moving to slide 16 and our segment production results.
Bankers Life total collected premiums were up 2%, primarily driven by a 9% increase in annuity collected premiums. Annuity account values on which spread income is earned increased 5%. This is due to both higher new sales and strong persistency of the in-force. Life and health NAP were down 2% and 5%, respectively. The life sales decline was primarily driven by higher declination rates on simplified issue business as a result of the new underwriting requirements implemented late last year. Ultimately, this change should improve our future underwriting margins. Offsetting this decline, fully underwritten universal life sales are up 21% year to date. Health sales were partially impacted by higher sales of third-party Medicare Advantage plans, which we do not report as NAP.
Growth in our broker-dealer and registered investment advisor businesses, combined with the previously mentioned increase in Medicare Advantage sales, drove our fee revenue up 15% over the comparable quarter. Total producing agent count decreased 6% on an average trailing 12-month basis. On a sequential basis, we materially increased the number of first-year producing agents. This is the result of our recent national rollout of recruiting pilots that led to a higher yield of successful new agents and higher first-year agent retention. While it will take time for these improvements to impact the size of the total agent force, we are encouraged by the progress as it validates that our recruiting and retention initiatives are beginning to take hold. We will continue to emphasize agent retention and productivity. Moving to Washington National. Total collected premiums were up 3%.
This includes a 3% increase in supplemental health, partially offset by the continued runoff of the closed Medicare Supplement block. Total NAP was up 2% from the year ago quarter, driven by a 31% increase in worksite life sales. These results stem from continued momentum in initiatives to diversify product offerings and build upon 2017 growth of 15%. Second quarter 2018 PMA worksite sales were up 20% versus the prior year, marking the fifth consecutive quarter of double-digit growth for this channel. The PMA average producing agent count is flat to prior year. However, it was partially offset by recruiting initiatives in the worksite channel and strong veteran agent retention in both channels. Washington National's growth initiatives continue to advance with positive results.
We are seeing early success in our efforts to expand the Washington National geographic footprint with a 14-state expansion program that has generated nearly $2 million of incremental NAP year to date. Our pilot to sell short-term care in the PMA individual channel is gaining traction. We expanded the distribution across additional territories based on its early success. This pilot is particularly encouraging in that it leverages the breadth of the diverse CNO product portfolio and distribution capabilities. For Colonial Penn, total collected premiums were up 2% in the quarter, driven by growth in the block and stable persistency. NAP was up 5% due to higher cost-effective advertising spend and strong sales efficiency. We also continue to see success with our marketing diversification efforts. A 25% increase in web and digital sales this quarter was driven by investments in the platform and in customer experience enhancements.
I'll 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 $0.61, up 27% from the prior year. Operating earnings per share were $0.49, up 9%. Excluding the significant items recorded in the second quarter of 2017, operating earnings per share were up 17%. Operating return on equity was 9.6%, increased from 2017 levels as we are benefiting from lower corporate tax rates. Holding company cash and investments were $376 million, relatively unchanged from the first quarter of 2018. Estimated consolidated risk-based capital was 444%, up from the first quarter of 2018, reflecting higher statutory net income and benefits from some asset reallocation that occurred in the quarter.
Turning to slide 18 in segment earnings, Bankers Life earnings reflect lower Medicare Supplement margins, primarily as a result of the implementation of crossover processing that occurred in the first quarter, and lower LTC margins reflecting outperformance versus expectations in the second quarter of 2017. Washington National's earnings in the period reflect higher supplemental health margins as we continue to experience lower levels of incurred claims. Colonial Penn's EBIT was slightly below the prior year due to some opportunistic investment in direct response television advertising. We continue to expect Colonial Penn's EBIT to be in the $10 million-$20 million range for 2018. Earnings for the LTC and runoff segment were higher, reflecting lower incurred claims. Lastly, corporate segment results were largely flat versus the prior year.
Turning to slide 19 and our key health benefit ratios, Bankers Life Medicare Supplement benefit ratio was 73.1%, in line with expectations in the first quarter of 2018, but higher than prior years as a result of the previously mentioned implementation of crossover processing. We continue to expect the Medicare Supplement benefit ratio will be in the 71%-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 76.5%. This is in line with expectations but slightly higher than the past several quarters due to slightly higher incurred claims. We are temporarily suspending guidance on the LTC interest-adjusted benefit ratio until the recently announced reinsurance transaction closes later this year. Washington National supplemental health interest-adjusted benefit ratio was 56.6%, significantly better than expectations due to continued favorable incurred claims.
As this is the third quarter of favorable experience, we now expect the interest-adjusted benefit ratio to be in the 56%-59% range for the remainder of 2018. I'll now turn it back over to Gary.
Thanks, Erik. CNO's objective to significantly reduce our long-term care exposure is nearly complete and continues our strong track record of execution. Our sights shift squarely to accelerating long-term profitable growth. As we have consistently communicated, the diversity of the franchise and the depth and breadth of our product offerings are central to our strategy. It is the people behind the execution who ensure our success. To that point, during the second quarter, CNO introduced investments in our workforce through an enhanced compensation program that leverages the benefits of tax reform. Like many companies, we have the opportunity to offer a one-time bonus payout to employees. At CNO, we opted instead to invest in a broader enhanced compensation program that includes an annual cash bonus program, an employee stock purchase plan, and a one-time stock option grant.
These compensation enhancements will provide continued incentive over time and therefore drive the top-to-bottom associate alignment necessary to achieve sustained success. It is important to note that there is no change to our stated position to deploy 100% of free cash flow to its highest and best use over time. The timing and amount of future deployment will depend on options for deployment and excess capital levels at that time. The announcement of the transaction to reduce our long-term care risk completes the fix and focus chapter at CNO. It positions us on a path to continue delivering long-term shareholder return. The post-closing company profile presents a unique investment opportunity in the insurance sector as a well-capitalized company with a path to higher ratings and ROE.
We expect additional value to be realized through multiple expansion to a level that is more in line with sector peers as LTC contagion and tail risk fears are materially reduced for CNO. Thank you for your continued interest in CNO Financial Group. We will now open it up for questions. Operator?
At this time, I would like to remind everyone, in order to ask a question, please press star then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Randy Binner from B. Riley FBR. Your line is open.
Good afternoon. Thank you. I'm going to try and ask a few high-level questions about what the business might look like after the deal closes in the third quarter. I guess the first is, just to understand this, the business, the long-term care block with Wilton, is going to be reinsured out of Bankers, but that reinsured block is going to be reported not in Bankers but in the runoff segment. Just clarifying that and just trying to understand why it would be moved there instead of just stay resident in Bankers.
Yeah, Randy, this is Erik. Thanks for the question. The reinsured block is going to move out of the Bankers Life segment and into the LTC and Runoff segment because it is just that. It is an LTC block that is in runoff. That would be consistent with how we expect to manage it, recognizing that we are moving from managing that business ourselves to managing a counterparty that's going to be managing that business. That's how we view it, and that's a rationale for moving it to runoff. Now, from an income statement and balance sheet perspective, the changes are going to be fairly transparent since the income statement is, in essence, going to be ceded to Wilton. You won't see much by way of financial impact on a quarterly basis running through the income statement.
On a balance sheet basis, you will see some numbers that look a little bit different, basically moving the assets and liabilities from the Bankers Life segment and into the Closed Block segment.
Right. You mentioned in your prepared remarks that this business had moderate or very modest GAAP earnings. I guess to the extent that's the case, we shouldn't be missing a lot of bottom line at Bankers. From a premium and kind of investment income perspective pretax, is there any way you could size what that might look like for the Bankers segment going forward?
Yeah, I think it's roughly about $180 million of premiums that will leave the system for Bankers. Offhand, I don't know the amount of net investment income. I think the main point is what you hit on, that the impact to the Bankers Life segment EBIT numbers that we have been reporting is going to be pretty minimal.
I guess for net investment income, we would just presume that the assets backing that business no longer are productive. Is that the right way to think of it?
Yeah, that's right.
Okay. Then in the runoff segment, your current runoff produces some policy in net investment income. Because this is 100% quota share on marginally profitable business, you're going to manage this piece of the runoff effectively to a break-even. Is that fair?
That's right, yeah. What you'll see in the LTC and Runoff Segment, from an income statement perspective, is not going to look much different or won't actually look any different than it does today.
I'll do one more, and then I'll drop in the queue. The benefit ratio in Bankers Life. If I took the premiums that are leaving and assumed that they were perfectly unprofitable, is that a decent way to kind of approximate what the benefit ratio would do? And maybe directionally, could you say, is the benefit ratio for Bankers Life overall going to be better after this business leaves?
Yeah. We're working on, really what we're doing is bifurcating the blocks right now in preparation for actually moving it into the LTC and Runoff Segment. When we do that, we have to sort of recalculate everything that is retained and in the Bankers Life Segment. We haven't gone all the way through that. But our estimate right now is that, yes, the interest-adjusted benefit ratio would decline by a couple of points on a retained basis in the future.
For just for the LTC?
Yeah, the LTC retained business. Yeah, that's right.
Yeah. Of course. Understood. Okay, let me drop back in the queue. Thank you.
Your next question comes from Erik Bass from Autonomous Research. Your line is open.
Hi. Thank you. Just had a couple of questions about sort of your capital structure post the transaction. You talk about maintaining holding company liquidity of at least $150 million. I guess, would you be comfortable running close to this level, or would you expect to rebuild a bit of a buffer to provide flexibility for other actions? Should we think of that sort of being a use of free cash flow for the next quarter or two?
Hi, Erik. Yeah, this is Erik Helding. Thanks for the question. $150 million is our stated objective as a minimum. I think practically speaking, I think we've said this in the past, we likely would run at something higher than this just to have some dry powder on hand. I will tell you, the way I'm thinking about kind of the LTC risk reduction transaction is that when we talked about ranges of RBC being 425 to 450, minimum holding company of $150 million, but wanting to hold more. Because we've reduced risk significantly, I have much more confidence in running at the lower end of those ranges than I did previously.
Thanks. That's helpful. That actually was my next question just on the RBC and why you think that 425 to 450 is still the right RBC ratio target given the amount of risk reduction that you've done. Also just wanted to clarify whether that contemplates any impact from tax reform, or is that sort of what your target is pre any impact?
Yeah. Maintaining kind of the stated guidance on RBC of 425%-450%. How we're thinking about running RBC at the Bankers Life legal entity is something closer to 400%, again, which is down from, it's been about 420%, 425%. Again, that reflects sort of the reduced risk profile and being comfortable running Bankers Life at a slightly lower level. Mechanically what happens is when you run your consolidated calculation as a result of running Bankers at 400%, consolidated's going to be probably about 430%, 435%. Much more towards the lower end of that range. That's how we're thinking about kind of RBC going forward. Now to your second question, no, that does not contemplate any impacts from tax reform nor does it contemplate the impacts related to the changes in the C1 charges, which the NAIC is currently debating.
It's really those two reasons why I'm kind of hesitant to reduce the RBC ratio guidance range at this particular point in time. I want to see those things get flushed through the system and then kind of see how our balance sheet looks, and then see what the reactions are sort of externally.
Thanks. That's helpful. Just finally, last balance sheet question. Just the investment portfolio, should we expect any change there as a result of the transaction? Assuming you probably are holding some of higher yielding assets and potentially lower rated assets to back the portfolio. Should we expect any reduction there?
I don't think so. I think the pre- and post-transaction portfolios are going to materially look the same. There's going to be some differences. I think the overall asset duration's going to be slightly lower. I think in terms of quality, I think it's going to be largely the same.
Great. Thanks.
Your next question comes from Ryan Krueger from KBW. Your line is open.
Hi, thanks and congrats on the transaction. I was trying to calculate it, but I'm not sure if I'm doing it right. Could you just give us the dollar amount of the reserve margin post-transaction on Bankers LTC, and then what the reserve margin was on the block that you are reinsuring?
Yeah, Ryan, this is Erik. As of 12/31/2017 on a post-transaction basis, the reserve margin's about $215 million. On a pre-transaction basis, it was about $100 million higher than that, about $315 million. We've given up $100 million of margin, but there's a lot of moving pieces behind that. If you think about the blocks of business that were ceded, the ALR on those blocks of businesses had several hundred million dollars of negative ALR. As part of the $2.7 billion, we also ceded the claim reserves that were part of that legacy block, and that had a slight positive margin. That netted down to roughly $100 million in negative margin. We should have otherwise seen an increase in the dollars of margin.
The other thing that we did as part of this transaction was because we ceded the blocks that were projected to lose money, we released the $190 million of [FLR]. That's actually what brought the dollars of reserve margin down. That's a good thing. I think the most important thing from our perspective is the fact that on a percentage of net GAAP liabilities, that number doubled. That's the key.
Got it. Thank you. As you were working through the transaction, certainly makes sense why you did the pre-2003 block. Just curious why, was there an opportunity to also do more of the 2003 to 2008 block that you had talked about in the past as well? What led to this specific decision?
That block was never really a priority for us. We're really focused on the pre-2003 business.
Okay, thanks. Last one, should we think about any impact to your tax assets? In other words, now that the loss, if that present value of tax assets, will that go up after you do this due to new tax assets that are created?
Yes, that's correct. We are creating some new life NOLs. There will be incremental tax assets. There's an offset though, because we were previously carrying over life income to cover some of the non-life NOLs that existed. There's an incremental tax benefit, there's an increase to the valuation allowance to reflect that we're not going to be using those non-life NOLs to the extent we previously were. They net out.
Okay. Got it. Thanks a lot.
Your next question comes from Jeff Schmitt from William Blair. Your line is open.
Right. If there's $2.7 billion of reserves, assume you're getting 5% or 6% yield on that, call it $150 million or $160 million of investment income, that's not going off the books, that's being transferred into the runoff segment. Is that right?
No, Jeff, that's not correct. The assets are moving off the books. The investment income will follow.
Okay. If there's minimal impact on GAAP earnings, as you said, what's offsetting that? I mean, obviously there's some fees from Wilton Re that offset that?
That's correct. From an income statement perspective, we're ceding off premiums, net investment income, we're ceding off claims, change in reserve, some commissions, and things like that. That piece of business generates a small gain. It largely gets offset by the TSA fees that we get paid by Wilton for the next three years.
Mm-hmm. Okay. Just looking at the producing agents, I guess surprised to see that much of a drop in Bankers Life, particularly those with three-plus years of experience. Can you give a status update on your efforts to increase retention there?
Yeah. We've been really focused on, as we've talked about before, driving the yield from our recruiting efforts. We've been much less focused on the front door metrics per se, and more focused on getting agents to convert past that first-year. Our first-year retention numbers are, as we said verbally, we didn't indicate that in the data, but as we said verbally, we're very pleased with. In terms of the plus three year, I think we're looking at, what is it? The number went from 1,847 to 1,835, so you're talking about less than a 1% move. If I understood the question correctly, that's not been as much the point of focus. Well, I shouldn't say it that way. A 1% move, I don't know that I would draw a lot of conclusions around that.
We've really been focused on the longer-term retention, and I think that's just a blip.
Got it. Okay. Thank you.
I want to clarify a question that you asked, and I want to make sure because I want to make sure we responded to it correctly. You were asking about the offset in investment income due to the $2.7 billion. It's true that we're getting money from Wilton Re in the form of a transition services agreement to support certain activities, but those payments don't offset all of that investment income.
No.
That's a small piece of it. What's really offsetting that investment income is other things that we would've been accruing because that's a loss-producing block. When you net out what we would have been accruing and some fees and other things, that's together what's offsetting the $100 and some odd million dollars of investment income. I just want to make sure we didn't give you the impression that it's the TSA payments that are offsetting that. I don't know if we already lost him. Okay. Jeff, if you're still there, we can't hear you, but I guess we'll go on to the next caller.
Your next question comes from Daniel Bergman from Citi. Your line is open.
Thanks, and good afternoon. To start, I was hoping you could provide a little more detail on the mechanics of the trust account that Wilton's setting up. It sounds like initially it's funded with assets equal to the statutory liabilities plus $500 million. I just wanted to see how this would work if there's kind of future deterioration in the block. In other words, for example, if statutory reserves had to be increased by $250 million right after the deal closed, would Wilton then be required to put an additional $250 million into that trust? Just any color there, and in general, any comments around the structuring, how you got comfortable with the counterparty risk would be very helpful.
Yeah. Hi, Dan. This is Gary. I'm going to make a couple general comments, and then I'll ask Erik to weigh in with the specifics. I think when you look at that overcollateralization account, there's a few things that I want to make sure are clearly understood. The first thing is, please remember that this is 100% coinsurance. This is not a stop-loss treaty. The trigger for this is not simply if there's adverse claims development. The second point I want to make, I think it's important to look at our history of reserve adequacy and not having to take charges. In other words, typically when we set up the reserves, if you look back at our history, thankfully we've been pretty accurate about that. The third thing I'd point out, remember that the policies are also running off.
If something happens X number of years from now, there are a number of the policies that will run off over time. It's actually, relatively speaking, quite quick. I think the main thing to remember, this trust gets put into play not simply when there's adverse development on the reserves of the claims, but rather if there's adverse development and Wilton is unable to meet those financial requirements. It's not simply in the case of just adverse claims development where the losses or where this collateral account kicks in. I don't know, Erik, if you want to add some details to that, perhaps some numbers.
Yeah, I think that's well said. What gets transferred in the trust are the statutory liabilities, which are the reserves plus IMR that's created as part of the transaction, and then the additional $500 million. I think one thing I want to clarify is Wilton is obligated to maintain the trust and make sure that it's always adequately funded. I think that's a key point. If there's deterioration for one reason or another, it's not our obligation to top off the trust. I think that's one point of clarification. I made mention in my prepared remarks about there's a gradual drawdown of $62.5 million every five years, that was done very specifically to mimic, at a slower pace, the runoff of the reserves, as Gary mentioned. The reserves are running off fairly quickly because it's an aged block.
What'll happen is, over time, the collateral that's in the account, even though it's going to be getting pulled down every five years, is actually going to be a greater proportion of the reserves, and really growing until essentially the end of the life of this block. I think that's an important distinction. I think one other thing I'd mention is if there's adverse deterioration that's significant and there's actuarial justification, the first thing that we would do is, or that Wilton would do is go out and seek premium rate increases to offset any of that. That's kind of the first line of defense. To Gary's point, whatever can't be made up from that is then the obligation of Wilton and its capital structure.
Got it. That's very helpful. Appreciate the color. Thanks. If I could, just be moving to RBC. I was hoping you'd give a little bit more detail on the drivers of the quarter-over-quarter increase in the RBC ratio. I was just trying to get a sense, was there any portion of that that came from portfolio repositioning and was there any unwind of some of the changes that you guys had made in the portfolio last quarter?
Yeah, Dan, I made mention of it in my prepared remarks. We did have higher statutory income, and as we were moving towards having better clarity about a deal materializing in the second half of the quarter, we did proactively move some stuff around in order to regenerate some of the RBC that we had used up in the first quarter for some of those trades that we talked about. Yes, that was about 12 points of the improvement from the first quarter came from that reallocation exercise.
Got it. Thank you.
Your next question comes from Humphrey Lee from Dowling & Partners. Your line is open.
Question related to Bankers Annuity sales. Looking at the sales growth this quarter, definitely a good development. I was just wondering, can you give us some color in terms of what drove the stronger production in annuities, and how should we think about the trajectory from here?
Hi, Humphrey. This is Gary. Thanks for the question. The growth in annuities, we were pleased with it. I think it's fantastic progress, but frankly, I think we're capable of doing even better. Really what's driving it, I think, is a combination of a couple of factors. First of all, a little over a year ago, we launched a new annuity product that's had great reception, so we've been very pleased with that. Number 2, it's been part of our stated strategy as we move to the right to move where more and more of our advisors are getting their securities license and being able to give consumers real assistance around accumulation, income, and longevity, as opposed to just straight up mortality or health products like life and Med Supp. It's been part of that concerted effort.
As more of our producers have gotten their securities licenses, they've been getting into more households and offering more of those types of planning services. I would tell you, it's a combination of the product, it's a combination of part of our distribution strategy with the broker-dealer, and it's also a function of consumer need. As more and more middle-income Americans retire, and we all know that there's 10,000 Americans retiring a day. As more folks retire, they need these types of products. We are pleased with it. We think we're capable of even more.
On the licensing, can you remind us what number of Bankers agents now is licensed to sell securities?
Have we disclosed? I'm not sure we've disclosed that. We started out with one out of 12. We said that our stated goal was to have one out of five. I can tell you that we continue to make progress every quarter, we expect, we're still working through some of this, we expect that with the Q3 results, our broker-dealer will then officially be two years old, and the results will be at a point where it makes sense to start sharing more disclosure. We'll be giving you more visibility beginning next quarter. To directly answer the question, we continue to make very good progress on those ratios and are very pleased with how many of our agents are taking that next step in getting their securities license.
Got it. Additional color on the broker-dealers would be helpful. Shifting gear on the TSA fees, would that be kind of going through in Bankers or going through in runoff LTC?
Humphrey, this is Erik. Let me just make sure I got my gymnastics correct. To the extent the seeded profit, the seeded P&L has actually been moved over to the runoff segment, then yes, it should run through there. That's correct.
Okay. Because it's an administration fee, would that be qualified as non-life income?
I believe so, yes.
Okay. In reality, the earnings amount, you're talking about the limited impact between losing the block of business versus getting the TSA fees. It's somewhat augmented because of the tax benefits coming through. Is that the way to think about that? I'm just trying to get a sense of, after three years, how should we think about the net earnings impact from the transaction?
Yeah. To answer your question, I'm not thinking of it that way in terms of life, non-life income and how that's offsetting in some benefit. Not at all. Really what happens is, the seeded block of business makes a little bit of money now, and that's on a fully allocated sort of income statement basis. That is going off the books and over to Wilton Re. That loss of income here in the next couple of years is going to get offset by what Wilton's going to pay us to administer the business for the transition period. Now, kind of beyond three years, what happens is, the profits on this block of business are declining every year, what we are giving up is a smaller number, and it actually, from a projection perspective, turns into a positive for us.
That's something we are trying to talk about in the prepared remarks was, this is a positive for earnings growth and ROE trajectory, because the blocks of business are projected to lose more and more money over time. By moving those off our income statement and our balance sheet, we have sort of more of a tailwind to earnings and ROE growth rather than a headwind.
Got it. Thank you for the color.
Your next question comes from Thomas Gallagher from Evercore. Your line is open.
Hi. A few questions on long-term care and the deal. Can you just explain what was behind the trust structure? Was that something the regulators wanted? Was that something that you wanted? Was that to avoid having to put up reinsurance recoverables? Can you provide a little perspective on that?
Hey, Thomas. This is Erik. No, there was no regulatory requirement. This is an onshore trust with an onshore reinsurance partner, trust was not required to secure reserve credit. This was something that Wilton Re and us agreed to jointly.
Okay. Just that's where the structure went. No one pushing you to do it that way, that was just mutually agreed upon.
Correct.
I guess, Gary, I heard your comment about your priority was this older block because I think from what I heard or what I saw, from a stress test standpoint, this had more risk in it than what remains. Did you contemplate reinsuring your whole long-term care exposure? Is there any reason why down the road you might not consider that?
I guess I wouldn't want to try and predict what we might consider in the future. What I would tell you is that the block that remains, we are very, very comfortable with, in particular, the business after 2008 is profitable. Never say never, but at this point, there's certainly no compelling force to part with that. In terms of the 2003 to 2008, we didn't see the kind of upside from it. To a large extent, we undertook this transaction to give our shareholders more comfortable visibility, and we did that by getting rid of the block that had the greatest potential volatility as respects earnings and reserves. Any of the other blocks that we have don't have those characteristics, really, there was no compelling need. Again, particularly when you look at the business issued after 2008, that's profitable.
We don't want to give that up.
Got it. Final question. I know you don't disclose it this way exactly, but can you give at least a rough approximation of what % of your earnings going forward will be long-term care?
Yeah, Tom, this is Erik. We don't disclose that. I'm going to have to pass on that for now. What we're doing as part of the bifurcation of this block and moving over to the closed block or the LTC and runoff block is thinking about incremental ways that we can enhance disclosure around the retained block, I think that's something that we'll take into consideration.
Okay, thanks.
Your next question comes from Alex Scott from Goldman Sachs. Your line is open.
Thanks. My first question was just around the process a little bit, if you're able to talk about it. You've worked with Wilton in the past. Is this something you just worked on sort of exclusively with them, or were there sort of a number of interested reinsurance counterparties that looked at this deal?
Hi, Alex. Thanks for the question. We're really pleased to have transacted on this deal with Wilton. As you know, we've done three other transactions with them. We think the world of them, have a good relationship with them, and are very pleased to have done this deal with them. As you know, I suspect you know pretty well, there are often NDAs in situations like this. There are other parties with whom we may want to transact in the future. The short answer is we're not doing any kissing and telling right now.
Got it. Okay. Understood. When I think about ROE going forward, I saw the slides and heard your comments. When I think about that 11%, sort of what you printed plus the 150 basis points that was mentioned, how much upside do you see as we roll forward over the next few years? How much higher can you get that ROE? What would be the drivers of that?
Well, for the moment, our position is that we're not providing ROE guidance. I'm going to stay with that. I will share with you a couple other comments, though. We feel pretty bullish about the business. I really like what I see. Both our board and our management team recognize it's a priority to continue to increase that ROE, and we think we're capable of driving it higher. We are stopping short of providing any specific guidance.
All right. Okay, thanks guys.
Your next question comes from Randy Binner from B. Riley FBR. Your line is open.
Thank you for the follow-up. No ROE guide, can we presume it would be better from this transaction?
We're certainly not aiming to make it worse, Randy.
On the NOL, this is I think in follow-up to Humphrey's question. Just to get that right, the net impact to NOL, the offset is complete on that piece? There's no net change to the NOL or no material net change expected?
Hey, Randy, it's Erik. Thanks for the follow-up question, because I realize I had misstated that. There is a positive benefit on a net basis of about $60 million.
It's a $60 million good guy, and that good guy is in the life NOL or the non-life NOL?
Yep. The life NOL.
Oh, okay. That adds a little bit of value there. One more, if I can, and just try this. The RBC ratio pro forma, which you share on page 11 or slide 11 of your slide deck, that is estimate of RBC post-closing. The ratio itself doesn't change. How should we think about that kind of numerator and denominator change that gets to that 435 pro forma RBC ratio of 435?
In the Bankers Life legal entity, what ends up happening is that their required capital drops by about $45 million. I've got it actually here in front of me. What was capital of roughly $1.6 Billion at the end of the second quarter for Bankers would end up coming out to somewhere around $1.4 billion after giving effect for the capital contribution. The denominator goes from about $380 million down to about $340 million.
That was all I had. Thanks for the follow-up.
This ends the Q&A session. I now hand it back over to the presenters for closing remarks.
Thank you, operator, and thank you all for joining us on today's call.