Good morning. My name is Theresa, and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2014 earnings results call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during that time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Helding, you may begin your conference.
Good morning. Thank you for joining us on CNO Financial Group's third 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 several other business leaders available for the question and answer period. During this conference call, we will be referring to information contained in yesterday's press release. You can obtain the release by visiting the media section of our website at www.cnoinc.com. This morning's presentation is also available in the investors section of our website and was filed in a Form 8-K earlier today. We expect to file our Form 10-Q and post it on our website by November 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 this presentation, we'll be making performance comparisons, unless otherwise specified, any comparisons made will be referring to changes between third quarter 2013 and third quarter 2014. With that, I'll turn the call over to Ed.
Thanks, Erik. Good morning, everyone. CNO posted another strong quarter, and our businesses performed well as we continue to deliver growth in sales, collected premiums, annuity account value, and earnings. Consolidated sales were up 2% in the quarter, led by continued growth at Washington National and Colonial Penn, which were both up 7%, partially offset by lower sales at Bankers Life, which is down 1% in the quarter. The disappointing sales results at Bankers are largely attributable to recruiting challenges. I'll come back to that in a moment. Our financial position remains strong, and our key capital ratios are at investment-grade level. We continue to return capital to shareholders, repurchasing $164 million of common stock and equivalents in the quarter, including the repurchase of the outstanding warrants held by Paulson & Co. On July 1st, we successfully closed the sale of CLIC.
The proceeds have greatly enhanced our liquidity position, and we now have over $430 million of cash and investments at the holding company. Our consistent performance, strong balance sheet, and proactive approach to de-risking our business continues to be recognized by rating agencies. In August, AM Best upgraded CNO's financial strength rating to B++ while maintaining our positive outlook. This sets the stage for the company to be A-rated sometime in 2015. Let me now come back to Bankers. We are focused on long-term profitable growth and have a track record of execution. Our Bankers Life business model is solid, and we are focused on striking the right balance of time and resources between recruiting, location expansion, and productivity. Turning to slide six. We have had great success in increasing our operating earnings by proactively managing our in-force blocks of business and continuing to invest in initiatives to drive growth.
For the third quarter, operating earnings excluding significant items increased by 11%, and operating earnings per share were up 19% as a result of our continued commitment to return capital to shareholders via securities repurchases. Since 2011, we have bought back approximately $1.1 billion in common stock and equivalents at an average price of just under $11 per share. With a significant amount of excess capital, continued strength in capital generation, investment-grade metrics, and leverage of 17%, we continue to monitor the key factors that will determine the extent and timing of recapitalizing. With that, let me now turn it over to Scott to discuss our segment results in more detail. Scott?
Thanks, Ed. Beginning with Bankers Life, NAP declined 1% in the quarter, putting us up just 1% on a year-to-date basis and prompting us to revise our sales guidance for 2014. The primary driver of our sales shortfall can be traced to recent challenges in recruiting and has led to a contraction in our overall agent force, despite continued improvements that we are seeing in agent productivity. I'll discuss some of the steps we are taking to address the recruiting challenges in a moment. Collected premiums at Bankers grew by 2% overall but were up 4% when excluding annuities. We continue to see increases in life premiums due to higher sales and increases in Medicare supplement due to favorable persistency.
These increases are being partially offset by a continued decline in long-term care sales 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. Although annuity sales were down in the quarter, we continue to benefit from higher persistency, and average annuity account values increased by 2% during the quarter. Delving deeper into our recruiting and productivity results, new recruits are down 11% year to date. Simply put, the same level of recruiting is no longer producing the same level of recruits. This is primarily the result of an improving job market and increased competition for candidates. In addition, we have been putting greater emphasis on increasing agent productivity and retention and have made good progress on both fronts.
As a result, we are operating with a larger base of experienced, more productive agents than we did a year ago. Improving the productivity of our agent force elevates our sales culture, improves retention, and positions us to grow with less reliance on new recruits. We recognize that to achieve our growth ambitions, we will need to strike the right balance between productivity and new agent recruiting and are taking measures to calibrate accordingly. In order to address the recruiting challenges, we are implementing some tactical adjustments, including the deployment of a new applicant tracking system, new recruiting programs and candidate sources, and increased field support in the form of training, incentives, and support services.
These tactics and modifications will help us identify and drive more target candidates into the recruiting funnel, enable us to move more of them successfully through the process, and ultimately lead to higher conversion ratios of candidates to contracted agents. Recognize, however, that due to the onboarding process, it will take time for these results to materialize, but we expect recruiting to stabilize in the coming months and improve during 2015. Turning to Washington National. Sales were up 7% in the quarter, with individual market sales up 10% and worksite sales up 2%. Supplemental health sales were up 7%, primarily driven by sales in the PMA channel. PMA sales were up 15%, with strong performance in both market segments, and an increase in producing agents, which were up 16%. Supplemental health collected premiums increased by 4%, reflecting a one-time catch-up in premium refunds in the quarter.
Fred will provide more color on this later in the presentation. Moving on to slide 10. Colonial Penn posted 7% sales growth, another solid quarter after a difficult start to the year. A positive result was mainly driven by strong sales in both web and digital-generated activities, as well as in the new simplified issue term and whole life products. During the quarter, we also saw an improvement in the marketing cost to sales ratio as a result of both lower TV cost per lead and lead generation diversification efforts. Colonial Penn in-force EBIT and collected premiums were up 16% and 6%, respectively. We expect Colonial Penn to achieve break-even EBIT for 2014 as this segment continues to drive solid economic value for the company. Turning to slide 11. Our business segments are making strategic investments, and overall, we are pleased with the progress on those initiatives.
These programs are expected to lead to specific outcomes that are consistent with our long-term strategic priorities for each of our business models. At Bankers, we expect these investments to support a larger and more productive agency force. Achieving enhanced productivity is already resulting in improved retention levels and growth in NAP per agent. These gains will lessen pressure on growing recruits, but as we discussed, we will need to stabilize the level of recruiting to 2012 and 2013 levels. Although we are not pleased with this year's sales results, we view 2014 as a small setback due to an acute challenge which is being addressed. We remain committed and confident in the fundamentals of the business model and our ability to produce growth rates in excess of industry averages.
At Washington National, we are making investments in product availability, technology, and field force expansion that will help our PMA organization sustain their growth trajectory. In addition, introduction of our enrollment technology platform and new group products starting in the fourth quarter will enable us to expand our worksite market presence and contribute to 2014 sales growth of 7%-9%. Colonial Penn is making good progress on its initiatives as well. We are seeing expansion of the demographics that our products reach and the lead methodologies we are using to reach them, both of which are helping drive improved marketing effectiveness. We continue to expect 2014 sales growth of 5%-7% during the year. Taken together, we now expect consolidated sales growth of 3%-5% in 2014, but remain committed to longer-term growth rates in the mid to high single digits.
I'll now turn it over to Fred to discuss CNO's financial results. Fred?
Thanks, Scott. I'll focus my comments on earnings development and capital conditions, where we recorded another strong quarter on both fronts. If you adjust for the significant items, we recorded operating earnings of $0.32 per share. This quarter's significant items netted to approximately $0.03 a share of positive earnings impact, consisting of adjustments for reserve redundancies in both our Bankers Long-Term Care and Medicare Supplement businesses. In addition, there were offsetting impacts between the segments from the installation of a more advanced process to identify the status or death of our insureds. The majority of our insurance earnings drivers performed at or better than expected, notably annuity and health margins in Bankers and life margins at Colonial Penn. Washington National experienced weakness in their supplemental health margins, and market volatility impacted our corporate investment results.
Core capital ratios and holding company liquidity remain strong, in part reflecting the completion of the CLIC transaction. We accelerated capital deployment in the quarter, repurchasing approximately $107 million of common stock and $57 million for all outstanding warrants issued as part of the original Paulson investment. Before I leave this slide, with the sale of CLIC, we moved our annual review of core prospective insurance assumptions, including new money rates, to align with our annual loss recognition and cash flow testing exercise in the fourth quarter. As has been our practice in the past, we will provide detailed disclosures on our actuarial testing results with fourth quarter earnings. Turning to slide 13 in our normalized segment earnings, Bankers' EBIT benefited from continued strength in the Medicare Supplement, long-term care, and annuity margins.
The recapture of traditional life policies from Wilton Re contributed roughly $3 million of EBIT to our Bankers segment and benefited from strong mortality. We would estimate the annualized run rate EBIT contribution from this block to be in the $10 million range. Washington National's EBIT was down modestly as a result of elevated supplemental health claims in the quarter and the natural runoff of Medicare supplement and other residual closed blocks now housed in this segment. Colonial Penn reported solid earnings and sales growth driven by cost-effective marketing spend. As Scott has noted, we carefully track metrics on the effectiveness of our marketing spend in generating leads and in converting those leads to premium. Our overall marketing spend to NAP ratio has been strong in recent quarters, and this is positively impacting earnings results.
We anticipate break-even EBIT for the year as we continue to actively invest in the business. Corporate segment results were somewhat impacted by market volatility in the quarter. We maintain a diversified investment portfolio at the holding company, including a COLI investment, which together have a moderate exposure to equity and hedge fund investments. When markets are flat or down and volatility is on the rise, corporate earnings will naturally be impacted. Overall historical performance has been very strong, and we're simply traveling consistent with the broader markets. Turning to slide 14, I mentioned earlier a few notable items impacting our health margins in the quarter that deserve some additional color. Looking at our Bankers Life med supp and LTC lines, in both cases, margins were positively impacted by redundancies in reserves.
This is simply the quarterly practice of assessing claims development and with additional experience in hand, looking back at reserves established in previous quarters and adjusting accordingly. We normalize these redundancies out of earnings and our benefit ratios as they are not necessarily reflective of expected future experience. Long-term care redundancies were approximately $7 million and Medicare supplement $3 million in the quarter. As I noted earlier, I installed an enhanced process to identify the death of insureds. This is commonly referred to as a Death Master File process, named for the use of DMF data from the Social Security Administration. We apply this process across our health, annuity, and life businesses, with each line of business impacted differently. Our LTC line benefited by approximately $3 million in EBIT. This impact is a one-time increase in mortality and associated reserve release.
Washington National supplemental health was impacted by a reduction in premium as we sell joint policies where the passing of a spouse results in lowering of the premium, thus premium refunds were issued. Looking then at normalized benefit ratios, Bankers Medicare supplement continued a pattern of favorable claims trends, and we would expect that to continue into the near term. As a result, we are seeing the pace of rate increases naturally slow, premium refunds increase, and persistency improve. We maintain our benefit ratio guidance in the 70% range. In the case of long-term care, we are working on various initiatives designed to address claims trends. However, we are in the early days of execution. This quarter's redundancies are more the result of normal variances in claims trends.
We continue to experience stress on older and more comprehensive LTC blocks, which may require some level of rate action in the future to sustain stable performance. We do believe we are benefiting from a prudent approach to reserving, active management of the in-force, and the unique characteristics of our LTC business model. We maintain our benefit ratio guidance in the 79% range. As noted in our press release, Washington National supplemental health benefit ratios were modestly elevated at 55% as we experienced a spike in cancer claims in the period. There can be periods where a small number of larger cancer claims emerge. At this point, we do not view the quarter's claims results as systemic and are maintaining our benefit ratio guidance of 54%. Turning to slide 15 in investment results.
While rates remain low and spreads are tight, 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. As is often the case, it was the result of a few isolated prepayments, so this source of investment income can be variable. Impairments in the quarter were limited to one legacy private equity investment. While overall credit conditions are favorable, we are reluctant to climb out on the credit curve to support new money rates and are therefore being tactical and selective in our investment decisions. Slide 16 profiles our capital position. We ended the quarter with an RBC ratio of 425%, down from the second quarter, but in line with our third quarter expectations.
Statutory earnings in the quarter of $60 million reflect the removal of CLIC results and the recapture fee of $28 million paid to Wilton Re for the Bankers Life block. In addition, there were timing impacts as we pay accrued interest on Colonial Penn's surplus note of $15 million in the quarter. In addition to statutory earnings, our RBC ratio reflects investment results, including the private equity impairment and the seasonal timing of statutory dividend activity in the quarter. Our overall outlook for consolidated RBC remains in the 415% range. Leverage held steady in the quarter despite more robust capital deployment, is expected to remain in the 17% range for 2014. We ended the quarter with $432 million of liquidity and investments at the holding company, an increase as a result of the CLIC transaction, and which size our deployable capital at approximately $250 million.
As noted in our press release, we repurchased the Paulson warrants for $57 million. The transaction closed in early September and was negotiated at market, meaning no implied discount or premium. The transaction reduced diluted share count by 3.3 million shares, only 25% of the reduction reflected in our quarter-ending average diluted share count. The transaction offered us an opportunity to put our excess capital to work quickly and efficiently. We are maintaining our securities repurchase guidance in the range of $350 million-$400 million for 2014, which is inclusive of the warrants repurchase. Turning to slide 17 and ROE development, our normalized operating ROE came in at the mid 8% range, supported by strength in core earnings and a more material bump in capital return to shareholders.
Despite our deployment activities, we have been retaining higher levels of capital in both the insurance companies and at the holding company. When excluding the impact of the OCB transactions, average equity is up roughly $300 million as compared to this time last year. This has supported our ratings momentum but challenges ROE progression. We discussed at a high level our three-year plan at this past June's investor conference and noted a number of potential operating variables, including new money investment rates, long-term care performance, and the pace of investment in our platform. We are in the middle of working through our financial plan for 2015 through 2017 and are closely monitoring developing headwinds of new money rates and our revised 2014 sales expectations. ROE development depends on a number of factors in our plan, so it's too early to make any adjustments to long-range targets.
We will update guidance on 2015 and longer-range trends as part of the reporting of our fourth quarter results. As Ed noted, we continue to monitor markets and weigh the value of recapitalizing the balance sheet. Being a below investment-grade issuer, we require strong market conditions to overcome the incremental penalties and transaction costs that arise when taking out our current debt structure prior to call dates. With that, I'll hand back to Ed for some closing comments.
Thanks, Fred. Before opening it up for questions, let me touch on our key areas of focus at CNO. First, we're committed to sustaining the sales momentum that we have at Washington National and Colonial Penn while addressing recent recruiting challenges at Bankers Life, as Scott touched on. Achieving greater operational efficiencies is critical as we invest in technology to increase productivity and enhance the customer experience. We will continue to drive shareholder value by effectively deploying our excess capital through investments to drive organic growth, developing non-organic opportunities, and returning capital to shareholders. Lastly, as Fred mentioned, we will continue to monitor the capital markets for the optimal time to execute on a recapitalization of our balance sheet. As we have said, the next recap is not a question of if, but when and to what extent. With that, we'll now open it up for questions. Operator?
At this time, if you would like to ask a question, press star, then the number 1 on your telephone keypad. Your first question comes from the line of Randy Binner with FBR Capital Markets.
Hey, good morning. Thanks. I'd like to ask some questions about sales at Bankers. That seems to be kind of the main debatable issue in the quarter here. I hear that the sales guide, I think for 2014 was still 3%-5%, and then it's mid-single digits growth going forward. I guess, should I take it from that like the kind of the high end of the guidance from the June investor day, I think it was 6%-10% was kind of the range given for 2014-2016. Are we kind of out of that high single digit or low double digit potential from Bankers given the kind of the setbacks and delays that have happened this year?
Hey, Randy, this is Scott. First of all, just a couple of points of clarification. The guidance that we gave for this year is 0%-3%.
That's for Bankers Life sales.
Oh, 3%-5% is consolidated.
three to five was consolidated. We didn't provide any guidance for 2015. The guidance that was provided at Investor Day for Bankers was six to eight, but we were guiding towards the low end of that.
For longer term, I guess what I'm thinking back to June is that there was a longer-term kind of 14 to 16 goal that ranged up to the high single digits.
We're not prepared to discuss that right now. We'll plan on addressing that 2015 and kind of longer-term growth rates during the Q4 results.
I guess just to understand a little bit more what's going on. I think this year got off to a slow start because of winter weather. We saw that across other folks who sell life insurance. It seems like something else happened. I guess from your comments, it sounds like the thing that's changed beyond the job market is more competition for candidates. Could you give us more color on that? I'd like to understand that a little bit better. Is that other life insurers recruiting folks, or is it that folks have other sales job opportunities out there when they look at this opportunity?
Good question, Randy. The answer is both. The kind of general trend is that the job market is improving, and there are more opportunities in the marketplace. Remember, we're recruiting to a straight commission opportunity. We're finding that we're seeing kind of a higher level of fallout during the recruiting process as some candidates might land a salary position. Certainly, that's kind of general market trends. We're also seeing more aggressive tactics being used by competitors in our space, and primarily other health-focused carriers, but also some life and annuity carriers as well, just getting more aggressive with tactics and being more prominent out in the marketplace. To answer your question, it's a little bit of both.
When you talk about new initiatives, I guess training, recruiting, a lot of that stuff makes sense. The application tracking, I guess I'd be interested to hear about what exactly that is and how that can improve the process.
Sure. Just a little bit of context. For every agent that we contract, we get nearly 100 others that show interest in the position and schedule an interview. You can see that we lose a lot of interested candidates in the process for all sorts of reasons, including communication, scheduling conflicts, possibly our messaging, they fail the state exam, et cetera. The steps that we're taking, and specifically the application tracking system, is targeted at improving each step of the process along the way. Staying engaged and close and continuing to track the individual's progress through the funnel. For example, the tracking system will generate text reminders to remind people to come to an interview. It will help us remarket to those that don't show up, no-shows. It will allow us to prioritize candidates using predictive modeling.
Those are some of the examples of things that the tracking system will allow us to do. As I alluded to, we're doing other things, and we also have other things under consideration. Some of these things have been under consideration for a while, but we really haven't had to make any changes because we had a more favorable environment. Now that that environment has changed, we're going to have to put more effort and look to make some targeted improvements in the process.
Okay, that's helpful. I just have one more follow-up. When you talk about other health and life carriers being more aggressive out in the market, I guess what would be a typical thing they'd be more aggressive with, and why do you think they're more active in the market now? Is it opportunities around Obamacare or the aging population? Just a little bit of color on those two pieces would be helpful.
Sure. Tactics could range from anything from offering subsidies, sign-on bonuses, expense coverage, those types of things. Aggressive also includes being more aggressive on job boards. Essentially, a number of our competitors have duplicated our process or replicated our process. That's what we're seeing in the form of aggressiveness, some examples. To answer your follow-up, yes, I think there is a clear correlation between both the changes in the health marketplace and continued expansion of the standardized plans, both in the underage as well as in the overage targeted population.
Okay, thanks. Well, I'll leave it there. Good luck with all that stuff, and we'll look forward to the update on the fourth quarter call.
Yeah. Randy, thanks. Let me just add a couple of things. With not just Bankers, but with our distribution systems in total, it's like we run the rest of our business with a financial discipline that we want to have the economic return, and that's something that we're very mindful of and very much
Keeping in front of us in that we don't finance our agents at Bankers Life. That's part of the economic return equation that we operate on there. It's important to get sales that contribute to the overall net present value of the enterprise. That pricing discipline carries on the distribution for us. The other thing, given that started out talking about Bankers, but mixed in consolidated sales, I just want to reiterate what's also in our slide deck of that for 2014 consolidated, we are expecting 3%-5% sales growth. We're also committed to our long-term growth expectations. To the extent those need to be updated, that will be covered in the Q4 call.
All right. Thank you.
Your next question comes from the line of Erik Bass with Citigroup.
Hi, good morning. Thank you. I guess first, just a question for Fred on your annual assumption review comment. Am I understanding correctly that you're now planning to review both GAAP assumptions and the statutory cash flow testing in the fourth quarter, so there was no detailed GAAP review this quarter?
Well, that's right in a sense. Every quarter, we, under GAAP rules of engagement, are required to take a look at our core assumptions and see whether or not things have deviated to a point to where we need to make an adjustment. It's just that, like most companies, if we're going to make a change to a longer-term perspective assumption, it typically requires a fairly good amount of study and a more consistent track record of that assumption performing before we'd make an adjustment, so we take a deeper annual look. What we've done historically is we would look at interest rate-related adjustments in the third quarter, historically. Remember that had an awful lot to do with the fact that we owned these various runoff blocks that we had in OCB, which had very acute exposure to interest rates.
You might recall all of the interest rate-related adjustments we've made to our GAAP results that were entirely made in the runoff blocks of business, in the CLIC business in particular. Now with the removal of that business, the long-term interest rate assumption has primarily an impact from an actuarial perspective on the long-term care block and the margins we have in that long-term care block. In that particular case, it's much smarter to review interest rate assumptions or new money rate assumptions together with all of the assumptions embedded in your long-term care business to make a holistic determination of the margin in that business, and therefore, whether or not you would need to do anything on a GAAP or cash flow. We've always done our GAAP loss recognition testing and cash flow testing work in the fourth quarter.
As you know, we've always included in our fourth quarter, at least more recently in our fourth quarter results, a detailed breakdown of those GAAP and stat margins. That remains the same. We simply move the new money rate assumption because it really needs to be incorporated into long-term care, having now sold the CLIC business.
Got it. I guess following up on that point, how should we think about current new money rates relative to your assumptions? I know they've been-
Sure
trending above year-to-date. I guess, how long would rates have to remain at current levels before we start to enter the charge scenarios that you laid out at Investor Day?
Yeah. I think one of the things we did, Erik, is we included, you might have noted, we included in the appendix of our slides some of the rate sensitivity work that we disclosed as part of our investor conference this year. We did that just so that you can again be reminded of the types of scenarios that would give rise to financial impact and how big those financial impacts would be. Something I would remind you of, though, is that it's unlikely we would adopt an assumption that is long-range flat or down and long-range flat or flat forever, simply because that's not normally what a forward curve would suggest to us.
What's more likely is that you would both bump out your new money assumptions as having not recovered to your expectations and possibly adjust the slope of that recovery to be closer to what a forward curve would suggest. That's really what I anticipate we'll look at in the way of our assumptions. I would fully anticipate that we're going to hold flatter, that is not really have a recovering, probably reduce modestly the new money rate and have the trajectory of recovery different than what we currently have as an assumption. Quite honestly, that's really just a reflection of the markets and of the forward curve dynamics that we're seeing. That will have implications for the amount of cushion or margin that we have in our long-term care business.
Again, realize that there's an assortment of other assumptions, mortality, morbidity, and other dynamics, along with all of the actions that we're taking to try to defend and improve our situation on LTC. All of these studies will be taken into account before we would get to the stage of where we would have to do something on a GAAP or a cash flow testing basis. Again, I think there's some room there, whereas prior to having sold the CLIC business, we would have been talking on this phone call right now about a more immediate estimate of what the financial impact might be because there was basically zero margin in our interest rate assumptions relative to GAAP margins.
One thing I would note is another aspect of this to think about is just what the earnings impact may be just from pure investment income as we go forward. A general rule of thumb to think about with our general account, if you hold all else equal, meaning the turnover rates, which as I mentioned in my comments, we've been really throttling back on. We run very tight ALM, including ALM on our long-term care business.
Where we're effectively matched up. One thing to note is that we don't have a heck of a lot of earnings impact from a lower new money rate, it does bleed in over time. For example, a 50 basis point reduction in new money rates on our current state of general account and turnover would have the effect of an $8 million-$10 million pre-tax annualized impact to earnings. That would climb each year as we stay in a current low-rate environment. That's the order of magnitude of impact in sort of that next year's results if you just hold to a down new money rate, down from what we're currently investing in.
Thanks. That's helpful. If I could just ask one more thing, if you could just comment about the implications of recent moves in the high yield market for the potential timing of a recap. In the current environment, could you still issue with investment grade-like terms?
Yeah, it's a good question. What we are seeing with market volatility is, and this is really not a CNO thing, as you suggest in your comments, Erik, it's really more a broader below investment grade. Again, more particularly, below investment grade financials will be that much more volatile than even the high yield market, for reasons we've talked about in the past. During periods of market volatility, we will normally see our spreads gap out, potentially very dramatically. We've seen periods where our spreads in a very short period of time have moved out upwards of 100 basis points. It can be very volatile, which is part of why we're on a mission to get out from underneath being below investment grade. What we have not seen deteriorate is the overall environment for reasonable terms or favorable terms.
What I would say, though, is we will benefit from stable and favorable credit markets because not only are we trying to push for investment grade-like terms, but we're really needing to attract investment grade fixed income investors to some degree into our bonds. That will require a level of favorability in the marketplace or stability in the marketplace. We remain comfortable that we can achieve investment grade-like terms such as little to no amortization, much more favorable covenant package, perhaps slightly longer tenure to our bonds. The spreads are something we have to be careful about.
When you're paying a $30 million penalty, which would be approximately our estimate at this point in time to take out those bonds, or a net $16 million cost before the October next year call date, you really are going to want to drive as good a rate as possible to try to keep the debt costs under control and keep this thing to more of an NPV neutral to positive dynamic. That's why we're being patient. It's obviously been choppy markets right now.
Got it. That's helpful. Thank you.
Your next question comes from the line of Humphrey Lee with UBS.
Good morning, guys. Just want to follow up on Bankers sales and particularly on the agent recruitment. I saw that originally you were expecting to slow down your recruiting this year as you become more selective in your process and while you're focusing more on productivity gain. For the 11% year-to-date decline in new recruits, how does that compare to your original expectations?
Humphrey, we had expectations of recruiting being essentially flat year-over-year. We're tracking right now down 11%. We're down to that extent.
Okay.
You might remember from our June conference, Humphrey, we had average agent count increase over the life of our financial plan, 14 to 16 of, I think, 1% or 2%, 1%-3%, perhaps, range. That's important because we had productivity improvements in the 5% range. That will tell you something, right? We never have been relying entirely on the recruiting engine to support the sales growth, but we have expected the recruiting engine and average agent count to not hurt us. In other words, the plan has been modest increase in average agents, but more concentration on improving the productivity. As Scott mentioned in his comments, the productivity is working, but the agent recruiting and therefore average agent count is down. It's not as if we are relying on some sort of bullish agent count increase to support our growth rates.
Yeah, just a little bit more color on that, Humphrey. Our second and beyond agent force is up 2%. The productivity which ties to retention is working. To Fred's point, we didn't expect the recruiting to hurt us part. That is what we're seeing. Just to give some perspective, the 11% equates to about 600 agents. If you think about, we have 300 locations. To recover 600 additional recruits, it requires about an additional two to three recruits per location. We think that's manageable. Given some of the things, the tactics that I discussed, we think we can close the gap. It certainly is a more challenging environment.
This is helpful. I think in your early remarks, you talked about the average rate of converting applicants to agents that kind of tailing off this year. Can you give us a sense of how the average conversion rate over the past few years compared to where it is now?
We really aren't prepared to disclose that level of detail. I can tell you that just this year, certainly this year, in the beginning in the fourth quarter, and we saw it in the first quarter, we did see a deterioration of those conversion rates actually in the range of what we're seeing in decrease in recruiting levels.
Okay. Just one more on productivity. I think the 5% is pretty much at the high end of your 2014 outlook kind of provided in June of yesterday. Do you think you still have more leverage to pull to mitigate some of the weaker recruiting in view today?
Some of the investments that we have been making the last couple of years, we do expect and have a longer ramp time, will support that consistent level of productivity gains, we're not expecting to drive beyond 5%. We're going to have to make, in order to achieve the ambitions that we've set out, and to achieve growth rates in excess of industry averages, we're going to need to stabilize and improve our recruiting situation.
Got it. Thanks.
Your next question comes from the line of Sean Dargan with Macquarie.
Thank you. Regarding Bankers LTC, I just want to make sure I'm getting the moving parts right. The favorable development that you saw this quarter was related to the claims reserves, essentially IBNR. Is that a way to think about it?
It is a way to think about it. Yeah, we had two things positively impacting long-term care results that we would characterize as more non-recurring. One is the redundancies, which is, yes, think about it as of having effectively trued up an IBNR, and that is we establish reserves based on a view of where we see claims rolling out, and that history of claims activity. When we now fast-forward to more current information, we're able to look back and make a judgment call as to whether or not we overshot or undershot that dynamic. This, by the way, is a very mechanical exercise. This shouldn't be necessarily viewed as we just sort of thought about it and felt there was redundancies or deficiencies. This is similar to the type of squaring of the triangle dynamics you'll find in other forms of more health or property casualty type businesses.
It's somewhat mechanical. Each quarter, we actually have this going on. It's just that most quarters, it's not at a more material level. What made this more material is we typically see an elevated level of claims in the first quarter of each year. That has been the pattern. We therefore structured our reserves in anticipation of that trend or dynamic and didn't see it to the level we had anticipated, and therefore, looking back, saw clear redundancies in those reserves and released them. That was about $7 million in change in the quarter. There was an additional $3 million that was related to the DMF or advanced process of identifying death of insureds in long-term care, where, as I mentioned, you then identify it, and you release the reserve associated with that policy, and that will be a small bump. That was about $3 million.
Even as you back those things out, we still recorded about a 79% benefit ratio, which is right on top of what we would expect, and trending stable.
Okay. I believe you said in response to Erik's question that you may need to address claims trends that are stressing some of the older blocks with rate increase. Is that because the margin is declining, or are claims among that cohort trending worse than expected?
Yeah, it's a little less to do with trending and a little more to do with the current state of affairs that those more comprehensive policies are in. These are the more comprehensive as in nursing home inflation related type products. They also tend to be some of the older products. As you know, we've somewhat long ago moved away from that and are selling much shorter benefit, less comprehensive product these days, and really for the past several years. Those cohorts of products have been, frankly, the same products in many cases where we have gone in and been successful, more or less, on a state-by-state basis with achieving rate increases in the past. The ongoing performance of those policies continues to be strained.
As you know, we're not always successful in obtaining rate increases that we believe and document as being justified in qualifying for rate adjustments. Many of those policies we need to continue to monitor, and my comment is simply to say that when we go through a quarter like this with redundancies, you need to be careful about extrapolating that into believing that we just simply are in a universally different quality or trajectory going forward. We still have pockets of policies that struggle, and that do require and really deserve a rate action to stabilize.
Got it. Just one more on LTC. As we think about the testing you'll do on statutory active life reserves in the fourth quarter, did I hear you say earlier, putting aside the impact of developments in mortality and morbidity, the interest rate component alone, meaning where new rates have moved, would be a negative for margin?
They would be, if you hold all else equal. It's a little bit more a dynamic for loss recognition testing than cash flow testing, i.e., GAAP, for the simple reason that GAAP loss recognition testing is based on more of a best estimate as opposed to more of a prescribed interest rate in statutory. We naturally have a forward curve assumption that calls for improving treasuries and therefore improving, as in rates increasing, and better new money rates. What I'm suggesting to you is just the simple math, and that is, if I now have to extend another year of low rates where I had previously, i.e., this time last year, assumed a level of recovery in rates, I, by definition, am going to eat into that margin.
If I further tip the recovery of those rates, whereby it's now a longer period of time for recovery to an ultimate higher rate, I also will take some degradation in margin. My reminder to all of you is, first, we have margin. Remember, you're eating into margin. That shouldn't be confused with the taking of a GAAP hit. Secondly, there are a whole assortment of assumptions that get reviewed, backed by studies and detailed analysis. As you can see in our book of business, there are some trends that, at least thus far, seem to be moving in the right direction. Need to be careful about extrapolating that into the future. At a minimum, we're not seeing deterioration in claims activities, which would raise red flags in different ways. We're putting all of that under review, and hopefully that helps. Yes, absolutely.
Low rates you'll see eat into those margins.
Thanks, Fred. That's very helpful.
Yep.
Your next question comes from the line of Colin Devine with Jefferies.
Colin, are you there?
Colin, go ahead.
Yeah. Operator, let's go to the next caller, and we'll see if Colin gets back in the queue, and we can bring him up again. Hello?
Your next question comes from the line of Edward Williams with Capital Returns.
Yeah, good morning. With the full year buyback guidance maintained and $301 million done through 9/30, inclusive of the Paulson warrants, implies a Q4 expected of $49 million-$99 million. Just wondering, given recent market volatility, if you've been able to repurchase any shares post quarter close, Q4 to date?
We tend not to update sort of on-the-run repurchase, Ed, so we will kind of stick to our practice of updating repurchase activity at the end of the quarter. Your math is correct in terms of what you're solving for. That is a range of roughly $48.5-$98.5 would be the implied fourth quarter repurchase range. I would also note that on our slide, our capital target slide, you'll notice that we have assumed in the way of a capital utilization plan, $375 million worth of repurchase for the year. I would suggest to you that that is our target expectation. We'll move in and around that target based on how we see capital conditions and opportunities emerge throughout the quarter. We don't kind of do on-the-run disclosures of what we've repurchased or not.
Fair enough, I appreciate that color. Maybe you can just remind me if you've had an active 10b5 at any point earlier this year.
What I will tell you is that we're very tactical in how we repurchase shares. By that, what I mean is, we like the daily open market approach that allows us to assess each day whether or not we're putting our capital to work, even small amounts of capital to work at IRRs that make sense relative to alternative uses of capital. We will, on occasion, utilize 10b5 programs for the reasons you're alluding to, that is being able to have a more consistent and constant level of repurchase when we have natural blackout periods. After that, though, I'm not going to kind of get into specifics.
That's great color. Thanks very much, guys.
Yep.
Your next question comes from the line of Colin Devine with Jefferies.
Thanks. I'll try again. I appreciate that.
Great.
A couple questions. First, with respect to agent recruiting and also retention, is it possible to start getting a little more granularity on that so we can sort of track it and compare it and really breaking out, obviously recruiting, but obvious what you're doing on retention would be one question across the different businesses. The second one, Fred, with respect to interest rates, you talked about extending rates are going to be low for another year into your assumptions. What happens to your margin if it's two or three years?
I guess the final one, should I take it that you're comfortable or it's too early to tell if you might be doing a FAS 60 unlocking in the fourth quarter?
Yeah. Why don't I take the last ones first, Colin? First, good to hear your voice again, and welcome to the call.
Yeah.
One of the things that we did back in June at the investor conference, is we spent a little bit more time on the stress testing results of interest rates. What I did this quarter is parked in the appendix. We didn't talk to it on the call today, but I do want you to refer to it. Parked in the appendix Two slides on low for long rate stress tests, which actually address your issue. The first slide really lays out three different assumptions, mild, moderate, and severe, which in fact do what you're saying, either flatlining rates for an extended period of time followed by recovery, lowering and flatlining followed by recovery, or lowering and flatlining indefinitely. The next slide gives you an idea of the GAAP impact to earnings. Importantly, you have two components.
By the way, very importantly, this is now all about long-term care, because we've really have shed businesses that were previously susceptible to the same testing. This is really looking at long-term care. When you do that, you'll see under certain scenarios, particularly the moderate and severe, you're taking a level of impact when you apply those assumptions. We show that on an after-tax basis. Under the severe test, which is drop 50 basis points and hold flat forever, you're taking an after-tax immediate hit of roughly $47-ish million, realizing roughly a third of that is related to intangible write-off. The remaining is the establishment and increase of a future loss reserve, because under that assumption, as you know, we now have more policies that are moving into a negative cash flow position and need to establish a reserve today for that.
Now, under the moderate stress test, which is drop 50 basis points, hold flat through 2019, then recover slowly, that drops to more of a $15 million after-tax impact, but more directly related to the hiking up of a future loss reserve, and that sticks with you for a while. That ends up being a more consistent drag on your earnings. You would then apply on top of that, the investment income drag that I mentioned earlier. That should help you piece together how to think about the multi-year effect of low-for-long interest rates.
Thanks.
And-
Yeah, you want me to take that?
No, Colin, to your first question. Just a baseline, we do report, as you alluded to, the number of recruits and the change in that number of recruits period-over-period, as well as the average agent force size period-over-period, and the total agent force. That's what we've typically reported. We don't generally break out and report retention by year. That can get somewhat cumbersome and frankly, fairly confusing. I did mention the 2%, which is excluding our first-year agents. Our base agent force is up about 2% from a year ago. Doing more granular level recruiting or reporting than that is possible. We'll have to look at it. I'm not willing to commit to it at this time.
Okay.
Colin, let me come back to one other question you asked. You asked me sort of a global question, as you enter into the period of looking at your assumptions, are you seeing anything? I would say, Colin, that's a bit too early. The only exception being is we're clearly sitting here in a rate environment that I can provide more color and context to. That's what I was prepared to do. The other policyholder behavior activities and things on long-term care, like claims trends and so forth, I'm not in possession of material to be able to comment on those margins. One thing I would tell you is just sort of look back at our performance.
We haven't seen material swings and dynamics that at the moment cause me concern, I would anticipate there being sort of the normal level of offsetting noise that travels through, just not able to comment on it. Interestingly, there is one development that actually is a little bit different than actuarial assumptions, loss recognition testing, and cash flow testing. I don't know how many of you have picked up on this, we're watching it carefully. That is the Society of Actuaries has issued new mortality tables related to pension liabilities. In our case, we have a fairly small agent deferred comp liability. As those of you who have been following us over the quarters know that those liabilities will swing around with interest rates. They can also swing around with mortality.
It's a little unclear as to what's going to be adopted and when and how the industry might react to it, we're watching that. I wouldn't characterize it as a big number as it respects to CNO because we very simply have a small relative liability as a company. We got to watch that one. It's an assumption that we're paying attention to.
Yeah, Fred, I think it's keeping a few of your competitors up at night.
Probably. Probably some very big companies outside our industry. We're watching that, but more to come.
Okay. Thank you.
Your next question comes from the line of Randy Binner with FBR Capital Markets. Randy, your line is open.
Can you guys hear me?
Now we can.
Yes. Now we can, Randy.
Sorry. Yeah, I'm not sure what happened there. Just a couple of follow-ups. The asset adequacy piece got hit pretty well, but just on the last piece you were talking about there, Fred, you mean on the COLI, right? The mortality table adjustment for pensions. That would come through on the COLI item, is that right?
It's actually, yeah, our agent deferred comp liability. I'm pretty sure these numbers are directionally correct. We've got something in the neighborhood of $150 million, $160 million agent deferred comp liability. There are other similar liabilities that maybe are another $25 million or $30 million. As you recall, Randy, in fact, last quarter, I believe, then the third quarter of last year this time, we took positive and negative. Last year was a positive, this last quarter was a negative adjustments for the discount rate moving around. It's that same liability that I'm talking about. The biggest part of it is agents deferred comp, which is actually held in the Bankers Life unit, so it tends to affect the Bankers Life's legal entity statutory as well. That's the liability I'm talking about in the mortality study application.
Okay, not the COLI? Because the COLI is at the corporate level-
Yeah
for the executives, right?
Yeah.
Okay.
Yeah. That's right. That COLI is a separate account COLI contract that fluctuates with the actual underlying performance of assets in that separate account. As I mentioned, it has an equity investment orientation, and while the S&P was relatively flat, the Russell 2000 and other aspects of the equity markets were down in the third quarter, which caused that contract to underperform.
Okay, cool. Just one other detail that I think, Fred, you had mentioned that the make-whole on the existing $275 million senior secured note was kind of $30 million. That's decayed over time, right? I think we were talking about it being $33 million this summer.
Exactly.
Now it's probably under-
Yeah
28. It's actually kind of $5 million better than the last time we all talked about it. I know that you've said a lot about this potential recap, but does that $5 million help, or is that kind of washed away with the widening of spreads and the other items you talked about, I think, with Erik Bass?
Yeah. It has been periodically overwhelmed by the gapping out of spreads. You have it exactly right, Randy. Actually, our best estimate right now of that penalty come, say, November 1, if you were to call the window opening up to where you would entertain recapitalization, is about $29 million. It has been coming down and will continue to come down. It bleeds down to about $13 million come October 1 of 2015.
Sure.
We've said generally at a pace of about $4 million a quarter, it does make a difference. We are largely NPV driven on this. We're trying to be as economically driven as we can. It really does help each quarter as that clips down. We got to be patient on the capital markets.
All right. Understood. Thanks for taking the follow-up.
Yep.
There are no further questions at this time.
All right. Thanks, operator, and thanks to everyone on the call for your interest in CNO.
Thank you, ladies and gentlemen. That does conclude today's conference call. You may now disconnect.