Thank you, Mr. Erik Helding, you may begin your conference.
Thank you. Good morning, and thank you for joining us on CNO Financial Group's fourth quarter 2013 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 2013 Form 10-K and post it on our website by February 24th.
Let me remind you that any forward-looking statements we make today are subject to a number of factors which may cause actual results to be materially different than those contemplated by the forward-looking statements. Today's presentation contains a number of non-GAAP measures, which should not be considered as substitutes for the most directly comparable GAAP measures. You'll find a reconciliation of the non-GAAP measures to the corresponding GAAP measures in the appendix. Throughout this presentation, we will be making performance comparisons, and unless otherwise specified, any comparisons made will be referring to changes between fourth quarter 2012 and fourth quarter 2013. With that, I'll turn the call over to Ed.
Thanks, Erik. Good morning, everyone. CNO posted another strong quarter, and our businesses continue to perform well as we delivered growth in sales, collected premiums, and earnings. As we have discussed in the past, we have been making significant investments in our various business platforms over the past several quarters, and those investments are yielding results. Consolidated sales were up 8% in the quarter and 6% for the whole year. We continue to return capital to shareholders and repurchased $31 million of stock in the quarter. During the quarter, we also paid $6.6 million in common stock dividends. Our solid performance and ongoing financial strength continue to be recognized by the rating agencies. In last week, we were placed on review for upgrade by Moody's. We look forward to continuing our dialogue with the rating agencies and are optimistic that our positive momentum will continue.
Lastly, as detailed in yesterday's press release, I am pleased to report that we have entered into a reinsurance transaction in which we will cede our closed block long-term care business to Beechwood Re. We will provide more details on this later in the presentation. Turning to slide six. As I previously mentioned, we have been investing in our business platform to enhance growth, and we are pleased with the results that we have seen across a number of different measures. Sales increased by 5% in 2012 and 6% in 2013. Collected premiums in our core business segments, excluding annuities, increased by 3% in both 2012 and 2013. Lastly, despite a prolonged period of low interest rates, we have been able to grow our annuity business.
Annuity assets under management increased by 4% in 2012 and 1% last year, with increases in indexed annuities partially offset by declines in fixed annuities driven by low market interest rates. These results are confirmation that the investments we are making in agent recruiting and productivity, branch expansion, new product introduction, and enhancing the customer experience are working. As I mentioned in our 2014 outlook call, we will be accelerating investments in these areas. Yesterday, we announced that we have entered into a reinsurance agreement in which CNO will cede 100% of its closed block OCB long-term care business to Beechwood Re. This is an important step in accelerating OCB runoff as the liability profile of long-term care is quite specialized. As we have said before, it was unlikely that we would have a global solution for OCB given the various lines of business and legal entities involved.
Coupled with settling the outstanding material class action litigation in OCB, this transaction allows us to focus on the variety of options we have to further accelerate the runoff of the fixed annuities, traditional life, and interest-sensitive life products that remain in OCB. The LTC transaction involves approximately $550 million of statutory reserves or roughly 10% of OCB's overall reserve. Also important to note, this transaction reduces CNO's consolidated long-term care exposure by 12%. On a pro forma basis, this transaction is accretive to 2013 pre-tax earnings by approximately $5 million and increases 2013 return on equity by roughly 25 basis points. The transaction does not have a material impact to either GAAP leverage or consolidated risk-based capital. This transaction was structured to provide significant safeguards for the company and policyholders. The assets will be held in market value trusts with over-collateralization.
These trusts are subject to strict investment guidelines and periodic mark-to-market true-ups. All required regulatory approvals for the transaction have been received. Fred will go into more details on this transaction later in the call. 2013 was another outstanding year for CNO. We increased operating earnings per share and return on equity while growing book value. We have been able to further lower our overall cost to capital while improving financial strength and ratings. We achieved all of this without having to sacrifice growth. Our balanced approach to investing in growth, improving financial strength, ratings, and returning capital to shareholders continues to pay off. CNO's 2013 total return was 91%, exceeding the peer group average, and follows our sector-leading performance in 2012. Let me now turn it over to Scott to discuss our core segment results in more detail. Scott?
Thank you, Ed. Bankers Life results were again positive in the quarter. Total sales were up 7%, driven by continued strength in health sales, which were up 6% overall. This increase was driven by Medicare Supplement, which was up 10%, but was partially offset by lower long-term care sales, which were down 5%. Medicare Advantage sales, which are not reported as NAP, but provide us with recurring fee income, experienced considerable growth during the period as well. On a policies issued basis, Medicare Advantage was up 53% over the prior year. Life sales were up 5%, and we continued to see growth in annuities, which were up 11% in the quarter. Our overall sales continue to benefit from an increase in our agent force and our branch expansion initiatives.
This continued positive momentum in sales resulted in collected premium growth of 6%, propelled by growth in nearly every product line. As I mentioned last quarter, is especially impressive given the continued decline in long-term care and the decline in Coventry PDP quota share premium, as that program has converted to a fee-only arrangement. Adjusted for these two decreases, Bankers' premium growth was 9%. Washington National had an exceptional fourth quarter, as sales were up 15% in both of our sales channels recorded double-digit growth. PMA sales were up 13%, and our independent partners channel was up 24%. Voluntary worksite sales were up 29% in the quarter and benefited from increased group enrollments. Sales growth and continued strength and persistency contributed to collected premium growth of 8% over the prior year. Growth in our PMA agent force was also strong, with producing agents up 10%.
Moving on to Colonial Penn. Sales were up 3%. This was below our expectations as we experienced a challenging television advertising environment during the quarter. Lead generation efforts faced incremental ad spend by general advertisers, which reduced available air time in the quarter. In addition, we also saw an increase in life insurance direct response advertising from other carriers. These factors led to increased marketing costs and negatively impacted lead generation and conversion. Despite this lower pace of sales, Colonial Penn recorded collected premium growth of 6% and experienced in-force EBIT growth of 9%. Before I wrap up, let me speak briefly about our long-term care strategy. As we have said in the past, long-term care insurance serves an important role in the retirement care and security of the middle market.
Middle-income baby boomers greatly underestimate the likelihood of one day needing long-term care, and many either incorrectly think that Medicare will pay for ongoing long-term care or simply do not know how they will fund their care. Having a robust marketplace that includes private long-term care options is important for our country, as it will reduce the burden on already strapped state Medicaid programs. Despite this growing need, long-term care presents many challenges as insurers work to balance the need to price products profitably with providing affordable solutions for consumers. While new products currently offered in the marketplace are significantly different than products of the past, older blocks of the business continue to be challenging, recognizing that re-rate actions are becoming increasingly more difficult in the current regulatory environment. At CNO, we continue to actively work our in-force block via rate actions and diligent claims management.
Our current long-term care products generally provide limited benefit periods. This is slowly shifting our in-force to a lower overall risk profile. Over the long range, we are focused on working with the regulators, legislators, and industry partners to address this important need. CNO remains committed to serving the needs of its customers by offering long-term care products. Turning to slide 13. Our business segments accomplished much during the year. At Bankers Life, sales for the year were up 6%. We grew our agency force by 3% and increased the number of branches and satellites to a total of 301. Washington National introduced new products and had a successful recruiting year. This resulted in record-breaking sales for Washington National as they posted growth of 9%. Although 2013 sales growth at Colonial Penn was below our expectations, collected premium growth was up 7%, and in-force EBIT grew by 14%.
As I detailed in our outlook call back in December, we expect this positive momentum to continue into 2014. At Bankers Life, while we will continue to look opportunistically to add locations, we will begin to shift investments towards initiatives that are focused on driving increases in agent productivity. We will continue to emphasize advanced life sales training and will launch a new branding and digital marketing program. Lastly, we plan on making investments to drive growth in agents that are also registered as financial advisors. These initiatives, taken together with the ramp-up of our new branches and satellites that we have opened over the last two years, should generate sales growth of 6%-8% in 2014. At Washington National, we will be introducing new group underwritten supplemental health insurance products, enabling us to acquire accounts in which it is required that all employees have the opportunity to purchase coverage.
In addition to our work site expansion plans, we will drive growth in our own agency distribution through initiatives to increase sales in the individual market. This includes development of a new program to recruit agents experienced in marketing supplemental health insurance as their primary product line. We will also continue developing new field leaders and relocating talent to underserved areas to increase our geographic coverage. These initiatives should result in 2014 sales growth of 7%-9%. At Colonial Penn, we will be closely monitoring and managing our television ad spend and will tactically adjust marketing activities based on market conditions. While it's still early in the year, we continue to project full-year sales growth in 2014. However, if we are unable to achieve our targeted pricing returns, we will reduce advertising spend. This will likely result in lower sales.
At the same time, we will continue the expansion of our Patriot program, diversify our lead activity by growing our non-TV lead sources. Further increase our online presence. These efforts should drive improvements in our overall lead generation and conversion rates. We continue to expect a modest EBIT loss of approximately $5 million in 2014 at CPL. Let me now hand it over to Fred, who will discuss CNO Financial's investment results. Fred?
Thanks, Scott. CNO recorded another strong quarter on the earnings and capital front. If you adjust for the significant items in the quarter, we recorded operating earnings of $0.31 per share. This quarter's significant items included favorable development of prior period loss reserves in our Bankers Medicare Supplement business, offset somewhat by reserves established for certain remediation efforts also impacting the Bankers segment. OCB recorded a one-time reinsurance settlement related to legacy life insurance policies. Overall, margins performed as expected in the quarter and consistent with what we highlighted during our December outlook call. We completed our loss recognition testing as well as preliminary cash flow testing with no significant adjustments. I'll cover this in more detail in a few minutes. Core capital ratios and holding company liquidity strengthened.
We repurchased $31 million of common stock in the fourth quarter, coming in a bit lower than our normal quarterly pace, but consistent with our tactical approach and our annual guidance. As indicated during our outlook call, there were several positive tax developments impacting net income, which I'll touch on in a moment. Finally, we took an important initial step in addressing our runoff businesses, executing on one of our more complex blocks. Let's turn to slide 15 to go into greater detail on the OCB long-term care transaction. To be clear, the transaction involves only our closed block LTC reserves reported as part of our OCB segment and does not involve our Bankers Long Term Care business. The 100% coinsurance agreements moved roughly $550 million of statutory long-term care reserves off the balance sheets of two CNO legal entities.
About two-thirds of the reserves came out of our Washington National legal entity, domiciled in Indiana, and the remaining from our smaller New York legal entity. The reinsurance agreements required approval by the New York Department of Insurance and review by the Indiana Department, a rigorous process that we believe reflects well on the financial integrity of the transaction. We have confidence in the financial and operational management of Beechwood Re and their business partners. However, our structure recognizes our counterparty is not currently rated, and like many reinsurance entities, domiciled and regulated offshore. As a result, we built in protections where assets in reserve credit trusts and supplemental over-collateralization trusts secure and effectively credit enhance the structure. Reserve credit trusts are regulated as to asset quality, so-called Regulation 114 trusts in New York, for example, and the supplemental trusts are governed by somewhat traditional general account investment guidelines.
In addition, both trusts are market value trusts with quarterly maintenance provisions that ensure asset values are adequate to provide reserve credit and to secure associated reinsurance receivables. The pro forma impact of the transaction is rather modest overall. The net loss on the transaction was a little over $65 million, and statutory capital transferred was $43 million. Recognize this business generates a modest loss on a statutory basis, and there is a natural bid-ask on underlying assumptions used for valuation. The transaction had no material impact to leverage and RBC and is marginally accretive to both GAAP and statutory earnings. Turning to slide 16 and our segment earnings, Bankers' EBIT benefited from continued strength in Medicare Supplement and annuity margins, while long-term care benefit ratios have stabilized and are consistent with our experience in recent quarters.
Washington National posted a solid quarter of collected premium growth in their supplemental health business, and benefit ratios recovered somewhat from their elevated levels in the third quarter. Overall, our normalized health margins came in as expected, and we would not adjust the guidance provided during our December outlook call. Colonial Penn reported a loss in the quarter. As Scott noted, the pace and effectiveness of ad spend in the second half of 2013 impacted both sales results and earnings. Our corporate segment experienced strong investment results as we have proactively put some of our excess liquidity to work in the form of alternative and equity-oriented investments. Before I leave this slide, it provides a helpful picture of the natural seasonality in our results and expected drop-off in earnings for the first quarter.
The seasonality in our results is driven by the combination of Bankers Medicare Supplement enrollment dynamics, Colonial Penn's seasonal ad spend, and mortality, which tends to be elevated in the first quarter. Turning to slide 17 in investment results, we put money to work at higher rates than our full year expectation of 4.75%. Slowing turnover allows us to be extremely tactical in our investment decisions. Invested assets are up year-over-year, driven by steady aggregate growth in our in-force business, and prepayment income was modestly favorable. Realized gains were elevated due in part to readying for the transfer of cash and assets in support of the long-term care reinsurance transaction. Impairments were a bit elevated, but not out of the ordinary and were concentrated in just a couple of holdings. Overall credit conditions remain favorable.
Slide 18 profiles our loss recognition testing results and comments on preliminary cash flow testing. Our GAAP loss recognition testing margins in aggregate remained strong and increased over last year. This largely the result of net new business and net favorable policyholder experience. The interest rate recovery had very little impact on our loss recognition testing results. Although our 2013 performance exceeded our previous estimates, we did not materially change our new money rate assumptions since they already reflected continued recovery in 2014. Cash flow testing margins also improved, in this case, supported somewhat by the interest rate recovery as well as other favorable policyholder experiences. Cash flow testing is done on a legal entity basis, with all insurance entities passing the standard scenarios. There was very little in the way of adjustments to asset adequacy reserves in 2013.
The chart here on this slide shows our loss recognition testing results on a line of business basis. As you look over the results, you quickly conclude that OCB Interest Sensitive Life and Bankers Long-Term Care have the lowest margins and are therefore vulnerable should conditions deteriorate. The remaining lines of business are quite healthy and able to withstand stress testing. Let's turn to slide 19 and take a deeper dive into Bankers Long-Term Care results. Before diving into these statistics, let me give you some helpful perspective. First, understand over the past few years, our sales mix has shifted towards short-term and less comprehensive product. These products contribute much less in the way of dollar-based margin, but also carry far less tail risk. In determining assumed rate increases for our margin testing, we only reflect a continuation of rate increases already presented to the states in past filings.
We did not assume any new rounds of rate increases. Accordingly, rate increases contributed very little to our estimated margin. We continue to believe that rate increases will be challenging. Should the environment for increases change, we would enjoy margin upside. We have updated certain mortality and morbidity studies. Our assumptions are based on those studies and do not reflect future improvement. Finally, we have seen a level of increased persistency in recent quarters, pressuring our benefit ratios and have assumed higher persistency in our estimates. Our current loss recognition testing margin for Bankers LTC is only about $250 million, thin when considering the size of the overall reserves and sensitivity to key variables summarized on this slide. Of particular note is nursing home inflation, which represents half of our tested liabilities and is far more sensitive to assumptions.
From a cash flow testing standpoint, Bankers Life benefits from being able to aggregate its long-term care results with Medicare Supplement for legal entity reserve adequacy purposes, thus enjoying ample margins. This drives home how important it is to have a diverse suite of retirement health products in serving the middle market. What's the overall assessment? We need to continue to be diligent in working all aspects of this business to preserve and produce greater actuarial margins. Slide 20 profiles our capital position. We ended the quarter with an RBC of 410%, up considerably over 2012 year-end. Reaching the 400% milestone is meaningful in that it paves the way for further upgrades and is consistent with our risk management practices. Our RBC benefited from strong statutory earnings in the quarter and favorable trends in required capital, including capital supporting our commercial mortgage portfolio.
Leverage dropped below 17%, reflecting retained earnings in the period even after our reinsurance transaction. We continue to amortize debt per our agreements. We ended the quarter with over $300 million of liquidity and investments at the holding company and would size our deployable capital at approximately $160 million. We are in a strong capital position and remain dedicated to securing investment-grade ratings over time, a goal we believe is critical to unlocking additional shareholder value. Overall capital generation remains strong in the $500 million annual range, and deployment in 2013 was balanced but favored share repurchase. We provide share repurchase guidance during our outlook call and expect to enter back into the market during the first quarter. Slide 21 provides a current view of our tax assets. As mentioned during our outlook call, this has been an active year on the tax planning front.
During the year, we settled on disputed item with the IRS. Together with continued growth and taxable income, supported a sizable valuation allowance release and related economic value. In the fourth quarter, we executed on a trading strategy to more fully utilize tax assets set to expire at year-end. The investment strategy yielded a valuation allowance release in the fourth quarter of $65 million, an economic benefit approaching $50 million. In total, these activities resulted in the release of approximately $300 million of our valuation allowance during 2013 and extended our cash flow benefits by another full year. As noted in our outlook call, we eventually become a more considerable taxpayer in 2016, estimating about a $50 million annualized drag on our free cash flow as we begin to pay more cash taxes.
Turning to slide 22 in ROE development, we calculate ROE on a trailing four-quarter basis, adjusted for AOCI and the carrying value of our NOLs. Our normalized operating ROE traveled in the mid 8% range as we closed out 2013 and benefited from both favorable earnings performance and significant capital actions. We have made great progress towards our 9% run rate goal by the end of 2015, recognizing we are running off significant blocks of business, have accelerated investment in growth and infrastructure, and have built up capital in support of investment-grade ratings. The two levers we continue to monitor are OCB Solutions and the potential for another recapitalization. This quarter is a good example of progress on both fronts, with the OCB LTC transaction helping our ROE and Moody's placing our ratings under review for upgrade.
The key variables on any recapitalization are cost of capital, structural flexibility, and opportunistic deployment. All three need to come together to be impactful. We remain focused on a few simple drivers of sustainable shareholder value, building ROE while lowering the beta in our business, and unlocking value through executing on OCB strategies, leveraging our tax assets, and effectively deploying excess capital. With that, I'll hand back to Ed for some closing comments.
Thanks, Fred. Some might say we had a gold medal year in 2013. We finished the year strong and see significant opportunity ahead in 2014. The Closed Block Long-Term Care reinsurance transaction paves the way for us to further accelerate the runoff of our OCB Closed Blocks of business. As I have said in the past, the combination and alignment of exclusive distribution, a suite of products that serve the needs of our target underserved middle markets, and a back office that is aligned with serving the needs of our customers and agents, provides us with sustainable competitive advantage. We will continue to invest in initiatives that will increase the reach and productivity of our agency force and in initiatives that will drive increased back-office efficiency while improving the customer experience. We feel these investments will enable us to continue to achieve sales growth that is above the industry average.
Our balanced approach to deploying excess capital over the past couple of years has been successful. Since 2011, we have repurchased $845 million of common stock and equivalent, and we initiated a common stock dividend in 2012 and increased it in 2013. At the same time, we have paid down a significant amount of debt, and leverage now stands slightly below 17%. We have built capital in our insurance companies to support growth and drive RBC to over 400%, and we have increased liquidity at the holding company to more than $300 million. We believe that our business model, risk profile, and financial metrics are consistent with investment-grade ratings. We continue to believe that there is substantial shareholder value to be unlocked by building book value and return on equity while further lowering the beta in our business.
We took another important step yesterday when we announced our long-term care reinsurance transaction, we believe that there are additional levers that we can execute on to unlock additional value. We are optimistic that we can execute on additional transactions to further accelerate OCB runoff, continue profitable growth, leverage our valuable tax assets, optimize our capital structure, and deploy excess capital. Now we'll open it up for questions. Operator?
At this time, I would like to remind everyone, in order to ask a question, press star, then 1 on your telephone keypad. Your first question comes from the line of Erik Bass.
Just for the long-term care transaction, can you talk a little bit about how you thought about the trade-off between the reduction in GAAP equity and the increase in ROE and potential risk reduction benefits? As you explore potential future transactions within OCB, how do you weigh those different factors?
Yeah, Erik, thanks for the question. This is Ed. I'll start off. On the OCB LTC, we really looked at it from the standpoint of our risk profile. Here we had done a lot of work to stabilize and reduce volatility in this block. It was more the fact that we are reducing our exposure to closed blocks in LTC without sacrificing on financial terms.
Erik, as you know from following us, we've said this before, we are at the core economic-driven. We pay very careful attention to the GAAP outcomes of the transactions we look at. At the end of the day, we're trying to drive IRR, particularly if there's going to be a use of capital involved in the transaction, which was the case here. What's important to focus on is that this is a business that from a long-term care perspective, while it's stable and a bit more predictable because of its age, and that I think that lent a lot to being able to do a transaction. It's also a business that runs an interest-adjusted benefit ratio in the 120%-140% range from quarter to quarter.
It's a business that's in a negative statutory earnings position, and therefore, you naturally will appraise it out to contributing some level of capital as part of transferring the business. We looked at it from a sort of a traditional capital deployed payback period IRR to make sure that it was at least falling in line with what our expectations are for use of capital, and it does. Very importantly, and arguably more importantly as Ed's comments, that overall it has to do with us making moves that make sense to lower our exposures, in this case, long-term care exposure, but also with it, interest rate risk exposure as well as just pure asset leverage. We have asset leverage on runoff non-strategic blocks of business. We have to invest those assets in a way that generates returns to support the liability.
By definition, you need to go somewhat out on the credit curve to support the business like any other insurance business. The fact that this is in runoff and non-strategic means that when credit cycles return, which they will, it's particularly painful when it's on something you're running off that's less strategic. On top of that carries long-term care volatility potentially. For us, it's been priced appropriately for both sides. For our side, it's been priced appropriately to be attractive for Beechwood as well. For us, it's a lot around risk management.
Great. Well, thank you. That's very helpful color. Can you quantify maybe the difference between the stat and GAAP reserves for the remaining blocks within OCB?
Not off the top of my head. I would say this, that generally there's not a tremendous amount of difference, but there is a difference. The primary difference would be the best estimate-based reserving on a GAAP basis, which would generally lead to a lower level of reserves, if you will, as compared to more standardized and required typical reserving standards on statutory. That's one difference. In the long-term care block, that's a good example as to why you see lower GAAP reserves than you would see the transferred reserves in the transaction. Difference between best estimate reserves and standard approaches to statutory reserving. The other component would typically be things like DAC and PVFP, but in this particular case, most of these runoff blocks have less in the way of those types of assets, have either been written down previously or taken care of.
We've tended to talk about this as having generally around $5 billion of total reserves in OCB, of which this was around $550 million of it. That gives you some idea of the reserve levels.
Perfect. If I could just sneak in one last question. If capacity were available, would you consider reinsuring a portion of the older Bankers LTC block?
Our general rule of thumb is if there is an economic benefit to the company to look at that kind of a solution on a risk-adjusted basis, we would, like I think any company, entertain it. What I would say about this deal, I think there's the notion that this may be perhaps a watershed transaction that could lead to further long-term care closed block reinsurance transactions. I think that would be a bit of a jump from my view. The reason I say that is because this is an older block in runoff with relative stability around the variables that tend to push long-term care performance up and down.
The age of the block, the stability of it, the age of the actual policyholders themselves, a number of things that causes a more narrow spray of outcomes, if you will, on core assumptions that bake into the valuation. The other thing I would say about this block is in order to do a reinsurance transaction, it starts with are you properly reserved on a conservative basis? Otherwise, the bid-ask is going to be dramatically different between a prospective buyer and a prospective seller. To me, this speaks very well for our company's reserving practices and the attention we pay to managing these blocks of business that you could actually even reach agreement with another party who has enlisted third-party actuaries to look over the shoulder of the transaction. This block had unique characteristics that made it doable. It's also small.
For us, that made a difference because we could structure a deal without outsized counterparty risk to manage. For the reinsurer in this case, they could move into a line of business and work it and explore it without taking undue risk by taking on a big block. I think there's some unique natures with this block. We'll see. Should it be successful, it may open the door for looking at other opportunities as an industry.
Great. Very helpful. Thank you.
Your next question comes from the line of Randy Binner.
Great. Thank you. Good morning. I wanted to ask a couple questions related to capital and how the ratings outlook is looking. First, just on the RBC ratio, the first question is on the MIP or how commercial mortgage factors in. Could you quantify how much that supported the RBC ratio this quarter? The next question is, when Moody's put out their credit watch positive, they identified a floor of 320% for an upgrade on RBC, which seems low relative to the number that you reported. Can you help us maybe compare how their RBC may be different than the one that you report? I'll have a follow-up.
A couple things. One, the actual decrease in our required capital associated with the new mortgage methodology was just shy of $7 million of RBC decline. That equates to about 6 points of benefit in the RBC ratio this quarter. That's sequential. It's been a more sizable benefit over the course of the year. I would say it's probably over the course of the year approached nearly high teens or so of reduction in required capital, all told. It's been a clear contributor, but of course hasn't been the only contributor. In terms of your question about how to interpret a Moody's definition of risk-based capital. First of all, Moody's pays very close attention to our consolidated risk-based capital, and they, like any rating agency, factor that in and like to see the progress in it. They don't believe it to be a non-calculation.
What Moody's does do, as do I believe the other rating agencies, is they try to bust it down into looking at what the ratio might look like without consolidation benefits. As you may know, or many of you may know, if you consolidate various legal entities, you will pick up natural covariance benefits in the calculation of RBC. Those covariance benefits contribute to us generating a 410 RBC. It moves around a bit, but it's generally the case that we generate upwards of 50 points of RBC related to covariance benefits. If you're a Moody's or another rating agency that wants to back out that benefit, you'd back off those 50 percentage points. We don't think this is some sort of artful engineering that we're doing on covariance benefits. We haven't made this formula up.
We follow very strict practices as to how, in fact, covariance benefit works if you were to jam together the assets and liabilities of these various legal entities. From our perspective, we're reporting apples to apples with the industry when looking at other companies that have more large, singular legal entities and are afforded these covariance benefits. The one other caveat I would say is the agencies also look at individual company RBCs as well. Not surprisingly, they pay a little bit of careful attention to Bankers. The Bankers RBC ratio came in this quarter at 382%. They watch that because as you all know, Bankers, the legal entity, generates a good portion of the cash flow capital generation of the company.
Yeah, Randy, I would just add that consolidation covariance benefit and the way we calculate it is also recognized in the capital markets and is part of our credit and debt structure.
Well, great. That's a good kind of segue into the second part of my question because obviously, the covariance is real, if they chose not to look at it, that's fine. It's a situation here from a capital perspective where your debt to capital is going to keep low going down throughout the year to almost an inefficient level. It's three notches for Moody's and two for S&P to get to investment grade. I guess I'd be interested in any thoughts you have on the ability of the company to recap as a high below investment-grade issuer with almost investment-grade issuer terms, or if it really is a technicality that you at least have to be split-rated below investment grade to be able to do the recap.
I mean, it's a good question. I'll give you my perspective on it, Randy, that is that the bond markets have a nice ability to, within reason, pierce through the actual ratings of the company to assess the credit strength of the underlying property. We actually saw that in the last recapitalization and even refinancing we did, where clearly, I think the pricing we received, and even to some degree, the flexibility and terms were arguably a good notch above what we are actually reported at because you see some of the bond market and the lending market react to our favorable progress. As a result, it's not just a matter of when we receive investment grade, because we will eventually, that we're going to ring some big bell and go to market. We're going to watch things very carefully along the way.
I'm after some very simple things, I mentioned them in my comments. One, I want to see that I have a material benefit to my cost of capital because I know there's a cost associated with recapping the company, I want that cost recovered quickly, I want it to lower my permanent cost to capital. I want to watch that. The second thing is we really would benefit as a company from greater flexibility in the structure. Things like sweeps and baskets, which actually do come into play when we're looking at opportunistically deploying capital, are things that we need to adhere to that we're not real fond of. We also have awful lot just structure. We are in no risk of breaching covenants. We have substantial room and cushion, as you can imagine between covenant structures.
Just having a lengthy set of covenants is not a good position to be in. It's even an optically bad position to be in because it actually causes in a circular way the rating agencies to look at your financial flexibility as being somehow less flexible. With that, I'd also like to string out maturities to some degree. It's not just a matter of the fact that we have to amortize our debt. We also have some limits as to how far out we can go with our debt. I'm constantly having to stare a few years out to a fairly large maturity, and I need to be very careful about that. Those are the things I'm after.
If I can get those types of structural things before I reach the promised land of investment grade, we'll do what you would expect us to do. We'll go out to market and make it happen. Right now, that's not quite the case. We still have a bit more work to do, but we'll keep watching the markets carefully.
I appreciate the commentary. Thanks.
Yep.
Your next question comes from the line of Christopher Giovanni.
Good morning. Thanks so much. I guess question for Ed. I know in the past you've talked about looking to potentially try and bundle some OCB blocks to accelerate the runoff. I'm wondering if that's still the strategy or if we should think that based on dialogues, maybe that approach has changed. Recognizing LTC certainly was a bit unique, but I guess on a go-forward basis.
Yeah. Chris, I would say, similar to Fred's comments about the next recap, it will be opportunistic and try to optimize value. If bundling traditional life and interest-sensitive life insurance together, for example, gives us a better economic outcome, we'll entertain that. If also including the fixed annuities in the equation helps the economic metrics and outcomes, we'll do that. The converse is also true if we feel that we can optimize value by more than a bundled transaction, so one or more individual transactions, that's what we constantly assess is, as Fred said, we're driven by the IRRs and the shareholder value that's created out of a transaction or transactions.
Okay. You noted, you have gotten the regulatory approvals. The regulators for a number of other transactions in the space have been very involved as you would expect, but in some instances, maybe putting additional covenants or restrictions around transactions, be it whether it's a private equity player or even traditional players. Anything you guys are learning as you went through this process with LTC that you need to be mindful of when you think about other pieces of OCB?
We actually had a very good experience, I would say, in total, going through the regulatory process on this long-term care transaction. By that I mean, not that there was complete agreement in every line item of the document and not that there wasn't extensive exchange of information, questions, and detail required, but rather that it typically benefits you when you are aligned, meaning CNO has every interest to protect the financial integrity of our New York and our Indiana domiciled legal entities, therefore, structured at the get-go a transaction that we fully expected to be acceptable through the regulatory process. I also want to also make that same comment about Beechwood Re and the folks on their side.
They enlisted several different specialists surrounding their team, were quite helpful in working with us to together make it through the regulatory process and answer the call on all the questions. As you can imagine, the regulators had as many questions and requests for information around Beechwood Re and their entity as they did on the pro formas of this transaction. A, be prepared, and B, make sure you understand the perspective the regulators are coming at when it comes to protecting both policyholders and the legal entity. We did that quite successfully. We, for example, did not come out of this transaction with any sort of mandated requirement or threshold or outside the normal regulatory dynamic request of this transaction.
More so it was really clarifying, fine-tuning, getting language and compliance, expanding upon certain elements of the transaction to be more clear as to how it was going to work. It was a good experience.
Yeah, Chris, I would just add that the credit enhancement by being over collateralized by 7% is also very much at market. I think that outcome shows, I'll say, the beauty of alignment between the regulators, us, Beechwood, and the interest that we had to protect the companies and the policyholders.
Great. Just two quick ones on LTC. Fred, I think you made the statement you're still comfortable with that 79% interest adjusted benefit ratio. Just wanted to confirm that just based on the consistent comments you guys have made around rate actions really starting to slow. When you did the margin testing for LTC, you noted certainly higher persistency. Wondering if you can quantify what's embedded within your assumptions for persistency or lapses.
Sure. Yes, we are sticking with our guidance. I think our guidance specifically is 79% range, and what we recorded in the fourth quarter is consistent with that. To the degree it was pressured up in terms of being 80%, it is the same sort of pressure that we have been experiencing. Actually goes to your question somewhat, Chris. It's the same pressure in that as we've seen a slight or gradual tick up in persistency on certain pieces of our business, most notably, nursing home inflation and nursing home non-inflation that have pressured our benefit ratios. That's really been the primary driver of the slow escalation in benefit ratios since last year this time, and we believe it to be certainly in part due to the slowing, if you will, of rate increases.
In terms of our assumptions, the best way to talk to it is the notion of an ultimate lapse rate assumption, and we tend to assume just a little north of 1% ultimate lapse rate assumption. You've noted here in the document that we have done a stress test on that. The idea of ±10% lapse rate adjustment will tend to hover in and around 20 basis points, give or take, of movement in that lapse rate expectation, and that generated the ±$55 million of margin. Something I would say, I think something that you're typically going to want to do, and we perfectly understand that, is compare assumptions across the industry, right? To try to assess what may be aggressive and not so aggressive.
I think there's a be careful in doing that, whether you're talking about CNO or any other competitor in the marketplace, and that is, it may have a lot to do with the nature of the blocks of business, and even how those blocks of business are sold and where they're sold. For example, with us, that lapse rate being a bit north of 1% is just simply predicated on what we have experienced in our block, realizing that we sell into the middle market. The middle market, which has an affordability dynamic associated with it, will tend to naturally travel a little tick up in the way of lapsation just by virtue of the way the marketplace works. That's just a good example of how you could have two assumptions that are seemingly different. I would say the same goes for things like mortality and morbidity.
It's not just a matter of whether our not including a morbidity improvement is being conservative. It's also a factor of having studied our block of business and not seeing certainly pronounced or repetitive trends that would suggest morbidity improvement is going to happen in our block, and therefore, we don't believe it's supportable to assume that in our block. That doesn't mean that other blocks of business aren't seeing or experiencing that in the studies being conducted. Just a bit of an editorial comment as well as answering your question.
Okay. The older age of your block, does that influence it as well?
It could. It certainly does have different dynamics related to that. Yes, it could absolutely. One of the things I think about with the older age of the policy holders as well as the older age of the blocks themselves, is that you just sort of gradually gain a little bit more confidence in what you believe the spray of potential outcomes can be over time. I think one of the things that can be dangerous or more dangerous, certainly by having a younger age population of selling product to, is there's an awful lot of years to play out to your favor, and there's an awful lot of years to play out to your detriment.
Great. Thanks so much for the comments.
Your next question comes from the line of Mark Finkelstein.
Hi. Good morning. I guess back to the LTC transaction. Obviously, you went through a pretty thoughtful process in vetting the reinsurer and putting in place your own protections. Obviously, the risk there is also things go bad and the reserves come back to you. In thinking through that, and I know you, in answering Chris's question, talked about 7% over-collateralization as being kind of in line with market. My question is, how did you get comfortable that 7% generally was the right number of over-collateralization? Secondly, what other forms of due diligence got you comfortable in looking at the balance sheet or the mix of business that's in Beechwood, I know it's a new entity, on that overall?
Yeah. A few things, I'll paint a picture for you. One is, we of course, wanted certain levels of assurance around the type of initial capitalization that would be placed in the vehicle to support our business and any other business that's written. That's somewhat of a private matter from our perspective, but I can assure you that those types of questions and exchange of information not only happened with us, but also with regulators who are trying to assess the type of capitalization that is expected to be maintained over time in a way that they can understand best, right? Information there. Initial level of capitalization. Realize that we, in this particular case, are sending some level of capital over with the actual transaction itself, so that ends up being an additional capital infusion naturally as part of the transaction. Third, the over-collateralization of 7%.
There's a bit of a mechanical approach to that, Mark. Not entirely unlike the kind of mechanics you would see in, say, CDO technology, and that is, what's the expected level of over-collateralization that brings the counterparty risk up to, let's call it conventional A-rated standards.
These deals have been done in the marketplace, as you can imagine, with unregulated offshore and oftentimes newly formed entities, more so these days than ever before. Somewhat of a convention has been built up around the level of 102% not enough, 115% too much. What is that right amount of over-collateralization to dial in that kind of counterparty risk? Now, importantly, as you mentioned, there's a few other things to take note of. One, these are market value trusts, and so there's a natural true-up process that takes place every quarter should there be fallen angels, should asset classes fall out of favor. Obviously, there's potential for interest rate risk. These market value trusts, in the true-up provision, helps to assure you a certain level of credit integrity, if you will, as you go.
114 Trust in New York and similar styled trusts in Indiana, which represents the vast majority of assets involved here, already have strict limitations as to what can be put into the trust and what it needs to look like. On top of that, we have aggregate investment guidelines, and those are simply meant to mirror traditional general account asset allocation. It's just simply to say that we would not be comfortable if this was a transaction that was, say, levering off of an asset strategy that we thought was aggressive or unique, or even potentially less liquid. That's not the goal of Beechwood. That certainly wouldn't have flown through regulatory dynamics. We have all those protections.
Okay.
I'd add to that, Mark, that Fred alluded in his comments earlier about the partners that they've brought in, and advisors. Certainly, knowing those advisors and what they have worked on, and their credentials played a part, as well as is typical with reinsurance arrangements, there's the rights that we have to certain information and rights to review and audit. Those typical protections are there as well, that help the overall credit evaluation.
Okay. That's very helpful. On long-term care testing results, the asset adequacy testing that you did at year-end, I understand how it works and that you were able to kind of look at it with MedSup, et cetera, on an entity basis. Do you have any sense of, if you had to look at long-term care standalone, what, if any, impact there would've been, and if so, how much you would've had to add?
Yeah. On a standalone basis, the long-term care business passes the level scenario, for example, which arguably is a form of stress scenario, i.e., holding current rates level indefinitely. That gives you, just on the surface, a level of comfort with the asset adequacy on a standalone basis. However, it is absolutely true that under additional stress tests of the so-called seven interest rate tests that are commonly done.
Right
for example, that there are, in fact, some of those tests which would challenge, certainly, the asset adequacy on a standalone basis. Really requires, if you will, borrowing, if you will, or aggregating with the MedSup excess margin to pass all those standard scenarios. Mark, that's the way I would characterize it. Remember, when it comes to asset adequacy testing, it's not as simple as pass or fail, add or don't add. What can happen, and commonly happen, is that you pass these tests, but upon stressing the block, you as the appointed actuary would simply feel more comfortable with adding to the reserve levels. As I mentioned in my commentary, we certainly have not done that to any great degree, really just marginal movement in our asset adequacy reserves this year.
We wanted to make a point here on this call that, yes, margins improved year-over-year, including on long-term care. Yes, we have passed the appropriate scenarios that protect us from both a GAAP hit and statutory adding to capital. We also want to make the point that under our current assumptions, these remain thin margins, and this remains a business that we have to watch very carefully, which really is in part the driver of making sure that we've got adequate risk-based capital as a company.
I guess just maybe following up on that, I understand the level of comfort you get if rates stay flat, it operates okay on a standalone basis, it is a test that has to be looked at objectively from the chief actuary. If it was looked at on a standalone, you did go through this New York seven, would the increase have been a large number, moderate number? Any way of framing out what it would've been?
I don't have a way of really describing that for you. I think what you're asking is if you were to pick up this business, plop it in New York and test it out, would it have resulted in kicking up capital? I think that's kind of a hard one for me to answer right now, I don't have a good feel of what that would look like, Mark, and whether or not we would need to add materially to reserves under that scenario.
Okay. My final question, very quickly, is when you look at the rest of OCB, now that you've gotten rid of or reinsured the long-term care block, are there any other discrete blocks that generate statutory losses, or does everything else generate statutory income?
It's a good question. Based on what I know of the lines of business now, let's separate out one thing. There are some very small, little health-related businesses that can fluctuate, and I would suspect move in and out of very minor loss or profit positions depending on the quarter. Those are very tiny sort of slivers.
Right.
The major business is traditional life, is a business line, interest-sensitive life and annuities. Annuities is a ongoing profitable business for us from a run rate perspective other than the natural runoff of the business. Traditional life is generally a contributor to a level of profitability. By the way, traditional life is something in the $700 million-$800 million worth of reserves. Annuities hovers in around a little north of $1 billion worth of annuities in total. Interest-sensitive life is the big animal, right? That's about $2.3 billion of reserves. Interest-sensitive life's a tricky one, right? That's been a bit all over the map. For example, had it not been taking actions around non-guaranteed elements over time, that would be a business that would be more flatlined and potentially in a loss position.
It's in a marginal profit position. It is also a line of business, though, where mortality really can move around on that business, and so we will move in and out of quarters that are favorable and less favorable based on mortality. That gives you some color. I would call interest-sensitive life as volatile but intended to be marginally profitable. Annuity is profitable in somewhat traditional sense. Traditional life, I think, also the same way.
Okay. That's helpful. Thank you.
Yeah.
Your next question comes from the line of Humphrey Lee.
Good afternoon, guys. I guess just a quick follow-up on the long-term care insurance transaction. Was Beechwood the only reinsurer that was in the mix, or were there other reinsurers in the mix as well?
There were other parties looking at the transaction over time beyond just Beechwood. Generally speaking, what we found as an experience is that there is, and you all may be seeing this as well in the marketplace. There is, in fact, interest in long-term care blocks of business. That interest, in my view, is basically playing off the annuity-based, asset-driven interest that has emerged in the marketplace where those same players, these would be reinsurers that are toggled together with asset managers and have sort of a real asset-driven strategy that they're looking to exploit. Those same types of parties that have been doing transactions in the marketplace have found elements of long-term care blocks attractive, not the least of which is very long duration liabilities that could allow for asset strategies that would be beneficial to these parties.
There was a general attraction and actually has been in the marketplace to that kind of dynamic. What typically happens is they then turn their attention to the liability side, higher up the actuarial firms, and start to get very concerned very quickly as to how this will really work. Not to mention that the administrative dynamics associated with it are quite unique, specialized, and require partnering with a very specialized firm that does this for a living every day and in a large way, which is the case with Beechwood. That's exactly what they did, is partner with those right firms to gain that level of comfort, as Ed mentioned earlier. We saw multiple parties come in, and they spent some time on it and even priced out and offered up.
Beechwood Re, they really impressed upon us, one, took a lot more time and energy to really dive deep, enlisted, in my view, more in the way of expertise to dive into the dynamics of not just the asset side, but the liability side and the administration side. That level of investigation and detail, and partnership was what gave us more confidence and impressed us. That's really how this played out. There were multiple parties that had an interest, at least in the block.
The color is helpful. Another question. In the prepared remarks, Ed talked about with the reinsurance for the long-term care company in place for OCB. Now management can focus more on the remaining blocks of business and talk about some of the options. Can you comment on some of the options that you're seeing? Also, do you require high interest rates for some of these options to materialize?
Humphrey, on the second question, no, it's not necessarily dependent on interest rates. Hopefully, doing the LTC transaction in the current environment is an example of that. I think my answer largely is what I said before about how we look at the remaining blocks, which are the fixed annuities, traditional life insurance, and interest sensitive life. I think that they can be looked at separately and/or bundled two or all three together. I would say that the more traditional reinsurers definitely have experience and interest and do transactions with all three of those types of product lines, which is good for us as a potential seller. The other thing is that Fred just mentioned it, is certainly we know on the annuity side, there's been a lot of new entrants in that part of the marketplace, and we don't see that subsiding.
That's also good for us in our position of being a potential seller.
All right. Got it. Thank you.
Your next question comes from the line of Ryan Krueger.
Hey, I'll ask, I guess, another one on OCB. I don't think you have said how much statutory capital is backing the remaining liabilities, unless I missed it. Can you disclose that?
Yeah. Here's a couple of ways to think about it. One, here's the way to think about it. There's a couple legal entities involved, right? The two dominant ones now in particular, with the deal we've done, would be Conseco Life Insurance Company, which is an Indiana-domiciled company, and that is the legal entity behind the majority of the liabilities in OCB. I would suggest to you something in the neighborhood of $3.5 billion of the $5 billion is housed in some form in Conseco Life Insurance Company. Their total adjusted capital at Conseco Life Insurance Company travels right around $160 million right now. The remaining monies, let's take long-term care out of it since we just did a transaction. The remaining tends to be annuity business, and it is housed in Washington National Insurance Company, predominantly.
That's a little bit more difficult for me to sort of bust that down and assess the amount of capital backing that business. I'm not sure I would know even where to guess other than I would suspect it not to be a tremendous amount of business. Maybe, let's say, $25 million or so of capital. I'm going to completely speculate. That's maybe one way to think about it, Ryan.
Great. No, that's really helpful. Thanks. If I could just ask one more on the cash flow testing results because I thought that was really helpful. How should I think about sensitivity to mortality versus morbidity? I guess I ask because I understand it sounds like you haven't had much morbidity improvement of late, but I guess it sounds like you're also not assuming any improved mortality, and I was just trying to think about how those two differ from each other in sensitivities.
Yeah. First, to answer your questions right. We have not included any improvement in mortality or morbidity in our assumptions. What we do do with mortality, though, is we true mortality assumptions up for the most recent studies that are produced. In other words, we don't go off of, say, stale studies as to what the mortality should look like. We also look pretty heavily at our own mortality experience because as you get into, say, older age mortality, that's notorious for there being, say, less documented information around it and how best to understand it. We watch very carefully our own experience. I don't have a sensitivity for you on plus or minus mortality movements up or down over time. What we did on morbidity is a sensitivity as to 1% shift. I want to be very clear on what this is when we say shift.
What that mortality sensitivity is, it's not 1% per year improvement where you go out to year five or year 10. Let's use year 10 as an example, and our morbidity has improved by 10% come that time. This is a 1% shift where as you go out 10 years, we just assume what if it was just improved by 1% over our assumption and you run it all back, PV it all back. It's not a compounded, if you will, assumption. It's just a very straightforward shift, and that's why you get the lower sensitivity number. We haven't embedded any of that into our margins. We don't assume that because our studies don't suggest support for that at this time.
Okay, got it. Thanks for all the disclosure.
There are no further questions.
Thanks, operator, thanks everyone for your interest in CNO Financial Group.
Thank you. That does conclude today's conference call. You may now disconnect.