Good morning. My name is Shante, and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter and year-end results 2012 conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, 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. I would now like to turn the call over to Mr. Erik Helding. Sir, you may begin your call.
Good morning. Thank you for joining us on CNO Financial Group's fourth quarter 2012 earnings conference call. Today's presentation will include remarks from Ed Bonach, Chief Executive Officer, Scott Perry, Chief Business Officer and President of Investors Life, and Fred Crawford, Chief Financial Officer. Following the presentation, we will also have several other business leaders, including Eric Johnson, our Chief Investment Officer, available for the question and answer period. During this 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 this morning. We expect to file our fourth quarter 2012 Form 10-K and post it on our website on February 19th.
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, unless otherwise specified, any comparisons made will be referring to changes between 4Q 2011 and 4Q 2012. With that, I'll turn the call over to Ed.
Thanks, Erik. Good morning, everyone. The fourth quarter was another solid quarter of operating performance for CNO, topping off a very good year. Our businesses continued to perform well with consolidated sales, excluding annuities, up 7%, and operating earnings per share increasing by 39%. We continued to deploy excess capital during the quarter and returned $85 million to shareholders via stock repurchases and dividends while also paying down $32 million of debt. During the quarter, we increased our securities repurchase authorization by $300 million, and as of December 31st, had $350 million of capacity. We also continued to reinvest in our businesses by increasing marketing, adding new locations, expanding our geographic reach, and launching several new products. Scott will go into more details on these initiatives later in the presentation. Turning to the full year, 2012 was a year of accomplishments.
We achieved solid year-over-year sales growth, grew our agency force, and expanded our product portfolio. We greatly improved our financial strength and earnings profile as a company. We also were able to proactively address several legacy litigation issues during the year, which should lead to less volatility and enhanced flexibility as we move forward. The completion of the recapitalization further enhanced our financial flexibility. These efforts did not go unnoticed. We saw positive rating actions by all of our major rating agencies, including three upgrades. We returned a significant amount of capital to shareholders, nearly $550 million when giving effect for the third quarter convertible debenture repurchase. We enhanced the talent of our management team, hiring seasoned executives from outside the company while also promoting several internal executives as well.
Lastly, CNO achieved a total return of 49% during the year, far outperforming the S&P Insurance Index as well as our peer average. Turning now to slide seven. In addition to deploying excess capital into stock buybacks, debt reduction, and dividends, we are also continuing to invest in our businesses. We are making investments in initiatives that are increasing the productivity and size of our agent force while staying focused on profitable growth. We are increasing direct marketing, adding new sales locations to expand our presence in under-penetrated marketplaces, along with developing and launching new products that will meet the needs of our fast-growing target market. These investments are paying off. Consolidated core sales, excluding annuities, grew at an 8% compound annual rate since 2010 and were up 12% for the full year 2012. Turning to slide eight.
During the quarter, we produced operating earnings per share of $0.25, an increase of 39% over 4Q11. This meaningful increase was driven by the combined impact of increased operating earnings and a reduction in weighted average diluted shares outstanding. As we mentioned in previous calls, the low interest rate environment continues to be a headwind to earnings growth. Fred will discuss these items in more detail later in the presentation. Let me now turn it over to Scott to discuss our core segment results in more detail. Scott?
Thanks, Ed. I'd like to spend a few minutes talking about the significant accomplishments we've made across all three of our core operating segments in 2012. At Bankers, we grew our agent force by 6%, primarily due to increased productivity and retention. We added 25 new locations, bringing the total number of branches and satellites to 276. We introduced a new critical illness product in the first quarter, and it is now available for sale in 46 states. The launch has proven successful, with over $5 million of sales during the year. All of these achievements led to improved results, with NAP excluding annuities up 9%. At Washington National, core product sales increased by 13%. We achieved record high supplemental health sales and record high sales at our PMA and worksite channels. Our worksite sales growth for this year is far in excess of overall market growth rates.
At Colonial Penn, 2012 sales increased by 20%, fueled by our ongoing investment in direct advertising and enhancements that we have made to marketing materials. We launched a new term life product, and the rollout of our new customer relationship management system is resulting in significant productivity gains. Turning now to sales results at Bankers. As I mentioned earlier, our average agent force grew during the year, largely due to increased productivity and retention. Our unique distribution and marketing focus allowed us to pivot quickly during the prolonged low interest rate environment, which has been a drag on annuity sales. Sales excluding annuities for the quarter were $58.4 million, up 5% over the prior year. Much of the increase in sales was due to robust life sales, which were up 26% in the quarter.
Sales of our new critical illness product were strong, with nearly half of the previously mentioned $5 million in sales taking place during the fourth quarter. Medicare Advantage sales activity related to the annual election period was robust. As we have discussed in the past, Bankers partners with leading providers to sell Medicare Advantage and PDP. We currently have relationships with Humana, UnitedHealthcare, Aetna, and Coventry. We are also continuing our partnership selling of Humana Premier prescription plans in the Walmart locations across the country. We had a very successful annual open enrollment period for Medicare Advantage, and sales results, although not considered NAP, were up 32% over 2011. These MA sales are important as they allow us to reach, serve, and retain both new and existing customers. Turning now to Washington National.
Sales results for the quarter were strong. Sales of our core supplemental health and life products increased by 10%. This was primarily driven by continued gains in our voluntary and worksite distribution channel. The investments we are making to expand our life product offering are gaining traction. For the year, life sales totaled $6.7 million, an increase of 56% over 2011. We are also pleased with our recruiting and retention efforts. New agents at PMA were up 35%, in our partner channel, new partners increased by 19%. Slide 12 shows the sales results for Colonial Penn. 2012 sales growth at Colonial Penn continued in the fourth quarter, with sales up 11% year-over-year. The increase in sales is due to continued investments we are making in television and direct mail advertising.
Ongoing enhancements to direct mail kits, policy fulfillment packages, as well as the cutover to our new customer relationship management system continue to generate productivity gains for the segment. Although sales were down sequentially in the quarter, this is consistent with historical patterns. We also anticipate higher advertising spend in Q1, in line with seasonal expectations. We finished 2012 strong and are optimistic looking forward. Our strategy is focused on the rapidly growing pre and post-retiree middle markets that are being fueled by the aging of the boomer generation. This market needs the simple, straightforward products that we offer to address the things they are most concerned with, healthcare expenses, outliving their retirement, and providing a legacy for their families. Our segments are all well-positioned to meet these basic needs, whether through career agents, independent agents at the worksite, or direct.
In all three businesses, the capital deployment initiatives we identified to accelerate organic growth are progressing and ongoing. Bankers will continue to increase the number of locations and implement the manager trainee program, both of which will enable us to grow our agent force. Consistent with 2012 results, we expect to open an additional 25 new locations in 2013. While sales of annuities continue to be a challenge in this low interest rate environment, we are encouraged by overall agent force growth and our agents' ability to pivot within the portfolio, as discussed earlier. We are driving initiatives in 2013 to increase cross-selling activity and build on our success in the life insurance area with a focus on increasing premium per policy. Lastly, we expect this positive momentum to carry forward as our expansion location that we've opened in the last two years ramp up to full productivity.
At Washington National, we recently launched an innovative new critical illness product called Active Care, which has been well received by the field. We expect the increased focus and positive momentum in the voluntary worksite market to continue for both PMA and our independent partner channel. As the additional resources we've deployed fully ramp up, we expect the strong recruiting results to continue in both channels, and we expect that we will see additional recruiting gains in 2013. Finally, we recently teamed up with Olympic gold medalist Shannon Miller. This partnership will be positioned to help drive awareness of Washington National's presence in the supplemental health and worksite marketplace. At Colonial Penn, we will continue to invest in new lead generation and expect that advertising spend in the first quarter will be higher sequentially than in Q4.
We expect further improvements in sales productivity through the implementation of additional features of our new CRM system. We will be launching additional new products, as well as continuing our efforts targeting the Hispanic segment of our target market. Finally, last week, Colonial Penn announced partnership of the AARP Foundation Housing Solutions Center to bring better understanding of the senior housing issues. This effort further reinforces our commitment to the over 50 middle market. With that, I'll hand it over to Fred, who will discuss CNO's financial and investment results. Fred?
Thanks, Scott. CNO recorded another strong quarter that capped off a year of significant management actions and accomplishment. We recorded solid performance across all segments with net favorable results in core earnings drivers, including benefit ratios, investment income, and mortality margins. We enter 2013 in a strong overall capital and liquidity position, supporting our announced tender offer for our remaining outstanding convertible securities. Impacting net income was another reduction in our deferred tax valuation allowance. We had guided to a $12 million release in the fourth quarter. However, continued realized gains in excess of losses and a review of our state tax NOLs increased the total reduction in valuation allowance to $28.5 million. Continued profitability and consistent general account performance is allowing us to utilize these valuable tax assets.
When looking at normalized segment results, our underlying fundamentals continue to support growth in core earnings, while recognizing this was a quarter of strong net favorable performance in virtually all key earnings drivers. In the quarter, net investment income benefited all segments, largely driven by prepayments, calls, and make-whole premiums. Bankers' earnings reflect earned premium growth, stable benefit ratios, strong annuity persistency, and higher net investment income. Washington National posted another very strong quarter, driven by favorable benefit ratios in our supplemental health product line. Colonial Penn's results benefited from lower seasonal marketing spend and modest productivity gains. On a normalized basis, OCB, or our other CNO business, outperformed our 2013 guidance range on earnings before interest and taxes of $5 million-$20 million. This is a more volatile segment, as evidenced by the significant items running through this quarter.
Favorable mortality and net investment income were the primary drivers of normalized outperformance. If you normalize for significant items in the quarter, we posted $0.30 per share. We generally define significant items as unusual and falling outside the natural performance of core earnings drivers. In the fourth quarter, this was predominantly made up of an increase in legal reserves, both in Bankers and in our other CNO business segment. We continue to address largely legacy legal issues in an attempt to focus our resources on growing our business without meaningful contingencies to manage. Drilling deeper into our underwriting margins, Bankers' Medicare Supplement performed as expected, both in terms of premium growth and claims activity. Long-term care benefited from a spike in lapse-related reserve releases, largely the result of pricing actions on certain older blocks of policies that maintain higher reserves.
We included this as a significant item in the quarter, as pricing actions slow, this is not expected to repeat. Normalized long-term care interest-adjusted ratios of 72% came in modestly favorable but within our guided range. Washington National recorded another favorable quarter relative to our expectations with supplemental health benefit ratios at roughly 47%. We are particularly pleased with the steady growth in premium as a result of strong sales momentum throughout 2012. In the fourth quarter, our portfolio earned yields held steady, an accomplishment given the new money rate environment. As we have previously stated, we're not chasing yield. We are, however, exercising disciplined ALM and holding down portfolio turnover. We have all seen a welcomed recovery in treasuries in recent weeks. While lowering the risk profile surrounding our new money rate assumptions, much of what has been gained in treasuries has been offset by spread tightening.
We obviously remain cautious on rates. Note that prepayments, calls, and make-whole income were very favorable in the quarter. We noted this outperformance in our press release. Our expectation is to run more in the $2 million-$3 million a quarter range. Refinancing activity and corporate actions are hard to forecast. It's always nice when you have little to say about realized gains, losses, and impairments. A very good quarter contributing to favorable statutory capital dynamics, and as I mentioned earlier, a tax valuation allowance release. Credit performance of our portfolio continues to be favorable, with low or no impairments across virtually all asset classes. We completed our year-end loss recognition and cash flow testing. We thought it helpful to give you a high-level read on the results.
Loss recognition testing margins on the GAAP side are strong overall, recognizing these margins benefited from the adoption of the new DAC accounting, which effectively wrote down a meaningful portion of our intangibles. From a testing perspective, the more aggressive expensing of new business acquisition costs results in a greater contribution to testing margins from new business production. Cash flow testing has a similar story. With no material decline in overall margins year-over-year, recognizing the diversity of our product portfolio. All insurance entities passed the standard scenarios. We did add a modest amount of reserves to OCB interest-sensitive life business in the quarter. Recognizing there is judgment involved, our appointed actuaries will often add modestly to reserves to preserve margins on select product lines. While a headwind to capital, this reduces the risk of a cliff-like capital event should conditions deteriorate. Where are the pressure points?
They are straightforward and not unexpected. The Bankers Long-Term Care and other CNO business interest-sensitive life blocks are pressured by low rates, and in the case of interest-sensitive life, we have experienced GAAP and statutory charges in recent years. In terms of specific sensitivities and GAAP and statutory financial impact, we have recently shared the numbers that matter most as they are embedded in our interest rate GAAP and statutory stress testing disclosures. As you can see from this slide, there are several sensitivities and moving parts. For CNO, it's mostly about interest rates, and thus our stress testing disclosures. We ended the year with RBC ratio of 367%. This is particularly strong, recognizing we sent $420 million up to the holding company during 2012 and absorbed approximately $65 million in charges related to legacy legal settlements.
Leverage settled in a little under 21%. We expect this to gradually reduce in time as we naturally amortize debt. We ended the quarter with nearly $300 million at the holding company, split fairly evenly between investments and ready liquidity. This after kicking up our common stock repurchase in the quarter and debt amortization with it. As of year-end, we would size our deployable excess capital at around $150 million. As a result, announced last night a tender offer for the remaining convertible securities on our balance sheet. We issued a separate press release with the details of the tender. We are offering a modest premium consistent with comparable tenders of this nature. We simply view this as a tool in accomplishing our guidance on securities repurchase.
The principal reason to tender for the convertible debentures is to accelerate ROE and EPS benefits by reducing diluted shares. Relative to repurchasing our common stock in the open market, the tender has certain advantages in terms of capital treatment with rating agencies and overall financial flexibility. However, we are largely indifferent to the outcome, recognizing these securities are likely to become shares in 2013, and we have the capacity to repurchase our stock in the open market. We define capital generation as statutory earnings prior to taxes, surplus note interest, and contractual payments made to the holding company. That number was a half a billion dollars in 2012. We expect a similar result in 2013. Capital generation and amounts moved up to the holding company are converging. This is a result of no longer needing to build risk-based capital. Any retained capital primarily supports business growth.
With strength in RBC and stability in statutory earnings, we reconfirmed our December statutory dividend guidance of $250 million-$300 million for 2013. Turning to our outlook, there's a few seasonal earnings patterns worth noting as we move into the first quarter. At Bankers, the Medicare Advantage open enrollment period results in Medicare Supplement policy turnover, and with that, the effective write-off of DAC on lapsed policies. In addition, our PDP quota share tends to run at higher benefit ratios in the first quarter due to the timing of benefits given the payment of deductibles. These seasonal factors are somewhat predictable and typically result in a 25%-30% negative swing in Bankers' fourth quarter to first quarter sequential earnings. We have often discussed Colonial Penn's seasonal marketing spend, which accelerates in the first quarter of each year.
We guided in December to a full-year loss range of $5 million-$10 million, recognizing that a majority of that loss tends to be recognized in the first quarter. Turning to capital, we have affirmed all the capital guidance provided at our December investor conference. Note that the tender offer of our convertible securities is included in our guidance of $250 million-$300 million in securities repurchase for 2013. With that, I'll hand back to Ed for closing comments.
Thanks, Fred. As I mentioned earlier, 2012 was a significant year of accomplishments. These accomplishments further position CNO to execute on strategic initiatives over the next several years that will continue to improve our value proposition. We expect to invest $80 million-$85 million in strategic business initiatives over the next three years, as well as research non-organic strategies to accelerate the run-on of new business while exploring options to reduce the influence of our closed block. We will enhance the customer experience and continue to achieve operational efficiency. All of these initiatives will help increase our ROE to a 9% run rate by the end of 2015. We are focused, positioned, and committed to continue to drive enhanced shareholder value. Now we'll open it up for your questions. Operator?
At this time, I would like to remind everyone, in order to ask a question, simply press star one on your telephone keypad. Again, that is star one to ask a question. We'll pause for just a moment to compile the Q&A roster. Your first question is from the line of Chris Giovanni.
Chris, are you there?
Hello, Chris, your line is open.
Why don't we circle back to Chris and go on to the next question?
Okay. Your next question is from the line of Randy Binner.
Hey, thanks. Just a couple, if I could. Just on the tender, it seems like the time and the tender expires right at the end of the first quarter. I guess, should we assume that kind of buybacks, given the blackout period around earnings and then having the tender out over the next kind of month and a half, assume that buyback's basically on hold until the tender moves forward? Since there's kind of room in the $250 million-$300 million program for securities, is it possible that you'd be able to do some regular way buyback in the first quarter?
Yeah, Randy, really, the answer to the question is we are holding off on open market stock repurchase while the tender is working its way through. The reason is really just a couple practical reasons. One practical reason is just the appropriate management of capital and liquidity. In other words, should the tender, we don't have any way of predicting the actual outcome of the tender, but should it be, for example, 100% successful, that results in a fairly large check to write, if you will, as it relates to just managing the liquidity position we have. Of course, we have ample liquidity to handle it, but it would be upwards of $180 million to handle or settle the fully successful convert. As a result, we didn't want to pressure the liquidity and capital of the company by also buying back stock on top of that.
The other practical issue is that we would expect there to be some natural buying pressure on the shares as hedge funds who are short the stock as part of owning the convertible start to unwind those short positions. We don't want to further agitate it by also being in the market buying up. We'll come off this convert, we'll assess the success of the take-up rate on it, then we'll move forward throughout the year. We fully anticipate, irrespective of the take-up rate in the convert, that we'll accomplish our guidance range that we've put out there.
Okay, understood. Just to kind of clarify that more, though, because I think people will kind of focus in on buyback amounts as the year goes on. Assuming that it's 100% successful, the tender, then when would you need to kind of earn your way back to being able to buy back stock? Meaning, it is a big check to write, but there is ongoing free cash flow.
Oh, yeah
Would it be a situation where the second quarter would be kind of a zero buyback too, and we'd look to the back half to kind of round out the buyback effort?
No. First, we're not really going to guide the second quarter specific repurchase, we would expect to be back in the market naturally and working towards completing our guidance as soon as we're done with the convert and able to get back into the open market during the window period.
Okay, great. I just wanted to ask one more unrelated just to make sure it gets out there. The runoff segment had an above expected result this quarter, which is good. At your December investor day, you talked about maybe some optimism on being able to kind of free up capital in some portions of that, maybe the annuity and the term life portion of it. Any thoughts on progress there? Since that December day, there's been some significant activity on the private equity and reinsurance front in the life insurance industry. Just wondering if there's kind of any update there or thoughts or commentary on what's going on with private equity out there.
Yeah, Randy. Ed. You're right. Certainly, private equity's been active in the marketplace with acquiring different properties. All in all, we see that as favorable that we continue as we have in the past with stabilizing the OCB business, improving cash flows where and whenever we can and reducing volatility, and we think that continues to give us more flexibility. Timing and extent of any type of transaction, we're not in a place to give anything more definitive right now.
All right. Fair enough. Thanks.
Your next question is from the line of Chris Giovanni.
Morning. I guess first, just wanted to touch on the two litigation items in the quarter. The OCB charge of $5 million is certainly well below the 20-plus or so we've seen in the previous quarter. Should we be thinking we're kind of nearing an end of that potential outcome? Then within the Bankers, can you just comment what that specifically is related to?
Chris, I'll start on the OCB. We continue to make progress on outstanding litigation. We regularly, as part of that, assess where we are in the process, what accruals are appropriate. I think the steady drumbeat of progress continues. It is still volatile. We cannot say with any type of certainty where future litigation or charges would go. We do believe we're making progress on reducing volatility.
On the Bankers side, Chris, we did increase our reserves for the settlement of a couple of cases that relate to Bankers, more specifically related to Bankers, two cases involving long-term care policies. I would really emphasize that there was a unique set of circumstances surrounding these cases. It is nothing that is systemic in terms of either Bankers, their business model, nor the long-term care line of business. It was just sort of coincidentally falling into the category of those policies. We simply felt it was in our best interest to take action and move forward.
Okay. Within OCB, it's been, call it roughly $45 million for 2012. When we move forward in 2013, 2014, should we be, from a normalized standpoint, thinking about adding that back in-
Yeah
to the operating earnings?
Let's talk a little bit about OCB, because this was certainly an unusual quarter. You had unusual negatives and positives rolling through it. As I noted in my comments, we had very positive mortality, for example, a little bit of outperformance on investment income. I think a couple million dollars, for example, of prepaid make-whole premium running through that segment. At our December conference, we tried to bring greater transparency to OCB by busting down the various lines of business that make up the runoff block. As you all know, from focusing on OCB, the only thing these lines of businesses have in common is that they're in runoff. Otherwise, their earnings drivers and performance and the level of volatility around that is really different from line of business to line of business.
As a result, the progress we have made, that Ed mentioned, in terms of taking action on certain outstanding litigation items, has brought a level of greater confidence in where we see the go-forward OCB results, most notably that we expect them to be positive, and is slowly resulting in reduced volatility. We felt like giving some transparency was a good idea. However, it remains a volatile segment. As we work our way through the runoff block that naturally has thinner margins in terms of their assumptions, you should expect a level of volatility as we go forward, but that volatility calming down. We are making progress on it. We would not adjust our guidance of $5 million-$20 million. In many respects, the reported number came in on guidance if one believes this noise factor will continue to some degree through OCB.
Right now, it's a little bit early for us to just say, "Hey, normalize and run with a new level of OCB earnings," because we're still working through issues.
Chris, going back to the Bankers question, something else to keep in mind is that there was a partial accrual for this that just happened to be in our corporate segment that got reapportioned to the appropriate segment now, meaning Bankers. It also helps to explain somewhat of an outsized performance in corporate for the quarter.
Okay. Just lastly, a number of other financial firms continue to take on large cost-saving programs to improve returns in the challenging macro environment. You guys certainly haven't announced anything, but did mention back at your investor day that that's a potential kind of ROE stairstep in the future. Curious, one, I guess why don't you feel like you need to take one? Is it just your growth opportunities maybe are better than some other financial firms? Or just kind of an update on your latest thoughts around if or when that could potentially be a stairstep in the future.
Yeah. Chris, the reason primarily that we don't have one of those headline announcements is we believe very much in improving on an ongoing basis. That's management's job. We think we have been doing that. I think a prime example of that is we're over two-thirds of the way through a $35 million finance transformation that investment to transform our financial systems, allowing us to close and report earnings sooner and do other analyses and things, has gone unnoticed because we are doing a significant program and, in essence, doing that without the need for any type of announcement. Are there savings from that? Obviously, there are, because it's not noticeable that we have invested that much. We really see it as ongoing management's job to continually look for ways to improve efficiencies and enhance our financial flexibility.
Okay. Very helpful. Thanks for the thoughts.
Your next question is from the line of Paul Ferron.
Hey, good morning. Thanks. Was any portion of the litigation charge at Bankers related to the Unum Nicholas settlement? If so, I think you said you had reached agreement on a settlement in principle. Did anything change that drove an increase?
Yeah. Nothing has changed in terms of the settlement procedures on the Unum Nicholas case. That continues to proceed along as planned. The actual accrual in the quarter related to, in fact, continuing to review the accuracy and preciseness of both Unum Nicholas reserves as well as reserves associated with a similar case that we've been disclosing on in our financials, but where the facts and circumstances are very different. It was, in fact, different, but do keep in mind that we, as a matter of course, each quarter, put our reserves under review for possible true-ups, although we would expect them to be modest.
Paul, though Unum Nicholas is not in Bankers. That is in the OCB segment.
Okay. I'm sorry. Okay. On Bankers, in the past, co-insurance on private fee for service has been a decent earnings contributor when you have that earnings stream. Is there any potential to move to a co-insurance relationship with your partners on Med Advantage?
Hey, Paul, this is Scott. Yes, there is. We are talking to multiple partners about that potential.
Okay, thanks.
Your next question is from the line with Sean Dargan.
Thank you. I have a question about the shock lapse in long-term care in Bankers. As you implement these rate increases, is this the kind of thing that we can expect to see in future quarters?
It's a very good question. I made reference to this during my comments. That is, we have been talking now for a while, including more recently at our investor conference in a couple of quarters, that the rate activity, the rate increase activity here at CNO is expected to slow down. This is not a bad thing. This is because we've been at the rate exercise for a long period of time, the better part of four-plus years now. As you may know, several different rounds covering different blocks of business over the years. In many cases, we have brought the level of rate increases up to a more reasonable level consistent with the experience we have in the blocks.
We would generally expect that to slow down. With that, you would have less pressure on lapse rates and therefore gradually higher persistency. That, in fact, has contributed to a gradual move up in the benefit ratios. I would characterize it as more normalizing of benefit ratios than what we've seen in the past. This quarter was very isolated in the sense that it happened to be rate increases on policies that had generally longer benefit periods with inflation riders, older policies, and all of that combining to be high reserves per policy, such that the lapse experience in this set of policies had a disproportionate impact on releasing reserves and a positive benefit through our earnings.
It was a little bit more isolated and a little bit more about the characterization of the policies involved in the price increase than it was a broad-based rate increase dynamic. That's why we included it in significant items and pulled it out of our results because we wouldn't, in fact, expect that type of benefit to repeat.
Thanks. As we think about the interest-adjusted benefit ratio going forward, it would be somewhat less favorable than this quarter?
No. Actually, as you normalize for the roughly $4 million of lapse, shock lapse related benefit, our long-term care interest-adjusted benefit ratio came in around 72%. Back at our investor conference in December, we guided to a range of 71%-75%. If you look at our past couple quarters worth of results, we've been traveling more in that 75% range. Even normalizing for that benefit in the quarter, our benefit ratio for long-term care came in a little favorable within the range. We stick to the guidance of 71%-75%.
Thank you, Fred.
Yep.
Again, that is star one to ask a question. Your next question is from the line of Humphrey Lee.
Just a question about the tender offer again. With the $180 million earmark for the tender offer, assuming full tender, this will leave you about $70 million-$120 million of the $250 million-$300 million guided deployment for share buyback. Given you have $350 million of authorization and $150 million of deployable capital right now, before any subsidiary dividend in 2013, would you consider reassessing your capital plan for this year? Under what circumstance will management and the board increase the repurchase target?
At this point in time, Humphrey, we are sticking with our guidance. It's early days as we enter into 2013 and watch company performance unfold. Keep in mind that when you think about the sources and uses of free cash flow, in addition to securities repurchase, we have scheduled amortization of our debt that is a little bit north of $50 million annually. Remember that when buying back stock in the open market, not the convertibles, but in the open market, we have a $0.30 per dollar sweep provision that tends to contribute to debt amortization. We also would expect to post tender offer be in a net capital and liquidity building mode if you hold all else equal. In other words, if there's no disruption as we make our way through 2013.
Look, as a matter of routine, at least each quarter, but even throughout the quarter, we continue to assess capital conditions and with that, assess our guidance. We're not, at this point, going to adjust our guidance for 2013 on securities repurchase.
Okay. Kind of going to Bankers. For Bankers operating expenses seem a little bit elevated this quarter, even excluding the $10 million of litigation expense. I understand that some of that is because of the expenses for growth initiatives and incentive accruals for the quarter. What would you consider to be a more normalized run rate for the expenses of Bankers, and how long do you expect these kind of growth-related expenses to run through the income statement?
Yeah. For all the good reasons, I hope we expect some level of growth-related expenses to continue to run through Bankers. In isolation, that's a good kind of problem to have when looking at expenses. Setting that aside, you're absolutely right. In the quarter, we had litigation expenses. What Ed alluded to earlier is a little bit of geography in terms of taking down expense in corporate and putting up expense in Bankers. This was really just a reallocation of what had been put reserved on for a settlement-related issue. You have a little bit of that in there.
You also had with the strong performance of the company as well as the strong performance of the stock, which we noted earlier, you had a natural true-up of incentive comp related accruals as we head here into the first quarter and settle on that for our employees and professionals. You had all of those dynamics coming together and pumping up, if you will, the expense line item. To answer your question more specifically and realize this is a bit range bound, I would suggest all of those things taken in concert probably elevated the expense line in the $10 million-$15 million range pre-tax.
Okay. Got it. This is helpful. Then just one last one. There's the $6 million of out-of-period adjustment at OCB. Can you kind of touch upon a little bit what are some of the drivers for the adverse adjustments?
Yeah. As with any out-of-period adjustment, this was really the uncovering of an error. Very importantly, it was what drove it, and that is, as you may recall, and I'm not certain how actively we've talked about this, but we of course have talked a lot about finance transformation and the upgrade to our systems and our finance department. We've talked less about the fact that that also has included substantial upgrades and conversions in our valuation area, the core actuarial piece of our company that assesses reserves, as well as looking for areas where we can certainly improve data and the calculations using that data. In the course of that activity, there was a particular feature related to Universal Life where we had been establishing a reserve on this feature, relatively small block of policies and a relatively unique feature.
We had been establishing reserves, we had not really been grading those reserves in as accurately as we otherwise would like. Upon further assessment, and again with upgrades in systems and data, we went ahead and made that adjustment, found it, uncovered it was an out-of-period of adjustment, corrected it, and it amounted to roughly $6 million in the period. That's where the out-of-period adjustment came from, and we of course wouldn't expect it to continue in the future.
Given you're using kind of an upgraded valuation model, would this imply some of the kind of going forward reserve slightly higher, but definitely not in the $6 million range, of course, but there'll be a little bit of tick up in terms of that particular block of reserve?
Yeah. Realize that what is typically the case when you uncover these things or even just when you refine the accuracy of how you reserve, which also happens from time to time, is a lot of these things tend to be catch up in nature in the sense that there had been very small incremental amounts of reserve increase over a great number of periods, and now you're catching that up in effect. We wouldn't expect that to be some sort of signal that there is a higher reserving dynamic necessarily, a materially higher reserving dynamic going forward.
Okay. Got it. Thank you.
Your next question is on the line of Ryan Krueger.
Not a segment we tend to talk about too much, but in corporate, it seems like the investment income has been running better there, probably because of some of the initiatives you've been making at the holding company. Could you just talk a little bit about what you view as a good corporate run rate into 2013?
Yeah. There's a number of different things that run through corporate, as you note. As we have been talking about here recently, the corporate segment has started to morph into a real investment strategy for the company. I might ask Eric if he wants to add any color to this. You have a number of line items running through that. You have COLI business that's mark-to-market. You have hedge fund investments as part of our alternative portfolio, which again, will be volatile. You also have certain trading strategies, as well as just increased assets because we've been holding more liquidity. Realize all of those things are coming together to bring a little bit more energy to corporate with some real strategy behind it. Eric, I don't know if you have more color you'd like to add or.
Oh, the only thing I'd say is that, in terms of thinking about it, I think we released last quarter and probably in the deck again this quarter, in a model asset allocation for the corporate sector. I think that would give you a depiction of how we think about investing that money, predominantly liquid core or core plus type strategy with some leverage with as much smaller allocation to equities and hedge funds, CLO equity, et cetera. If you want to think about it in terms of the model allocation and think about a normalized set of returns for each of those asset classes, obviously, as you were into the latter part of last year, we were in a very good place, and benefited significantly in that area from market trends in spreads and in base rates as well.
That may or may not be replicated in future periods, and the market will really dictate that. Having said that, we think we have a model that will, over a sustained period, produce good returns for the corporate sector, as well as making available liquidity for other corporate initiatives as needed.
As you know, Ryan, we like this strategy for several reasons. One, it's one of the weapons we have to sustain net investment income in a world of declining new money rates, and potentially squeezing spreads. It's in part the strategy that's helped us maintain relatively stable dollar-based net investment income, despite the current yield environment. We also, of course, tend to hold the majority of our excess capital at the holding company for financial flexibility purposes in this particular quarter contributing to our announced tender. Also because it's tax-favored. We are trying to drive non-life income for tax purposes. What Eric is able to accomplish on the investment side of the holding company has that much more juice, if you will, for shareholders because of its tax-favored position.
Got it. Maybe just one more quick follow-up on that. Maybe just for the fourth quarter, could you give some sense of the investment performance in relation to what you guys would view as more normal for the corporate segment?
Yeah. Actually, both our COLI product that marks to market as well as our hedge fund performance was actually flat and really on the margin underperformed our expectations, whereas some of the strategies that Eric referred to really outperformed. It was a bit of a mixed bag. Some of the trading strategies really outperformed relative to recent quarters. I would say on balance, not far off what our expectation would be. Recognize, however, that I am going to use a fair amount of that holding company capital as part of exercising our tender offer, and that could have implications for the general and overall investment income that we produce as we go forward. Any other thoughts on that, Eric? That would be my read on it.
I think Fred has high expectations. I think we had a good quarter last quarter, but it's directionally where we should be going. There may be a little more air in it than I would put in the spreadsheet.
All right. Thanks. I just had one last one.
I'm not ready to give in on that, Eric.
In OCB, the $5 million-$20 million EBIT guidance for 2013, does that include a baseline level of expected litigation costs or is that kind of excluding litigation?
Yeah. What I would do is I would separate litigation costs, that is the cost associated with continuing to actively manage and defend and work through our various positions there from settlement activity, where you have perhaps a one-off, either reserve issue or outright settlement adjustment. We would exclude the more one-time settlement type elements, but we would absolutely include in the guidance a level of just pure litigation expense that comes with the territory.
Yeah. Ryan, in that, with the settlements,
For those that are in process, we hopefully are appropriately reserved. When and if a settlement is reached, any deviation from the run rate should hopefully be minimal as a result.
Okay. Very helpful. Thanks a lot, guys.
Your next question is from the line of Chris Giovanni.
One clarification for Fred and then a question for Scott. The comment you made around the LTC interest-adjusted benefit ratio, you talked about an expected range of 71%-75%. I think the outlook for 2013 from the investor day was 75%. Just, I guess, to clarify, are you feeling a little bit better about that expected 75%? Or is it just things are going to be volatile on a quarter-to-quarter basis? I guess even then, the range we're still getting at is the kind of the top end. I guess, how should we be thinking about that just for 2013?
Yeah, if you go to the investor conference, I don't mean to call out specific slides, but if you go to slide 64 of our investor conference deck, Chris, you're right. We called historical normalized benefit ratios as being between 71%-75%, then we guided to 75%. Let me correct my statement in that I think it's really appropriate for us to expect benefit ratios to be more on our guidance of 75%. It, of course, can fluctuate, and at 72%, it is falling in line with what our past experience has been these last couple of years, we would expect it to tick up. We've been using the term favorable to describe the 72% to sort of signal to you that we believed it to be better than what we would expect. I appreciate the question because that is worth clarifying.
We did guide to 75% range, it was more 71%-75% that we've had as a historical range.
Okay. Thank you. Just for Scott, I guess you talked about the expectations for the additional location rollouts, which certainly should help the growth. Curious if you can comment some around what you're seeing from agency productivity, and if you have whether it's cross-sell targets or anything to help us get comfortable with kind of the productivity we're seeing from the agents, specifically at Bankers Life.
Sure, Chris. We have seen improvements in productivity, and that's been a result of some of the cross-sell initiatives that we put in place last year and we're kind of ramping up this year. Given the headwinds in fixed indexed annuity markets, we've seen our agency force pivot successfully. I think a lot of the success we've seen in life sales and also with the introduction of the new critical illness product has been a result of cross-selling into either our Medicare Supplement, Medicare Advantage prospect or customer base. We'd expect more of that. That productivity tends to lead to improved retention, which given even kind of consistent recruiting results that we've seen over the last couple of years will help drive our agency force in average agency growth size, which is absolutely what we saw.
We attribute the growth in our agency force to productivity gains, which has driven improved retention, and those productivity gains have been largely as a result of cross-selling activity.
Okay. Thanks so much.
Yep.
At this time, we have no further questions. Do you have any closing remarks?
No. Thank you, operator, and thanks to everyone on the call for their interest in support of CNO Financial Group.