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CNO Financial Group, Inc. 10-Q 2011
CNO 06.30.2011 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2011
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___ to ___ 

Commission File Number 001-31792



CNO Financial Group, Inc.


Delaware
 
75-3108137
State of Incorporation
 
IRS Employer Identification No.
 
 
 
11825 N. Pennsylvania Street
 
 
Carmel, Indiana  46032
 
(317) 817-6100
Address of principal executive offices
 
Telephone


Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days:  Yes [ X ]  No [   ]

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [ X ]  No [   ]

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  Large accelerated filer [ X ]  Accelerated filer [   ] Non-accelerated filer [   ] Smaller reporting company [   ]

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):  Yes [   ] No [ X ]


Shares of common stock outstanding as of July 18, 2011:  249,431,710



TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION
Page
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II - OTHER INFORMATION
 
 
 
 
Item 1.
Legal Proceedings                                                                                                  
 
 
 
Item 1A.
Risk Factors                                                                                                     
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds                                                                                                 
 
 
 
Item 5.
Other Information                                                                                                         
 
 
 
Item 6.
Exhibits                                                                                                      


2

PART I - FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS.

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)

ASSETS

 
June 30,
2011
 
December 31,
2010
 
(unaudited)
 
 
Investments:
 
 
 
Fixed maturities, available for sale, at fair value (amortized cost:  June 30, 2011 - $20,893.1; December 31, 2010 - $20,155.8)
$
21,622.9

 
$
20,633.9

Equity securities at fair value (cost: June 30, 2011 - $128.6; December 31, 2010 - $68.2)
129.6

 
68.1

Mortgage loans
1,752.8

 
1,761.2

Policy loans
279.5

 
284.4

Trading securities
83.5

 
372.6

Investments held by variable interest entities
414.0

 
420.9

Other invested assets
252.2

 
240.9

Total investments
24,534.5

 
23,782.0

Cash and cash equivalents - unrestricted
580.2

 
571.9

Cash and cash equivalents held by variable interest entities
25.3

 
26.8

Accrued investment income
314.3

 
327.8

Present value of future profits
936.5

 
1,008.6

Deferred acquisition costs
1,762.6

 
1,764.2

Reinsurance receivables
3,172.5

 
3,256.3

Income tax assets, net
703.5

 
839.4

Assets held in separate accounts
17.4

 
17.5

Other assets
349.8

 
305.1

Total assets
$
32,396.6

 
$
31,899.6


(continued on next page)

The accompanying notes are an integral part
of the consolidated financial statements.















3


CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET, continued
(Dollars in millions)

LIABILITIES AND SHAREHOLDERS' EQUITY

 
June 30,
2011
 
December 31,
2010
 
(unaudited)
 
 
Liabilities:
 
 
 
Liabilities for insurance products:
 
 
 
Interest-sensitive products
$
13,152.8

 
$
13,194.7

Traditional products
10,424.4

 
10,307.6

Claims payable and other policyholder funds
978.0

 
968.7

Liabilities related to separate accounts
17.4

 
17.5

Other liabilities
703.7

 
496.3

Investment borrowings
1,305.3

 
1,204.1

Borrowings related to variable interest entities
317.3

 
386.9

Notes payable – direct corporate obligations
934.5

 
998.5

Total liabilities
27,833.4

 
27,574.3

Commitments and Contingencies


 


Shareholders' equity:
 

 
 

Common stock ($0.01 par value, 8,000,000,000 shares authorized, shares issued and outstanding:  June 30, 2011 – 249,415,210; December 31, 2010 – 251,084,174)
2.5

 
2.5

Additional paid-in capital
4,414.3

 
4,424.2

Accumulated other comprehensive income
372.7

 
238.3

Accumulated deficit
(226.3
)
 
(339.7
)
Total shareholders' equity
4,563.2

 
4,325.3

Total liabilities and shareholders' equity
$
32,396.6

 
$
31,899.6


The accompanying notes are an integral part
of the consolidated financial statements.


4


CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions, except per share data)
(unaudited)

 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2011
 
2010
 
2011
 
2010
Revenues:
 
 
 
 
 
 
 
Insurance policy income
$
679.6

 
$
667.9

 
$
1,346.8

 
$
1,332.5

Net investment income (loss):
 

 
 

 
 
 
 
General account assets
342.2

 
321.1

 
678.3

 
636.3

Policyholder and reinsurer accounts and other special-purpose portfolios
3.1

 
(22.7
)
 
40.5

 
1.3

Realized investment gains (losses):
 

 
 

 
 
 
 
Net realized investment gains, excluding impairment losses
13.0

 
11.2

 
31.4

 
26.6

Other-than-temporary impairment losses:
 

 
 

 
 
 
 
Total other-than-temporary impairment losses
(10.1
)
 
(29.3
)
 
(23.4
)
 
(47.0
)
Portion of other-than-temporary impairment losses recognized in accumulated other comprehensive income

 
1.4

 

 
(1.2
)
Net impairment losses recognized
(10.1
)
 
(27.9
)
 
(23.4
)
 
(48.2
)
Total realized gains (losses)
2.9

 
(16.7
)
 
8.0

 
(21.6
)
Fee revenue and other income
4.2

 
3.6

 
7.6

 
7.1

Total revenues
1,032.0

 
953.2

 
2,081.2

 
1,955.6

Benefits and expenses:
 

 
 

 
 
 
 
Insurance policy benefits
684.4

 
651.0

 
1,367.6

 
1,350.0

Interest expense
28.9

 
28.7

 
58.1

 
56.2

Amortization
101.5

 
96.6

 
238.2

 
199.2

Loss on extinguishment of debt
.6

 
.9

 
2.0

 
2.7

Other operating costs and expenses
124.4

 
124.2

 
239.5

 
242.6

Total benefits and expenses
939.8

 
901.4

 
1,905.4

 
1,850.7

Income before income taxes
92.2

 
51.8

 
175.8

 
104.9

Tax expense on period income
32.7

 
18.7

 
62.4

 
37.9

Net income
$
59.5

 
$
33.1

 
$
113.4

 
$
67.0

Earnings per common share:
 

 
 

 
 
 
 
Basic:
 

 
 

 
 
 
 
Weighted average shares outstanding
250,933,000

 
250,994,000

 
251,027,000

 
250,891,000

Net income
$
.24

 
$
.13

 
$
.45

 
$
.27

Diluted:
 

 
 

 
 
 
 
Weighted average shares outstanding
308,048,000

 
302,648,000

 
307,773,000

 
297,364,000

Net income
$
.21

 
$
.12

 
$
.39

 
$
.25


The accompanying notes are an integral part
of the consolidated financial statements.


5


CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Dollars in millions)
(unaudited)
 
Common stock and
additional
paid-in capital
 
Accumulated other
 comprehensive income
 (loss)
 
Retained earnings
 (accumulated deficit)
 
Total
Balance, December 31, 2009
$
4,411.3

 
$
(264.3
)
 
$
(614.6
)
 
$
3,532.4

Comprehensive income, net of tax:
 

 
 

 
 

 
 

Net income

 

 
67.0

 
67.0

Change in unrealized appreciation (depreciation) of investments (net of applicable income tax expense of $303.7)

 
553.2

 

 
553.2

Change in noncredit component of impairment losses on fixed maturities, available for sale (net of applicable income tax expense of $20.2)

 
36.1

 

 
36.1

Total comprehensive income
 

 
 

 
 

 
656.3

Cumulative effect of accounting change

 
(6.2
)
 
(9.7
)
 
(15.9
)
Beneficial conversion feature related to the issuance of convertible debentures
4.0

 

 

 
4.0

Stock option and restricted stock plans
6.0

 

 

 
6.0

Balance, June 30, 2010
$
4,421.3

 
$
318.8

 
$
(557.3
)
 
$
4,182.8

 
 
 
 
 
 
 
 
Balance, December 31, 2010
$
4,426.7

 
$
238.3

 
$
(339.7
)
 
$
4,325.3

Comprehensive income, net of tax:
 

 
 

 
 

 
 

Net income

 

 
113.4

 
113.4

Change in unrealized appreciation (depreciation) of investments (net of applicable income tax expense of $74.4)

 
131.6

 

 
131.6

Change in noncredit component of impairment losses on fixed maturities, available for sale (net of applicable income tax expense of $1.6)

 
2.8

 

 
2.8

Total comprehensive income
 

 
 

 
 

 
247.8

Cost of shares acquired
(16.2
)
 

 

 
(16.2
)
Stock option and restricted stock plans
6.3

 

 

 
6.3

Balance, June 30, 2011
$
4,416.8

 
$
372.7

 
$
(226.3
)
 
$
4,563.2


The accompanying notes are an integral part
of the consolidated financial statements.



6


CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
(unaudited)

 
Six months ended
 
June 30,
 
2011
 
2010
Cash flows from operating activities:
 
 
 
Insurance policy income
$
1,194.3

 
$
1,177.3

Net investment income
687.1

 
667.4

Fee revenue and other income
7.6

 
7.1

Insurance policy benefits
(1,022.6
)
 
(997.3
)
Interest expense
(42.2
)
 
(54.1
)
Policy acquisition costs
(215.1
)
 
(210.3
)
Other operating costs
(245.8
)
 
(240.2
)
Taxes
(2.5
)
 
(3.9
)
Net cash provided by operating activities
360.8

 
346.0

Cash flows from investing activities:
 

 
 

Sales of investments
2,931.9

 
4,572.6

Maturities and redemptions of investments
538.1

 
392.2

Purchases of investments
(4,050.8
)
 
(5,406.2
)
Net sales (purchases) of trading securities
304.4

 
(41.5
)
Change in cash and cash equivalents held by variable interest entities
1.5

 
(6.3
)
Other
(15.1
)
 
(9.2
)
Net cash used by investing activities
(290.0
)
 
(498.4
)
Cash flows from financing activities:
 

 
 

Issuance of notes payable, net

 
110.8

Payments on notes payable
(66.2
)
 
(116.5
)
Issuance of common stock
.3

 

Payments to repurchase common stock
(16.2
)
 

Amounts received for deposit products
837.7

 
882.6

Withdrawals from deposit products
(854.9
)
 
(862.0
)
Investment borrowings and borrowings related to variable interest entities
36.8

 
(62.2
)
Net cash used by financing activities
(62.5
)
 
(47.3
)
Net incease (decrease) in cash and cash equivalents
8.3

 
(199.7
)
Cash and cash equivalents, beginning of period
571.9

 
523.4

Cash and cash equivalents, end of period
$
580.2

 
$
323.7


The accompanying notes are an integral part
of the consolidated financial statements.






7

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________



BUSINESS AND BASIS OF PRESENTATION

The following notes should be read together with the notes to the consolidated financial statements included in our 2010 Annual Report on Form 10-K.

CNO Financial Group, Inc., a Delaware corporation (“CNO”), is a holding company for a group of insurance companies operating throughout the United States that develop, market and administer health insurance, annuity, individual life insurance and other insurance products.  CNO became the successor to Conseco, Inc., an Indiana corporation (our “Predecessor”), in connection with our bankruptcy reorganization which became effective on September 10, 2003.  The terms “CNO Financial Group, Inc.”, the “Company”, “we”, “us”, and “our” as used in these financial statements refer to CNO and its subsidiaries or, when the context requires otherwise, our Predecessor and its subsidiaries.  We focus on serving the senior and middle-income markets, which we believe are attractive, underserved, high growth markets.  We sell our products through three distribution channels: career agents, independent producers (some of whom sell one or more of our product lines exclusively) and direct marketing.

Our unaudited consolidated financial statements reflect normal recurring adjustments that, in the opinion of management, are necessary for a fair statement of our financial position, results of operations and cash flows for the periods presented.  As permitted by rules and regulations of the Securities and Exchange Commission (the “SEC”) applicable to quarterly reports on Form 10-Q, we have condensed or omitted certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  We have reclassified certain amounts from the prior periods to conform to the 2011 presentation.  These reclassifications have no effect on net income or shareholders’ equity.  Results for interim periods are not necessarily indicative of the results that may be expected for a full year.

The balance sheet at December 31, 2010, presented herein, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.

When we prepare financial statements in conformity with GAAP, we are required to make estimates and assumptions that significantly affect reported amounts of various assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting periods.  For example, we use significant estimates and assumptions to calculate values for deferred acquisition costs, the present value of future profits, certain investments (including derivatives), assets and liabilities related to income taxes, liabilities for insurance products, liabilities related to litigation and guaranty fund assessment accruals.  If our future experience differs from these estimates and assumptions, our financial statements would be materially affected.

Our consolidated financial statements exclude the results of transactions between us and our consolidated affiliates, or among our consolidated affiliates.

INVESTMENTS

We classify our fixed maturity securities into one of three categories: (i) “available for sale” (which we carry at estimated fair value with any unrealized gain or loss, net of tax and related adjustments, recorded as a component of shareholders’ equity); (ii) “trading” (which we carry at estimated fair value with changes in such value recognized as net investment income (classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios)); or (iii) “held to maturity” (which we carry at amortized cost).  We had no fixed maturity securities classified as held to maturity during the periods presented in these financial statements.

The trading account includes investments backing the market strategies of our multibucket annuity products and certain reinsurance agreements.  The change in fair value of these securities, which is recognized currently in income from policyholder and reinsurer accounts and other special-purpose portfolios (a component of investment income), is substantially offset by the change in insurance policy benefits for these products.  Prior to June 30, 2011, certain of our trading securities were held to offset the income statement volatility caused by the effect of interest rate fluctuations on the value of embedded derivatives related to our fixed index annuity products.  See the note entitled “Accounting for Derivatives” for further discussion regarding these embedded derivatives.  Our trading securities totaled $83.5 million and $372.6 million at June 30,

8

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


2011 and December 31, 2010, respectively.

Accumulated other comprehensive income is primarily comprised of the net effect of unrealized appreciation (depreciation) on our investments.  These amounts, included in shareholders’ equity as of June 30, 2011 and December 31, 2010, were as follows (dollars in millions):

 
June 30,
2011
 
December 31,
2010
Net unrealized appreciation (depreciation) on fixed maturity securities, available for sale, on which an other-than-temporary impairment loss has been recognized
$
.6

 
$
(4.4
)
Net unrealized gains (losses) on all other investments
732.0

 
476.5

Adjustment to present value of future profits (a)
(23.4
)
 
(17.6
)
Adjustment to deferred acquisition costs
(120.9
)
 
(76.2
)
Unrecognized net loss related to deferred compensation plan
(7.3
)
 
(7.7
)
Deferred income tax liability
(208.3
)
 
(132.3
)
Accumulated other comprehensive income
$
372.7

 
$
238.3

_________
(a)
The present value of future profits is the value assigned to the right to receive future cash flows from contracts existing at September 10, 2003 (the date our Predecessor emerged from bankruptcy).

At June 30, 2011, the amortized cost, gross unrealized gains and losses, other-than-temporary impairments in accumulated other comprehensive income and estimated fair value of fixed maturities, available for sale, were as follows (dollars in millions):

 
Amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
 
Estimated
fair value
 
Other-than-
temporary
impairments
included in
accumulated other
comprehensive
income
Corporate securities
$
14,263.3

 
$
769.2

 
$
(117.4
)
 
$
14,915.1

 
$

United States Treasury securities and obligations of United States government corporations and agencies
283.4

 
5.0

 
(9.8
)
 
278.6

 

States and political subdivisions
1,849.2

 
40.4

 
(46.1
)
 
1,843.5

 

Debt securities issued by foreign governments
.8

 
.1

 

 
.9

 

Asset-backed securities
739.6

 
19.0

 
(9.7
)
 
748.9

 

Collateralized debt obligations
189.6

 
4.8

 
(.9
)
 
193.5

 

Commercial mortgage-backed securities
1,410.6

 
80.0

 
(10.8
)
 
1,479.8

 

Mortgage pass-through securities
26.0

 
2.0

 

 
28.0

 

Collateralized mortgage obligations
2,130.6

 
38.3

 
(34.3
)
 
2,134.6

 
(10.3
)
Total fixed maturities, available for sale
$
20,893.1

 
$
958.8

 
$
(229.0
)
 
$
21,622.9

 
$
(10.3
)

The following table sets forth the amortized cost and estimated fair value of fixed maturities, available for sale, at June 30, 2011, by contractual maturity.  Actual maturities will differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without penalties.  In addition, structured securities (such as asset-backed securities, collateralized debt obligations, commercial mortgage-backed securities, mortgage pass-through securities and collateralized mortgage obligations, collectively referred to as “structured securities”) frequently include provisions for

9

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


periodic principal payments and permit periodic unscheduled payments.

 
Amortized
cost
 
Estimated
fair
value
 
(Dollars in millions)
Due in one year or less
$
107.7

 
$
109.0

Due after one year through five years
1,164.7

 
1,238.3

Due after five years through ten years
4,245.4

 
4,547.2

Due after ten years
10,878.9

 
11,143.6

Subtotal
16,396.7

 
17,038.1

Structured securities
4,496.4

 
4,584.8

Total fixed maturities, available for sale
$
20,893.1

 
$
21,622.9


Net Realized Investment Gains (Losses)

During the first six months of 2011, we recognized net realized investment gains of $8.0 million, which were comprised of $31.4 million of net gains from the sales of investments (primarily fixed maturities) with proceeds of $2.9 billion and $23.4 million of writedowns of investments for other than temporary declines in fair value recognized through net income.

During the first six months of 2010, we recognized net realized investment losses of $21.6 million, which were comprised of $26.6 million of net gains from the sales of investments (primarily fixed maturities) with proceeds of $4.6 billion and $48.2 million of writedowns of investments for other than temporary declines in fair value recognized through net income ($47.0 million, prior to the $(1.2) million of impairment losses recognized through accumulated other comprehensive income (loss)).

At June 30, 2011, fixed maturity securities and mortgage loans in default or considered nonperforming had both an aggregate amortized cost and a carrying value of $6.2 million.

Our fixed maturity investments are generally purchased in the context of a long-term strategy to fund insurance liabilities, so we do not generally seek to generate short-term realized gains through the purchase and sale of such securities.  In certain circumstances, including those in which securities are selling at prices which exceed our view of their underlying economic value, or when it is possible to reinvest the proceeds to better meet our long-term asset-liability objectives, we may sell certain securities.

During the six months ended June 30, 2011, we sold $.7 billion of fixed maturity investments which resulted in gross investment losses (before income taxes) of $39.0 million.  We sell securities at a loss for a number of reasons including, but not limited to:  (i) changes in the investment environment; (ii) expectation that the market value could deteriorate further; (iii) desire to reduce our exposure to an asset class, an issuer or an industry; (iv) changes in credit quality; or (v) changes in expected liability cash flows.

There was one investment sold at a loss during the first six months of 2011 that had been continuously in an unrealized loss position exceeding 20 percent of the amortized cost basis for more than 12 months prior to the sale of the investment. This investment had an amortized cost and estimated fair value of $4.0 million and $2.7 million, respectively.

We regularly evaluate our investments for possible impairment.  Our assessment of whether unrealized losses are “other than temporary” requires significant judgment.  Factors considered include:  (i) the extent to which fair value is less than the cost basis; (ii) the length of time that the fair value has been less than cost; (iii) whether the unrealized loss is event driven, credit-driven or a result of changes in market interest rates or risk premium; (iv) the near-term prospects for specific events, developments or circumstances likely to affect the value of the investment; (v) the investment’s rating and whether the investment is investment-grade and/or has been downgraded since its purchase; (vi) whether the issuer is current on all payments in accordance with the contractual terms of the investment and is expected to meet all of its obligations under the terms of the investment; (vii) whether we intend to sell the investment or it is more likely than not that circumstances will

10

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


require us to sell the investment before recovery occurs; (viii) the underlying current and prospective asset and enterprise values of the issuer and the extent to which the recoverability of the carrying value of our investment may be affected by changes in such values; (ix) projections of, and unfavorable changes in, cash flows on structured securities including mortgage-backed and asset-backed securities; (x) the value of any collateral; and (xi) other objective and subjective factors.

Future events may occur, or additional information may become available, which may necessitate future realized losses of securities in our portfolio.  Significant losses in the estimated fair values of our investments could have a material adverse effect on our consolidated financial statements in future periods.

Impairment losses on equity securities are recognized in net income.  The manner in which impairment losses on fixed maturity securities, available for sale, are recognized in the financial statements is dependent on the facts and circumstances related to the specific security.  If we intend to sell a security or it is more likely than not that we would be required to sell a security before the recovery of its amortized cost, the security is other-than-temporarily impaired and the full amount of the impairment is recognized as a loss through earnings.  If we do not expect to recover the amortized cost basis, we do not plan to sell the security, and if it is not more likely than not that we would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, the recognition of the other-than-temporary impairment is bifurcated.  We recognize the credit loss portion in net income and the noncredit loss portion in accumulated other comprehensive income (loss).

We estimate the amount of the credit loss component of a fixed maturity security impairment as the difference between amortized cost and the present value of the expected cash flows of the security.  The present value is determined using the best estimate of future cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security.  The methodology and assumptions for establishing the best estimate of future cash flows vary depending on the type of security.

For most structured securities, cash flow estimates are based on bond specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity, prepayment speeds and structural support, including excess spread, subordination and guarantees.  For corporate bonds, cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using bond specific facts and circumstances including timing, secured interest and loss severity.  The previous amortized cost basis less the impairment recognized in net income becomes the security’s new cost basis.  We accrete the new cost basis to the estimated future cash flows over the expected remaining life of the security.

The remaining non-credit impairment, which is recorded in accumulated other comprehensive income (loss), is the difference between the security’s estimated fair value and our best estimate of future cash flows discounted at the effective interest rate prior to impairment.  The remaining non-credit impairment typically represents changes in the market interest rates, current market liquidity and risk premiums.  As of June 30, 2011, other-than-temporary impairments included in accumulated other comprehensive income of $10.3 million (before taxes and related amortization) related to structured securities.

The following table summarizes the amount of credit losses recognized in earnings on fixed maturity securities, available for sale, held at the beginning of the period, for which a portion of the other-than-temporary impairment was also recognized in accumulated other comprehensive income for the six months ended June 30, 2011 and 2010 (dollars in millions):

11

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2011
 
2010
 
2011
 
2010
Credit losses on fixed maturity securities, available for sale, beginning of period
$
(1.8
)
 
$
(29.4
)
 
$
(6.1
)
 
$
(27.2
)
Add:  credit losses on other-than-temporary impairments not previously recognized

 
(1.3
)
 

 
(1.3
)
Less:  credit losses on securities sold
.2

 
10.1

 
4.5

 
13.5

Less:  credit losses on securities impaired due to intent to sell (a)

 
1.1

 

 
1.1

Add:  credit losses on previously impaired securities

 
(4.5
)
 

 
(10.1
)
Less:  increases in cash flows expected on previously impaired securities

 

 

 

Credit losses on fixed maturity securities, available for sale, end of period
$
(1.6
)
 
$
(24.0
)
 
$
(1.6
)
 
$
(24.0
)
__________
(a)
Represents securities for which the amount previously recognized in accumulated other comprehensive income was recognized in earnings because we intend to sell the security or we more likely than not will be required to sell the security before recovery of its amortized cost basis.

Gross Unrealized Investment Losses

Our investment strategy is to maximize, over a sustained period and within acceptable parameters of quality and risk, investment income and total investment return through active investment management.  Accordingly, we may sell securities at a gain or a loss to enhance the projected income or total return of the portfolio as market opportunities change, to reflect changing perceptions of risk, or to better match certain characteristics of our investment portfolio with the corresponding characteristics of our insurance liabilities.

The following table summarizes the gross unrealized losses and fair values of our investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that such securities have been in a continuous unrealized loss position, at June 30, 2011 (dollars in millions):

 
Less than 12 months
 
12 months or greater
 
Total
Description of securities
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
United States Treasury securities and obligations of United States government corporations and agencies
$
198.7

 
$
(9.8
)
 
$
.3

 
$

 
$
199.0

 
$
(9.8
)
States and political subdivisions
487.3

 
(12.1
)
 
216.0

 
(34.0
)
 
703.3

 
(46.1
)
Corporate securities
2,718.1

 
(70.2
)
 
519.0

 
(47.2
)
 
3,237.1

 
(117.4
)
Asset-backed securities
305.1

 
(8.6
)
 
9.7

 
(1.1
)
 
314.8

 
(9.7
)
Collateralized debt obligations
19.9

 
(.9
)
 

 

 
19.9

 
(.9
)
Commercial mortgage-backed securities
184.3

 
(7.6
)
 
47.6

 
(3.2
)
 
231.9

 
(10.8
)
Mortgage pass-through securities
.1

 

 
3.3

 

 
3.4

 

Collateralized mortgage obligations
840.5

 
(33.4
)
 
29.1

 
(.9
)
 
869.6

 
(34.3
)
Total fixed maturities, available for sale
$
4,754.0

 
$
(142.6
)
 
$
825.0

 
$
(86.4
)
 
$
5,579.0

 
$
(229.0
)


12

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


The following table summarizes the gross unrealized losses and fair values of our investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that such securities have been in a continuous unrealized loss position, at December 31, 2010 (dollars in millions):
 
 
Less than 12 months
 
12 months or greater
 
Total
Description of securities
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
United States Treasury securities and obligations of United States government corporations and agencies
 
$
196.9

 
$
(11.8
)
 
$
.2

 
$

 
$
197.1

 
$
(11.8
)
States and political subdivisions
 
1,201.9

 
(54.8
)
 
229.6

 
(45.9
)
 
1,431.5

 
(100.7
)
Corporate securities
 
2,633.0

 
(80.6
)
 
864.6

 
(88.4
)
 
3,497.6

 
(169.0
)
Asset-backed securities
 
272.2

 
(2.4
)
 
54.0

 
(3.9
)
 
326.2

 
(6.3
)
Collateralized debt obligations
 
117.0

 
(0.9
)
 
5.8

 
(.2
)
 
122.8

 
(1.1
)
Commercial mortgage-backed securities
 
15.5

 

 
111.8

 
(12.5
)
 
127.3

 
(12.5
)
Mortgage pass-through securities
 
.3

 

 
3.4

 

 
3.7

 

Collateralized mortgage obligations
 
661.0

 
(29.1
)
 
112.9

 
(6.4
)
 
773.9

 
(35.5
)
Total fixed maturities, available for sale
 
$
5,097.8

 
$
(179.6
)
 
$
1,382.3

 
$
(157.3
)
 
$
6,480.1

 
$
(336.9
)

Based on management’s current assessment of investments with unrealized losses at June 30, 2011, the Company believes the issuers of the securities will continue to meet their obligations (or with respect to equity-type securities, the investment value will recover to its cost basis).  While we do not have the intent to sell securities with unrealized losses and it is not more likely than not that we will be required to sell securities with unrealized losses prior to their anticipated recovery, our intent on an individual security may change, based upon market or other unforeseen developments.  In such instances, if a loss is recognized from a sale subsequent to a balance sheet date due to these unexpected developments, the loss is recognized in the period in which we had the intent to sell the security before its anticipated recovery.

EARNINGS PER SHARE

A reconciliation of net income and shares used to calculate basic and diluted earnings per share is as follows (dollars in millions and shares in thousands):


13

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2011
 
2010
 
2011
 
2010
Net income for basic earnings per share
$
59.5

 
$
33.1

 
$
113.4

 
$
67.0

Add:  interest expense on 7.0% Convertible Senior Debentures due 2016 (the “7.0% Debentures”), net of income taxes
3.7

 
3.4

 
7.4

 
6.0

Net income for diluted earnings per share
$
63.2

 
$
36.5

 
$
120.8

 
$
73.0

Shares:
 

 
 

 
 

 
 

Weighted average shares outstanding for basic earnings per share
250,933

 
250,994

 
251,027

 
250,891

Effect of dilutive securities on weighted average shares:
 

 
 

 
 

 
 

7% Debentures
53,367

 
49,793

 
53,367

 
44,663

Stock option and restricted stock plans
3,036

 
1,861

 
2,892

 
1,810

Warrants
712

 

 
487

 

Dilutive potential common shares
57,115

 
51,654

 
56,746

 
46,473

Weighted average shares outstanding for diluted earnings per share
308,048

 
302,648

 
307,773

 
297,364


Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding for the period.  Restricted shares (including our performance shares) are not included in basic earnings per share until vested.  Diluted earnings per share reflect the potential dilution that could occur if outstanding stock options and
warrants were exercised and restricted stock was vested.  The dilution from options, warrants and restricted shares is calculated using the treasury stock method.  Under this method, we assume the proceeds from the exercise of the options and warrants (or the unrecognized compensation expense with respect to restricted stock) will be used to purchase shares of our common stock at the average market price during the period, reducing the dilutive effect of the exercise of the options (or the vesting of the restricted stock). Initially, the 7.0% Debentures will be convertible into 182.1494 shares of our common stock for each $1,000 principal amount of 7.0% Debentures, which is equivalent to an initial conversion price of approximately $5.49 per share. The conversion rate is subject to adjustment following the occurrence of certain events in accordance with the terms of the 7.0% Debenture.

BUSINESS SEGMENTS

Beginning July 1, 2010, management changed the manner in which it disaggregates the Company’s operations for making operating decisions and assessing performance.  As a result, the Company manages its business through the following operating segments: Bankers Life, Washington National and Colonial Penn, which are defined on the basis of product distribution; Other CNO Business, comprised primarily of products we no longer sell actively; and corporate operations, comprised of holding company activities and certain noninsurance company businesses.  All prior period segment disclosures have been revised to conform to management’s current view of the Company’s operating segments.

We measure segment performance by excluding realized investment gains (losses) because we believe that this performance measure is a better indicator of the ongoing business and trends in our business.  Our primary investment focus is on investment income to support our liabilities for insurance products as opposed to the generation of realized investment gains (losses), and a long-term focus is necessary to maintain profitability over the life of the business.

Realized investment gains (losses) depend on market conditions and do not necessarily relate to the underlying business of our segments.  Realized investment gains (losses) may affect future earnings levels since our underlying business is long-term in nature and changes in our investment portfolio may impact our ability to earn the assumed interest rates needed to maintain the profitability of our business.

14

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


Operating information by segment was as follows (dollars in millions):
 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2011
 
2010
 
2011
 
2010
Revenues:
 
 
 
 
 
 
 
Bankers Life:
 
 
 
 
 
 
 
Insurance policy income:
 
 
 
 
 
 
 
Annuities
$
8.7

 
$
10.7

 
$
17.1

 
$
19.0

Health
343.3

 
342.4

 
683.1

 
688.3

Life
57.6

 
47.6

 
109.4

 
89.6

Net investment income (a)
196.9

 
160.5

 
406.5

 
346.4

Fee revenue and other income (a)
3.3

 
2.7

 
5.6

 
5.0

Total Bankers Life revenues
609.8

 
563.9

 
1,221.7

 
1,148.3

Washington National:
 

 
 

 
 

 
 

Insurance policy income:
 

 
 

 
 

 
 

Health
141.7

 
139.4

 
281.9

 
279.0

Life
3.8

 
4.1

 
7.9

 
8.7

Other
1.1

 
1.2

 
2.2

 
2.4

Net investment income (a)
46.7

 
45.9

 
93.0

 
91.3

Fee revenue and other income (a)
.2

 
.2

 
.5

 
.5

Total Washington National revenues
193.5

 
190.8

 
385.5

 
381.9

Colonial Penn:
 

 
 

 
 

 
 

Insurance policy income:
 

 
 

 
 

 
 

Health
1.5

 
1.6

 
3.1

 
3.4

Life
49.4

 
47.7

 
98.1

 
94.1

Net investment income (a)
10.5

 
9.7

 
20.8

 
19.4

Fee revenue and other income (a)
.2

 
.1

 
.4

 
.3

Total Colonial Penn revenues
61.6

 
59.1

 
122.4

 
117.2

Other CNO Business:
 

 
 

 
 

 
 

Insurance policy income:
 

 
 

 
 

 
 

Annuities
2.9

 
2.4

 
5.2

 
4.9

Health
7.1

 
7.5

 
14.4

 
15.2

Life
61.9

 
62.6

 
123.2

 
126.5

Other
.6

 
.7

 
1.2

 
1.4

Net investment income (a)
86.7

 
80.4

 
181.4

 
173.0

Total Other CNO Business revenues
159.2

 
153.6

 
325.4

 
321.0

Corporate operations:
 

 
 

 
 

 
 

Net investment income
4.5

 
1.9

 
17.1

 
7.5

Fee and other income
.5

 
.6

 
1.1

 
1.3

Total corporate revenues
5.0

 
2.5

 
18.2

 
8.8

Total revenues
1,029.1

 
969.9

 
2,073.2

 
1,977.2


(continued on next page)


15

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


(continued from previous page)

 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2011
 
2010
 
2011
 
2010
Expenses:
 
 
 
 
 
 
 
Bankers Life:
 
 
 
 
 
 
 
Insurance policy benefits
$
408.9

 
$
382.7

 
$
813.7

 
$
799.2

Amortization
69.7

 
70.6

 
171.6

 
137.6

Interest expense on investment borrowings
1.1

 

 
2.3

 

Other operating costs and expenses
45.4

 
46.6

 
85.5

 
94.3

Total Bankers Life expenses
525.1

 
499.9

 
1,073.1

 
1,031.1

Washington National:
 

 
 

 
 

 
 

Insurance policy benefits
118.3

 
116.7

 
230.5

 
229.2

Amortization
14.0

 
13.1

 
30.1

 
27.9

Other operating costs and expenses
38.5

 
39.9

 
77.0

 
76.1

Total Washington National expenses
170.8

 
169.7

 
337.6

 
333.2

Colonial Penn:
 

 
 

 
 

 
 

Insurance policy benefits
38.0

 
35.4

 
76.7

 
72.1

Amortization
8.6

 
8.8

 
17.6

 
17.5

Other operating costs and expenses
7.4

 
7.3

 
15.1

 
14.7

Total Colonial Penn expenses
54.0

 
51.5

 
109.4

 
104.3

Other CNO Business:
 

 
 

 
 

 
 

Insurance policy benefits
119.2

 
116.2

 
246.7

 
249.5

Amortization
9.9

 
3.6

 
19.0

 
15.8

Interest expense on investment borrowings
5.0

 
5.0

 
9.9

 
10.0

Other operating costs and expenses
20.3

 
20.0

 
37.9

 
38.8

Total Other CNO Business expenses
154.4

 
144.8

 
313.5

 
314.1

Corporate operations:
 

 
 

 
 

 
 

Interest expense on corporate debt
19.3

 
19.8

 
39.9

 
39.3

Interest expense on borrowings of variable interest entities
3.5

 
3.9

 
6.0

 
6.9

Loss on extinguishment of debt
.6

 
.9

 
2.0

 
2.7

Other operating costs and expenses
12.8

 
10.4

 
24.0

 
18.7

Total corporate expenses
36.2

 
35.0

 
71.9

 
67.6

Total expenses
940.5

 
900.9

 
1,905.5

 
1,850.3

Income (loss) before net realized investment losses (net of related amortization) and income taxes:
 

 
 
 
 

 
 

Bankers Life
84.7

 
64.0

 
148.6

 
117.2

Washington National
22.7

 
21.1

 
47.9

 
48.7

Colonial Penn
7.6

 
7.6

 
13.0

 
12.9

Other CNO Business
4.8

 
8.8

 
11.9

 
6.9

Corporate operations
(31.2
)
 
(32.5
)
 
(53.7
)
 
(58.8
)
Income before net realized investment losses (net of related amortization) and income taxes
$
88.6

 
$
69.0

 
$
167.7

 
$
126.9


16

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
___________________


___________________
(a)
It is not practicable to provide additional components of revenue by product or services.

A reconciliation of segment revenues and expenses to consolidated revenues and expenses is as follows (dollars in millions):

 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2011
 
2010
 
2011
 
2010
Total segment revenues                                                                                            
$
1,029.1

 
$
969.9

 
$
2,073.2

 
$
1,977.2

Net realized investment gains (losses)                                                                                            
2.9

 
(16.7
)
 
8.0

 
(21.6
)
Consolidated revenues                                                                                       
$
1,032.0

 
$
953.2

 
$
2,081.2

 
$
1,955.6

Total segment expenses                                                                                            
$
940.5

 
$
900.9

 
$
1,905.5

 
$
1,850.3

Amortization related to net realized investment gains (losses)
(.7
)
 
.5

 
(.1
)
 
.4

Consolidated expenses                                                                                       
$
939.8

 
$
901.4

 
$
1,905.4

 
$
1,850.7


ACCOUNTING FOR DERIVATIVES

Our fixed index annuity products provide a guaranteed minimum rate of return and a higher potential return that is based on a percentage (the “participation rate”) of the amount of increase in the value of a particular index, such as the Standard & Poor’s 500 Index, over a specified period.  Typically, on each policy anniversary date, a new index period begins.  We are generally able to change the participation rate at the beginning of each index period during a policy year, subject to contractual minimums.  We typically buy call options (including call spreads) referenced to the applicable indices in an effort to hedge potential increases to policyholder benefits resulting from increases in the particular index to which the policy’s return is linked.  We reflect changes in the estimated fair value of these options in net investment income (classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios).  Net investment gains related to fixed index products were $19.0 million and $(26.0) million in the six months ended June 30, 2011 and 2010, respectively.  These amounts were substantially offset by a corresponding change to insurance policy benefits.  The estimated fair value of these options was $100.9 million and $89.4 million at June 30, 2011 and December 31, 2010, respectively.  We classify these instruments as other invested assets.

The Company accounts for the options attributed to the policyholder for the estimated life of the annuity contract as embedded derivatives.  The expected future cost of options on fixed index annuity products is used to determine the value of embedded derivatives.  The Company purchases options to hedge liabilities for the next policy year on each policy anniversary date and must estimate the fair value of the forward embedded options related to the policies.  These accounting requirements often create volatility in the earnings from these products.  We record the changes in the fair values of the embedded derivatives in current earnings as a component o