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CNO Financial Group, Inc. 10-Q 2013
CNO 09.30.2012 10-Q/A


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q/A
Amendment No. 1
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
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 October 23, 2012:  227,011,634





EXPLANATORY NOTE

This Quarterly Report on Form 10-Q/A ("Form 10-Q/A") is being filed as Amendment No. 1 (the "Amendment") to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, which was filed with the Securities and Exchange Commission on November 1, 2012 (the "Original Form 10-Q"). This Form 10-Q/A is being filed to amend the consolidated balance sheet as of September 30, 2012; the consolidated statement of comprehensive income for the three and nine months ended September 30, 2012; the consolidated statement of shareholders' equity for the nine months ended September 30, 2012; and certain disclosures in the notes to the consolidated financial statements. Management and the Audit and Enterprise Risk Committee of CNO Financial Group, Inc. (the "Company") concluded that an inadvertent error involving a component of the calculation of accumulated other comprehensive income existed in the Original Form 10-Q that requires correction. The correction of this error had no impact on net income, earnings per share or cash flows. In addition, the correction had no impact on results, cash flows or capital measures calculated in accordance with statutory accounting principles.

Pursuant to generally accepted accounting principles, we are required to adjust certain balance sheet accounts to reflect the impact resulting from assuming that unrealized gains and losses on available for sale securities are realized and the proceeds are invested in securities earning current market yields. Such adjustments are commonly referred to as “shadow adjustments” and may include adjustments to: (i) deferred acquisition costs; (ii) the present value of future profits; (iii) loss recognition reserves; and (iv) income taxes. The net impact of these shadow adjustments is recognized in accumulated other comprehensive income. Amounts related to the shadow adjustments for certain long-term care products previously reported in our Original Form 10-Q have been corrected and are described in the note to the consolidated financial statements entitled "Correction to Previously Issued Financial Statements" contained herein. Shadow adjustments will vary from period to period and are primarily dependent upon the amount of unrealized gains or losses related to available for sale securities and the estimated gross profits of certain lines of business.

As a result of the correction, management has also re-assessed the effectiveness of its disclosure controls and procedures and internal control over financial reporting and concluded that they were not effective as of the end of the period covered by this report on Form 10-Q/A because of a material weakness in internal control over financial reporting. Specifically, controls in place to ensure the accurate calculation of shadow adjustments impacting accumulated other comprehensive income did not operate effectively. Therefore, management has subsequently concluded that the Company's disclosure controls and procedures were not effective as of the end of the period covered by this report. As a result of the identification of the error that led to the amendment of our Original Form 10-Q and the related reassessment of disclosure controls and procedures and internal control over financial reporting, we have emphasized the importance of performing and reviewing calculations consistent with the design of our internal control structure in an effort to ensure controls operate effectively. The Company believes this action has remediated the material weakness. The material weakness in internal control over financial reporting is further discussed in Item 4 contained herein.

The following sections have been amended from the Original Form 10-Q as a result of the restatement described above:

Part I - Item 1. Financial Statements
Part I - Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Part I - Item 4. Controls and Procedures

This Form 10-Q/A also includes as exhibits, certifications from our Chief Executive Officer and Chief Financial Officer dated as of the date of this filing. Except as described above, no other sections have been amended from the Original Form
10-Q. This Form 10-Q/A does not reflect information or events occurring after the November 1, 2012 filing date of the Original Form 10-Q, or modify or update disclosures set forth in the Original Form 10-Q, except to reflect the corrections discussed above.





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

 
September 30,
2012
 
December 31,
2011
 
(Restated)
 
 
Investments:
 (unaudited)
 
 
Fixed maturities, available for sale, at fair value (amortized cost:  September 30, 2012 - $21,825.7; December 31, 2011 - $21,779.1)
$
24,742.3

 
$
23,516.0

Equity securities at fair value (cost: September 30, 2012 - $174.0; December 31, 2011 - $177.0)
180.0

 
175.1

Mortgage loans
1,597.2

 
1,602.8

Policy loans
274.1

 
279.7

Trading securities
199.4

 
91.6

Investments held by variable interest entities
829.4

 
496.3

Other invested assets
265.0

 
202.8

Total investments
28,087.4

 
26,364.3

Cash and cash equivalents - unrestricted
415.3

 
436.0

Cash and cash equivalents held by variable interest entities
48.2

 
74.4

Accrued investment income
317.8

 
288.7

Present value of future profits
642.4

 
697.7

Deferred acquisition costs
623.4

 
797.1

Reinsurance receivables
2,967.7

 
3,091.1

Income tax assets, net
699.5

 
865.4

Assets held in separate accounts
15.7

 
15.0

Other assets
338.6

 
292.2

Total assets
$
34,156.0

 
$
32,921.9



(continued on next page)









The accompanying notes are an integral part of the
unaudited consolidated financial statements, which
include a summary of revisions to prior year balances in
connection with a change in accounting principle.



3



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


LIABILITIES AND SHAREHOLDERS' EQUITY

 
September 30,
2012
 
December 31,
2011
 
(Restated)
 
 
Liabilities:
 (unaudited)
 
 
Liabilities for insurance products:
 
 
 
Interest-sensitive products
$
12,930.3

 
$
13,165.5

Traditional products
11,004.3

 
10,482.7

Claims payable and other policyholder funds
977.6

 
1,034.3

Liabilities related to separate accounts
15.7

 
15.0

Other liabilities
709.0

 
556.3

Investment borrowings
1,650.9

 
1,676.5

Borrowings related to variable interest entities
766.9

 
519.9

Notes payable – direct corporate obligations
1,035.1

 
857.9

Total liabilities
29,089.8

 
28,308.1

Commitments and Contingencies


 


Shareholders' equity:
 

 
 

Common stock ($0.01 par value, 8,000,000,000 shares authorized, shares issued and outstanding: September 30, 2012 - 229,506,690; December 31, 2011 – 241,304,503)
2.3

 
2.4

Additional paid-in capital
4,251.2

 
4,361.9

Accumulated other comprehensive income
1,234.4

 
781.6

Accumulated deficit
(421.7
)
 
(532.1
)
Total shareholders' equity
5,066.2

 
4,613.8

Total liabilities and shareholders' equity
$
34,156.0

 
$
32,921.9

















The accompanying notes are an integral part of the
unaudited consolidated financial statements, which
include a summary of revisions to prior year balances in
connection with a change in accounting principle.



4


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

 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
Insurance policy income
$
690.2

 
$
673.5

 
$
2,071.3

 
$
2,020.3

Net investment income (loss):
 

 
 

 
 
 
 
General account assets
349.4

 
338.2

 
1,045.7

 
1,016.5

Policyholder and reinsurer accounts and other special-purpose portfolios
39.1

 
(54.9
)
 
87.4

 
(14.4
)
Realized investment gains (losses):
 

 
 

 
 
 
 
Net realized investment gains, excluding impairment losses
32.2

 
33.5

 
98.4

 
64.9

Other-than-temporary impairment losses:
 

 
 

 
 
 
 
Total other-than-temporary impairment losses
(23.1
)
 
(2.9
)
 
(34.5
)
 
(26.3
)
Portion of other-than-temporary impairment losses recognized in accumulated other comprehensive income

 

 

 

Net impairment losses recognized
(23.1
)
 
(2.9
)
 
(34.5
)
 
(26.3
)
Total realized gains
9.1

 
30.6

 
63.9

 
38.6

Fee revenue and other income
5.2

 
4.9

 
13.6

 
12.5

Total revenues
1,093.0

 
992.3

 
3,281.9

 
3,073.5

Benefits and expenses:
 

 
 

 
 
 
 
Insurance policy benefits
745.7

 
661.0

 
2,124.4

 
2,028.6

Interest expense
29.2

 
27.9

 
86.7

 
86.0

Amortization
60.9

 
58.6

 
215.8

 
224.1

Loss on extinguishment of debt
198.5

 
1.1

 
199.2

 
3.1

Other operating costs and expenses
217.5

 
182.0

 
617.8

 
527.8

Total benefits and expenses
1,251.8

 
930.6

 
3,243.9

 
2,869.6

Income (loss) before income taxes
(158.8
)
 
61.7

 
38.0

 
203.9

Income tax expense (benefit):
 
 
 
 
 
 
 
Income tax expense (benefit) on period income
(10.8
)
 
25.2

 
61.2

 
75.6

Decrease in valuation allowance for deferred tax assets
(143.0
)
 
(143.0
)
 
(143.0
)
 
(143.0
)
Net income (loss)
$
(5.0
)
 
$
179.5

 
$
119.8

 
$
271.3

Earnings per common share:
 

 
 

 
 
 
 
Basic:
 

 
 

 
 
 
 
Weighted average shares outstanding
231,481,000

 
246,965,000

 
236,555,000

 
249,673,000

Net income (loss)
$
(.02
)
 
$
.73

 
$
.51

 
$
1.09

Diluted:
 

 
 

 
 
 
 
Weighted average shares outstanding
231,481,000

 
302,708,000

 
292,983,000

 
306,085,000

Net income (loss)
$
(.02
)
 
$
.61

 
$
.45

 
$
.92


The accompanying notes are an integral part of the
unaudited consolidated financial statements, which
include a summary of revisions to prior year balances in
connection with a change in accounting principle.


5


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

 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(Restated)
 
 
 
(Restated)
 
 
Net income (loss)
$
(5.0
)
 
$
179.5

 
$
119.8

 
$
271.3

Other comprehensive income, before tax:
 
 
 
 
 
 
 
Unrealized gains for the period
689.4

 
973.6

 
1,252.8

 
1,248.1

Amortization of present value of future profits and deferred acquisition costs
(38.0
)
 
(125.9
)
 
(114.2
)
 
(163.0
)
Amount related to premium deficiencies assuming the net unrealized gains had been realized
(267.6
)
 
(241.0
)
 
(380.7
)
 
(241.0
)
Reclassification adjustments:
 
 
 
 
 
 
 
For net realized investment gains included in net income
(4.6
)
 
(55.1
)
 
(57.2
)
 
(69.1
)
For amortization of the present value of future profits and deferred acquisition costs related to net realized investment gains included in net income
1.7

 
3.9

 
5.9

 
3.7

Unrealized gains on investments
380.9

 
555.5

 
706.6

 
778.7

Change related to deferred compensation plan
(2.1
)
 
(2.4
)
 
(.5
)
 
(2.0
)
Other comprehensive income before tax
378.8

 
553.1

 
706.1

 
776.7

Income tax expense related to items of accumulated other comprehensive income
(135.2
)
 
(197.7
)
 
(253.3
)
 
(278.5
)
Other comprehensive income, net of tax
243.6

 
355.4

 
452.8

 
498.2

Comprehensive income
$
238.6

 
$
534.9

 
$
572.6

 
$
769.5



















The accompanying notes are an integral part of the
unaudited consolidated financial statements, which
include a summary of revisions to prior year balances in
connection with a change in accounting principle.


6


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, 2010
$
4,426.7

 
$
252.7

 
$
(867.8
)
 
$
3,811.6

Net income

 

 
271.3

 
271.3

Change in unrealized appreciation (depreciation) of investments (net of applicable income tax expense of $276.7)

 
495.0

 

 
495.0

Change in noncredit component of impairment losses on fixed maturities, available for sale (net of applicable income tax expense of $1.8)

 
3.2

 

 
3.2

Cost of shares acquired
(55.7
)
 

 

 
(55.7
)
Stock option and restricted stock plans
10.8

 

 

 
10.8

Balance, September 30, 2011
$
4,381.8

 
$
750.9

 
$
(596.5
)
 
$
4,536.2

 
 
 
 
 
 
 
 
Balance, December 31, 2011
$
4,364.3

 
$
781.6

 
$
(532.1
)
 
$
4,613.8

Net income

 

 
119.8

 
119.8

Change in unrealized appreciation (depreciation) of investments (net of applicable income tax expense of $248.9)

 
444.9

 

 
444.9

Change in noncredit component of impairment losses on fixed maturities, available for sale (net of applicable income tax expense of $4.4)

 
7.9

 

 
7.9

Extinguishment of beneficial conversion feature related to the repurchase of convertible debentures
(24.0
)
 

 

 
(24.0
)
Cost of shares acquired
(99.5
)
 

 

 
(99.5
)
Dividends on common stock

 

 
(9.4
)
 
(9.4
)
Stock option and restricted stock plans
12.7

 

 

 
12.7

Balance, September 30, 2012 (Restated)
$
4,253.5

 
$
1,234.4

 
$
(421.7
)
 
$
5,066.2

















The accompanying notes are an integral part of the
unaudited consolidated financial statements, which
include a summary of revisions to prior year balances in
connection with a change in accounting principle.


7


CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
(unaudited)
 
Nine months ended
 
September 30,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Insurance policy income
$
1,802.3

 
$
1,791.8

Net investment income
1,010.0

 
1,065.0

Fee revenue and other income
13.6

 
12.5

Insurance policy benefits
(1,611.5
)
 
(1,555.7
)
Interest expense
(84.3
)
 
(70.5
)
Deferrable policy acquisition costs
(141.4
)
 
(164.9
)
Other operating costs
(558.6
)
 
(513.6
)
Taxes
(5.5
)
 
(2.4
)
Net cash provided by operating activities
424.6

 
562.2

Cash flows from investing activities:
 

 
 

Sales of investments
1,852.5

 
4,390.5

Maturities and redemptions of investments
1,365.4

 
853.3

Purchases of investments
(3,570.2
)
 
(6,363.8
)
Net sales of trading securities
47.2

 
307.2

Change in cash and cash equivalents held by variable interest entities
26.2

 
7.1

Other
(24.3
)
 
(23.4
)
Net cash used by investing activities
(303.2
)
 
(829.1
)
Cash flows from financing activities:
 

 
 

Issuance of notes payable, net
944.5

 

Payments on notes payable
(779.0
)
 
(130.7
)
Amounts related to extinguishment of debt
(206.4
)
 

Issuance of common stock
2.0

 
.6

Payments to repurchase common stock
(99.5
)
 
(55.7
)
Common stock dividends paid
(9.4
)
 

Amounts received for deposit products
986.0

 
1,285.8

Withdrawals from deposit products
(1,201.4
)
 
(1,272.0
)
Issuance of investment borrowings:
 
 
 
Federal Home Loan Bank
200.0

 
517.0

Related to variable interest entities
246.7

 
122.2

Payments on investment borrowings:
 
 
 
Federal Home Loan Bank
(200.0
)
 
(267.0
)
Related to variable interest entities and other
(.8
)
 
(100.4
)
Investment borrowings - repurchase agreements, net
(24.8
)
 
57.1

Net cash provided (used) by financing activities
(142.1
)
 
156.9

Net decrease in cash and cash equivalents
(20.7
)
 
(110.0
)
Cash and cash equivalents, beginning of period
436.0

 
571.9

Cash and cash equivalents, end of period
$
415.3

 
$
461.9


The accompanying notes are an integral part of the
unaudited consolidated financial statements, which
include a summary of revisions to prior year balances in
connection with a change in accounting principle.

8

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 2011 Annual Report on Form 10-K as retrospectively updated by the Current Report on Form 8-K filed on September 4, 2012 in connection with a change in accounting principle.

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 2012 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.

As discussed in the note to the consolidated financial statements entitled "Recently Issued Accounting Standards", we have adopted the provisions of Financial Accounting Standards Update No. 2010-26 (“ASU 2010-26”), effective January 1, 2012, which modified the definition of the types of costs incurred by insurance entities that could be capitalized in the acquisition of new and renewal contracts. Pursuant to the guidance, we elected to adopt the provisions on a retrospective basis. Accordingly, all prior periods presented have been retrospectively adjusted.

The balance sheet at December 31, 2011, 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, fair value measurements of certain investments (including derivatives), other-than-temporary impairments of investments, 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.

CORRECTION TO PREVIOUSLY ISSUED FINANCIAL STATEMENTS

As further described below, the consolidated balance sheet as of September 30, 2012; the consolidated statement of comprehensive income for the three and nine months ended September 30, 2012; the consolidated statement of shareholders' equity for the nine months ended September 30, 2012; and certain disclosures in the notes to the consolidated financial statements have been amended to correct an inadvertent error related to a component of accumulated other comprehensive income. The correction of this error had no impact on net income, earnings per share or cash flows. In addition, the correction had no impact on results, cash flows or capital measures calculated in accordance with statutory accounting principles.

9

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


Pursuant to GAAP, we are required to adjust certain balance sheet accounts to reflect the impact resulting from assuming that unrealized gains and losses on available for sale securities are realized and the proceeds are invested in securities earning current market yields. Such adjustments are commonly referred to as “shadow adjustments” and may include adjustments to: (i) deferred acquisition costs; (ii) the present value of future profits; (iii) loss recognition reserves; and (iv) income taxes. The net impact of these shadow adjustments is recognized in accumulated other comprehensive income. Amounts related to the shadow adjustments for certain long-term care products previously reported in our Form 10-Q for the quarterly period ended September 30, 2012, filed with the Securities and Exchange Commission on November 1, 2012, have been corrected. Shadow adjustments will vary from period to period and are primarily dependent upon the amount of unrealized gains or losses related to available for sale securities and the estimated gross profits of certain lines of business. The following summarizes the increase (decrease) to the principal items impacted by the corrections (dollars in millions):

 
As reported in Form 10-Q
 
Corrections to shadow adjustments
 
As reported in Form 10-Q/A
Deferred acquisition costs
$
580.7

 
$
42.7

 
$
623.4

Income tax assets
594.5

 
105.0

 
699.5

  Change in total assets
 
 
$
147.7

 
 
 
 
 
 
 
 
Liabilities for insurance products
$
24,593.5

 
$
334.4

 
$
24,927.9

Accumulated other comprehensive income
1,421.1

 
(186.7
)
 
1,234.4

  Change to total liabilities and shareholders' equity
 
 
$
147.7

 
 
 
 
 
 
 
 
Comprehensive income:
 
 
 
 
 
For the three months ended September 30, 2012
$
425.3

 
$
(186.7
)
 
$
238.6

For the nine months ended September 30, 2012
$
759.3

 
$
(186.7
)
 
$
572.6

 

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: (i) investments purchased with the intent of selling in the near term to generate income on price changes; and (ii) investments supporting certain insurance liabilities (including investments backing the market strategies of our multibucket annuity products) and certain reinsurance agreements. The change in fair value of these securities is recognized in income from policyholder and reinsurer accounts and other special-purpose portfolios (a component of net investment income). Investment income from trading securities backing certain insurance liabilities and certain reinsurance agreements is substantially offset by the change in insurance policy benefits related to certain products and agreements.  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.  During the second quarter of 2011, we sold this trading portfolio and invested the proceeds in higher yielding investments which were classified as available for sale. See the note entitled “Accounting for Derivatives” for further discussion regarding these embedded derivatives.  The trading account also includes certain fixed maturity securities containing embedded derivatives for which we have elected the fair value option. The change in value of these securities is recognized in realized investment gain (losses). Our trading securities totaled $199.4 million and $91.6 million at September 30, 2012 and December 31, 2011, respectively.


10

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

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 September 30, 2012 and December 31, 2011, were as follows (dollars in millions):

 
September 30,
2012
 
December 31,
2011
 
(Restated)
 
 
Net unrealized appreciation (depreciation) on fixed maturity securities, available for sale, on which an other-than-temporary impairment loss has been recognized
$
9.6

 
$
(4.4
)
Net unrealized gains on all other investments
2,914.8

 
1,733.2

Adjustment to present value of future profits (a)
(200.7
)
 
(214.8
)
Adjustment to deferred acquisition costs
(458.0
)
 
(289.3
)
Adjustment to insurance liabilities
(334.4
)
 

Unrecognized net loss related to deferred compensation plan
(8.8
)
 
(8.3
)
Deferred income tax liabilities
(688.1
)
 
(434.8
)
Accumulated other comprehensive income
$
1,234.4

 
$
781.6

_________
(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 September 30, 2012, adjustments to the present value of future profits, deferred acquisition costs, insurance liabilities and deferred income tax assets included $(166.5) million, $(150.8) million, $(334.4) million and $234.6 million, respectively, for premium deficiencies that would exist on certain long-term health products if unrealized gains on the assets backing such products had been realized and the proceeds from our sales of such assets were invested at then current yields.

At September 30, 2012, the amortized cost, gross unrealized gains and losses, estimated fair value, other-than-temporary impairments in accumulated other comprehensive income 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
$
14,586.6

 
$
2,265.7

 
$
(28.8
)
 
$
16,823.5

 
$

United States Treasury securities and obligations of United States government corporations and agencies
164.2

 
6.9

 

 
171.1

 

States and political subdivisions
1,785.6

 
267.9

 
(5.4
)
 
2,048.1

 

Debt securities issued by foreign governments
.8

 

 

 
.8

 

Asset-backed securities
1,391.3

 
92.0

 
(6.6
)
 
1,476.7

 

Collateralized debt obligations
327.6

 
5.2

 
(.8
)
 
332.0

 

Commercial mortgage-backed securities
1,400.7

 
142.7

 
(.8
)
 
1,542.6

 

Mortgage pass-through securities
18.8

 
1.4

 

 
20.2

 

Collateralized mortgage obligations
2,150.1

 
178.1

 
(.9
)
 
2,327.3

 
(7.3
)
Total fixed maturities, available for sale
$
21,825.7

 
$
2,959.9

 
$
(43.3
)
 
$
24,742.3

 
$
(7.3
)


11

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

The following table sets forth the amortized cost and estimated fair value of fixed maturities, available for sale, at September 30, 2012, 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 periodic principal payments and permit periodic unscheduled payments.
 
Amortized
cost
 
Estimated
fair
value
 
(Dollars in millions)
Due in one year or less
$
178.3

 
$
180.7

Due after one year through five years
1,558.1

 
1,697.5

Due after five years through ten years
4,491.1

 
5,038.7

Due after ten years
10,309.7

 
12,126.6

Subtotal
16,537.2

 
19,043.5

Structured securities
5,288.5

 
5,698.8

Total fixed maturities, available for sale
$
21,825.7

 
$
24,742.3


Net Realized Investment Gains (Losses)

During the first nine months of 2012, we recognized net realized investment gains of $63.9 million, which were comprised of $89.0 million of net gains from the sales of investments (primarily fixed maturities) with proceeds of $1.9 billion, the increase in fair value of certain fixed maturity investments with embedded derivatives of $9.4 million, and $34.5 million of writedowns of investments for other than temporary declines in fair value recognized through net income.

During the first nine months of 2011, we recognized net realized investment gains of $38.6 million, which were comprised of $64.9 million of net gains from the sales of investments (primarily fixed maturities) with proceeds of $4.4 billion and $26.3 million of writedowns of investments for other than temporary declines in fair value recognized through net income.

At September 30, 2012, fixed maturity securities in default or considered nonperforming had an aggregate amortized cost of $.4 million and a carrying value of $.5 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 nine months ended September 30, 2012, we sold $393.8 million of fixed maturity investments which resulted in gross investment losses (before income taxes) of $15.3 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) prospective or actual changes in credit quality; or (v) changes in expected cash flows.

There were no investments sold at a loss during the first nine months of 2012 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.

We regularly evaluate all of our investments with unrealized losses 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

12

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

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 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) our best estimate of 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 in our portfolio.  Significant losses 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.

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. 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, except when the security is in default or considered nonperforming.

The remaining noncredit impairment, which is recorded in accumulated other comprehensive income, 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 noncredit impairment typically represents changes in the market interest rates, current market liquidity and risk premiums.  As of September 30, 2012, other-than-temporary impairments included in accumulated other comprehensive income of $7.3 million (before taxes and related amortization) related to structured securities.


13

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

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 three and nine months ended September 30, 2012 and 2011 (dollars in millions):
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Credit losses on fixed maturity securities, available for sale, beginning of period
$
(1.7
)
 
$
(1.6
)
 
$
(2.0
)
 
$
(6.1
)
Add:  credit losses on other-than-temporary impairments not previously recognized

 

 

 

Less:  credit losses on securities sold

 
.7

 
.3

 
5.2

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

 

 

 

Add:  credit losses on previously impaired securities

 

 

 

Less:  increases in cash flows expected on previously impaired securities

 

 

 

Credit losses on fixed maturity securities, available for sale, end of period
$
(1.7
)
 
$
(.9
)
 
$
(1.7
)
 
$
(.9
)
__________
(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 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.


14

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 September 30, 2012 (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
States and political subdivisions
 
$
40.2

 
$
(2.0
)
 
$
68.7

 
$
(3.4
)
 
$
108.9

 
$
(5.4
)
Corporate securities
 
300.5

 
(9.2
)
 
278.1

 
(19.6
)
 
578.6

 
(28.8
)
Asset-backed securities
 
42.1

 
(.3
)
 
137.8

 
(6.3
)
 
179.9

 
(6.6
)
Collateralized debt obligations
 
12.7

 
(.1
)
 
47.2

 
(.7
)
 
59.9

 
(.8
)
Commercial mortgage-backed securities
 
16.0

 
(.1
)
 
14.3

 
(.7
)
 
30.3

 
(.8
)
Mortgage pass-through securities
 

 

 
2.0

 

 
2.0

 

Collateralized mortgage obligations
 
58.5

 
(.5
)
 
36.0

 
(.4
)
 
94.5

 
(.9
)
Total fixed maturities, available for sale
 
$
470.0

 
$
(12.2
)
 
$
584.1

 
$
(31.1
)
 
$
1,054.1

 
$
(43.3
)
Equity securities
 
$
2.1

 
$
(.1
)
 
$

 
$

 
$
2.1

 
$
(.1
)

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, 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
 
$
9.1

 
$

 
$
.2

 
$

 
$
9.3

 
$

States and political subdivisions
 
6.9

 
(.2
)
 
155.4

 
(13.4
)
 
162.3

 
(13.6
)
Debt securities issued by foreign governments
 
.5

 

 

 

 
.5

 

Corporate securities
 
1,394.7

 
(57.0
)
 
466.2

 
(79.9
)
 
1,860.9

 
(136.9
)
Asset-backed securities
 
437.6

 
(14.5
)
 
147.5

 
(22.2
)
 
585.1

 
(36.7
)
Collateralized debt obligations
 
268.8

 
(6.3
)
 
1.7

 

 
270.5

 
(6.3
)
Commercial mortgage-backed securities
 
168.8

 
(5.2
)
 
33.0

 
(2.7
)
 
201.8

 
(7.9
)
Mortgage pass-through securities
 
1.2

 

 
2.2

 
(.1
)
 
3.4

 
(.1
)
Collateralized mortgage obligations
 
645.0

 
(20.8
)
 
29.7

 
(.6
)
 
674.7

 
(21.4
)
Total fixed maturities, available for sale
 
$
2,932.6

 
$
(104.0
)
 
$
835.9

 
$
(118.9
)
 
$
3,768.5

 
$
(222.9
)
Equity securities
 
$
41.6

 
$
(3.0
)
 
$
.4

 
$

 
$
42.0

 
$
(3.0
)

Based on management’s current assessment of investments with unrealized losses at September 30, 2012, 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

15

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

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):
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Net income (loss) for basic earnings per share
$
(5.0
)
 
$
179.5

 
$
119.8

 
$
271.3

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

 
3.7

 
11.1

 
11.1

Net income for diluted earnings per share
$
(5.0
)
 
$
183.2

 
$
130.9

 
$
282.4

Shares:
 

 
 

 
 

 
 

Weighted average shares outstanding for basic earnings per share
231,481

 
246,965

 
236,555

 
249,673

Effect of dilutive securities on weighted average shares:
 

 
 

 
 

 
 

7% Debentures

 
53,367

 
53,037

 
53,367

Stock option and restricted stock plans

 
2,353

 
2,639

 
2,712

Warrants

 
23

 
752

 
333

Dilutive potential common shares

 
55,743

 
56,428

 
56,412

Weighted average shares outstanding for diluted earnings per share
231,481

 
302,708

 
292,983

 
306,085


In the third quarter of 2012, interest expense of $3.7 million (net of income taxes) on the 7% Debentures was not added back to net income; and 56,651,000 equivalent common shares (comprised of 52,366,000 shares related to the 7% Debentures; 2,968,000 shares related to stock option and restricted stock plans; and 1,317,000 shares related to warrants) were not included in the diluted weighted average shares outstanding, because their inclusion would have been antidilutive in such period due to the net loss recognized by the Company.

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 and warrants (or the vesting of the restricted stock). The dilution from our 7.0% Debentures is calculated using the "if converted" method. 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% Debentures.

BUSINESS SEGMENTS

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.  

We measure segment performance by excluding realized investment gains (losses) and fair value changes in embedded derivative liabilities because we believe that this performance measure is a better indicator of the ongoing business and trends

16

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

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) and fair value changes in embedded derivative liabilities depend on market conditions and do not necessarily relate to the underlying business of our segments.  Realized investment gains (losses) and fair value changes in embedded derivative liabilities 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.

Operating information by segment was as follows (dollars in millions):
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
Bankers Life:
 
 
 
 
 
 
 
Insurance policy income:
 
 
 
 
 
 
 
Annuities
$
6.8

 
$
9.6

 
$
21.9

 
$
26.7

Health
335.1

 
334.0

 
1,010.6

 
1,017.1

Life
74.2

 
61.0

 
209.1

 
170.4

Net investment income (a)
221.6

 
158.0

 
642.1

 
564.5

Fee revenue and other income (a)
4.0

 
3.6

 
10.2

 
9.2

Total Bankers Life revenues
641.7

 
566.2

 
1,893.9

 
1,787.9

Washington National:
 

 
 

 
 

 
 

Insurance policy income:
 

 
 

 
 

 
 

Health
143.4

 
141.2

 
429.0

 
423.1

Life
3.6

 
3.9

 
11.6

 
11.8

Other
.8

 
.8

 
2.2

 
3.0

Net investment income (a)
50.9

 
47.3

 
151.9

 
140.3

Fee revenue and other income (a)
.3

 
.4

 
.8

 
.9

Total Washington National revenues
199.0

 
193.6

 
595.5

 
579.1

Colonial Penn:
 

 
 

 
 

 
 

Insurance policy income:
 

 
 

 
 

 
 

Health
1.3

 
1.4

 
4.0

 
4.5

Life
53.2

 
49.4

 
158.5

 
147.5

Net investment income (a)
9.9

 
10.1

 
30.1

 
30.9

Fee revenue and other income (a)
.2

 
.2

 
.6

 
.6

Total Colonial Penn revenues
64.6

 
61.1

 
193.2

 
183.5

Other CNO Business:
 

 
 

 
 

 
 

Insurance policy income:
 

 
 

 
 

 
 

Annuities
2.5

 
3.4

 
8.3

 
8.6

Health
6.2

 
6.9

 
19.3

 
21.3

Life
62.9

 
61.7

 
196.2

 
184.9

Other
.2

 
.2

 
.6

 
1.4

Net investment income (a)
86.7

 
74.6

 
259.2

 
256.0

Total Other CNO Business revenues
158.5

 
146.8

 
483.6

 
472.2

Corporate operations:
 

 
 

 
 

 
 

Net investment income
19.4

 
(6.7
)
 
49.8

 
10.4

Fee and other income
.7

 
.7

 
2.0

 
1.8

Total corporate revenues
20.1

 
(6.0
)
 
51.8

 
12.2

Total revenues
1,083.9

 
961.7

 
3,218.0

 
3,034.9


(continued on next page)

17

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

(continued from previous page)
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Expenses:
 
 
 
 
 
 
 
Bankers Life:
 
 
 
 
 
 
 
Insurance policy benefits
$
434.6

 
$
360.6

 
$
1,252.2

 
$
1,174.3

Amortization
35.6

 
44.1

 
143.0

 
159.5

Interest expense on investment borrowings
1.3

 
1.2