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CNO Financial Group, Inc. 10-Q 2014
CNO 03.31.2014 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 March 31, 2014
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 April 24, 2014:  217,857,078







TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION
Page
 
 
 
Item 1.
Financial Statements (unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
 
 
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
PART II - OTHER INFORMATION
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.


2


PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.



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

ASSETS

 
March 31, 2014
 
December 31, 2013
 
 
 
 
Investments:
 
 
 
Fixed maturities, available for sale, at fair value (amortized cost:  March 31, 2014 - $18,465.6; December 31, 2013 - $21,860.6)
$
20,143.8

 
$
23,178.3

Equity securities at fair value (cost: March 31, 2014 - $260.5; December 31, 2013 - $237.9)
277.6

 
249.3

Mortgage loans
1,501.7

 
1,729.5

Policy loans
102.6

 
277.0

Trading securities
235.5

 
247.6

Investments held by variable interest entities
1,134.1

 
1,046.7

Other invested assets
409.5

 
423.3

Total investments
23,804.8

 
27,151.7

Cash and cash equivalents - unrestricted
285.4

 
699.0

Cash and cash equivalents held by variable interest entities
140.3

 
104.3

Accrued investment income
259.3

 
286.9

Present value of future profits
527.7

 
679.3

Deferred acquisition costs
740.4

 
968.1

Reinsurance receivables
3,072.8

 
3,392.1

Income tax assets, net
870.7

 
1,147.2

Assets held in separate accounts
10.0

 
10.3

Other assets
401.0

 
341.7

Assets of subsidiary being sold
4,346.3

 

Total assets
$
34,458.7

 
$
34,780.6


(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)
(unaudited)

LIABILITIES AND SHAREHOLDERS' EQUITY

 
March 31, 2014
 
December 31, 2013
 
 
 
 
Liabilities:
 
 
 
Liabilities for insurance products:
 
 
 
Policyholder account balances
$
10,625.3

 
$
12,776.4

Future policy benefits
10,138.6

 
11,222.5

Liability for policy and contract claims
482.2

 
566.0

Unearned and advanced premiums
279.5

 
300.6

Liabilities related to separate accounts
10.0

 
10.3

Other liabilities
727.4

 
590.6

Payable to reinsurer

 
590.3

Investment borrowings
1,499.4

 
1,900.0

Borrowings related to variable interest entities
1,019.4

 
1,012.3

Notes payable – direct corporate obligations
844.1

 
856.4

Liabilities of subsidiary being sold
4,122.6

 

Total liabilities
29,748.5

 
29,825.4

Commitments and Contingencies


 


Shareholders' equity:
 

 
 

Common stock ($0.01 par value, 8,000,000,000 shares authorized, shares issued and outstanding:  March 31, 2014 – 219,266,947; December 31, 2013 – 220,323,823)
2.2

 
2.2

Additional paid-in capital
4,054.7

 
4,092.8

Accumulated other comprehensive income
766.2

 
731.8

Retained earnings (accumulated deficit)
(112.9
)
 
128.4

Total shareholders' equity
4,710.2

 
4,955.2

Total liabilities and shareholders' equity
$
34,458.7

 
$
34,780.6
















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
 
 
March 31,
 
 
2014
 
2013
Revenues:
 
 
 
 
Insurance policy income
 
$
685.9

 
$
691.2

Net investment income (loss):
 
 
 
 
General account assets
 
348.1

 
351.9

Policyholder and reinsurer accounts and other special-purpose portfolios
 
20.9

 
77.7

Realized investment gains (losses):
 
 
 
 
Net realized investment gains, excluding impairment losses
 
35.3

 
15.3

Other-than-temporary impairment losses:
 
 
 
 
Total other-than-temporary impairment losses
 
(11.9
)
 

Portion of other-than-temporary impairment losses recognized in accumulated other comprehensive income
 

 

Net impairment losses recognized
 
(11.9
)
 

Total realized gains
 
23.4

 
15.3

Fee revenue and other income
 
6.4

 
6.5

Total revenues
 
1,084.7

 
1,142.6

Benefits and expenses:
 
 
 
 
Insurance policy benefits
 
690.3

 
754.1

Loss on sale of subsidiary
 
278.6

 

Interest expense
 
24.6

 
27.3

Amortization
 
66.7

 
79.3

Loss on extinguishment of debt
 

 
57.7

Other operating costs and expenses
 
194.1

 
189.6

Total benefits and expenses
 
1,254.3

 
1,108.0

Income (loss) before income taxes
 
(169.6
)
 
34.6

Income tax expense:
 
 
 
 
Tax expense on period income
 
39.0

 
33.2

Valuation allowance for deferred tax assets and other tax items
 
19.4

 
(10.5
)
Net income (loss)
 
$
(228.0
)
 
$
11.9

Earnings per common share:
 
 
 
 
Basic:
 
 
 
 
Weighted average shares outstanding
 
220,307,000

 
222,081,000

Net income (loss)
 
$
(1.03
)
 
$
.05

Diluted:
 
 
 
 
Weighted average shares outstanding
 
220,307,000

 
243,467,000

Net income (loss)
 
$
(1.03
)
 
$
.05






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

5


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

 
Three months ended
 
March 31,
 
2014
 
2013
Net income (loss)
$
(228.0
)
 
$
11.9

Other comprehensive income, before tax:
 
 
 
Unrealized gains (losses) for the period
393.8

 
(183.3
)
Amortization of present value of future profits and deferred acquisition costs
(77.4
)
 
20.7

Amount related to premium deficiencies assuming the net unrealized gains had been realized
(237.5
)
 
135.3

Reclassification adjustments:
 
 
 
For net realized investment gains included in net income (loss)
(26.0
)
 
(14.8
)
For amortization of the present value of future profits and deferred acquisition costs related to net realized investment gains included in net income (loss)
.4

 
.8

Unrealized gains (losses) on investments
53.3

 
(41.3
)
Change related to deferred compensation plan
.3

 
1.0

Other comprehensive income (loss) before tax
53.6

 
(40.3
)
Income tax (expense) benefit related to items of accumulated other comprehensive income
(19.2
)
 
13.6

Other comprehensive income (loss), net of tax
34.4

 
(26.7
)
Comprehensive loss
$
(193.6
)
 
$
(14.8
)























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


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
 
Retained earnings (accumulated deficit)
 
Total
Balance, December 31, 2012
$
4,176.9

 
$
1,197.4

 
$
(325.0
)
 
$
5,049.3

Net income

 

 
11.9

 
11.9

Change in unrealized appreciation (depreciation) of investments (net of applicable income tax benefit of $13.8)

 
(27.0
)
 

 
(27.0
)
Change in noncredit component of impairment losses on fixed maturities, available for sale (net of applicable income tax expense of $.2)

 
.3

 

 
.3

Extinguishment of beneficial conversion feature related to the repurchase of convertible debentures
(12.6
)
 

 

 
(12.6
)
Dividends on common stock

 

 
(4.4
)
 
(4.4
)
Stock options, restricted stock and performance units
11.1

 

 

 
11.1

Balance, March 31, 2013
$
4,175.4

 
$
1,170.7

 
$
(317.5
)
 
$
5,028.6

 
 
 
 
 
 
 
 
Balance, December 31, 2013
$
4,095.0

 
$
731.8

 
$
128.4

 
$
4,955.2

Net loss

 

 
(228.0
)
 
(228.0
)
Change in unrealized appreciation (depreciation) of investments (net of applicable income tax expense of $19.1)

 
34.2

 

 
34.2

Change in noncredit component of impairment losses on fixed maturities, available for sale (net of applicable income tax expense of $.1)

 
.2

 

 
.2

Cost of shares acquired
(41.0
)
 

 

 
(41.0
)
Dividends on common stock

 

 
(13.3
)
 
(13.3
)
Stock options, restricted stock and performance units
2.9

 

 

 
2.9

Balance, March 31, 2014
$
4,056.9

 
$
766.2

 
$
(112.9
)
 
$
4,710.2















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

7


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

 
Three months ended
 
March 31,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Insurance policy income
$
593.2

 
$
622.4

Net investment income
321.1

 
314.4

Fee revenue and other income
6.4

 
6.5

Insurance policy benefits
(523.7
)
 
(542.4
)
Payment to reinsurer pursuant to long-term care business reinsured
(590.3
)
 

Interest expense
(18.3
)
 
(20.1
)
Deferrable policy acquisition costs
(56.7
)
 
(53.5
)
Other operating costs
(211.3
)
 
(212.0
)
Taxes
(.7
)
 
(.7
)
Net cash from operating activities
(480.3
)
(a)
114.6

Cash flows from investing activities:
 

 
 

Sales of investments
807.2

 
547.4

Maturities and redemptions of investments
469.6

 
630.4

Purchases of investments
(1,010.2
)
 
(1,656.7
)
Net sales (purchases) of trading securities
(3.1
)
 
41.2

Change in cash and cash equivalents held by variable interest entities
(36.0
)
 
(408.0
)
Cash and cash equivalents held by subsidiary being sold
(50.0
)
 

Other
(5.9
)
 
(7.0
)
Net cash provided (used) by investing activities
171.6

 
(852.7
)
Cash flows from financing activities:
 

 
 

Payments on notes payable
(12.5
)
 
(72.8
)
Expenses related to extinguishment of debt

 
(54.7
)
Amount paid to extinguish the beneficial conversion feature associated with repurchase of convertible debentures

 
(12.6
)
Issuance of common stock
3.4

 
11.6

Payments to repurchase common stock
(33.0
)
 

Common stock dividends paid
(13.3
)
 
(4.4
)
Amounts received for deposit products
329.6

 
308.5

Withdrawals from deposit products
(368.7
)
 
(374.1
)
Issuance of investment borrowings:
 
 
 
Federal Home Loan Bank
200.0

 
200.0

Related to variable interest entities
24.1

 
376.3

Payments on investment borrowings:
 
 
 
Federal Home Loan Bank
(217.2
)
 

Related to variable interest entities and other
(17.3
)
 
(.1
)
Investment borrowings - repurchase agreements, net

 
29.5

Net cash provided (used) by financing activities
(104.9
)
 
407.2

Net decrease in cash and cash equivalents
(413.6
)
 
(330.9
)
Cash and cash equivalents, beginning of period
699.0

 
582.5

Cash and cash equivalents, end of period
$
285.4

 
$
251.6

______________________
(a)
Cash flows from operating activities reflect outflows in the 2014 period due to the payment to reinsurer to transfer certain long-term care business.


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

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 2013 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.  The terms "CNO Financial Group, Inc.", "CNO", the "Company", "we", "us", and "our" as used in these financial statements refer to CNO and its subsidiaries.  Such terms, when used to describe insurance business and products, refer to the insurance business and products of CNO's insurance subsidiaries.

We focus on serving middle-income pre-retiree and retired Americans, 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 2014 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, 2013, 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.

The accompanying financial statements include the accounts of the Company and its subsidiaries. Our consolidated financial statements exclude transactions between us and our consolidated affiliates, or among our consolidated affiliates.

AGREEMENT TO SELL SUBSIDIARY

On March 2, 2014, CNO entered into a Stock Purchase Agreement (the "Stock Purchase Agreement") with Wilton Reassurance Company ("Wilton Re"), pursuant to which CNO has agreed to sell to Wilton Re all of the issued and outstanding shares of Conseco Life Insurance Company ("CLIC"), an indirect wholly owned subsidiary of CNO. Based on CLIC’s statutory capital and surplus as of March 31, 2014, as adjusted for certain intercompany reinsurance transactions to be completed prior to the closing, the purchase price is expected to be approximately $220 million in cash, subject to further adjustment as specified in the Stock Purchase Agreement for changes in CLIC’s statutory capital and surplus from March 31, 2014 to the closing date. Pursuant to the terms of our Senior Secured Credit Agreement (as defined in the note to the consolidated financial statements entitled "Notes Payable - Direct Corporate Obligations"), we are required to make a mandatory prepayment with the net proceeds received from the sale in excess of $125.0 million.

The transaction, which is expected to close by mid-year 2014, is subject to receipt of insurance regulatory approvals and satisfaction of other customary closing conditions.  No assurance can be given that the transaction will be completed.
 

9

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


The Stock Purchase Agreement contemplates that, at the closing, CNO Services, LLC ("CNO Services"), an indirect wholly owned subsidiary of CNO, will enter into a transition services agreement and a special support services agreement with Wilton Re, pursuant to which CNO Services will make available to Wilton Re and its affiliates, for a limited period of time, certain services required for the operation of CLIC's business following the closing. The costs of the services provided to Wilton Re are expected to approximate the fees received under the agreements.

We have accounted for the sale of CLIC as held for sale as management has entered into a definitive contract to sell the subsidiary and the completion of the sale is probable during the next 12 months at a determinable price. A business classified as held for sale is recorded at the lower of its carrying amount or estimated fair value less costs to sell. As the carrying amount of the CLIC business being sold exceeded its costs to sell, we have recognized an estimated loss on the sale of CLIC in the three months ended March 31, 2014, as summarized below (dollars in millions):

Estimated net cash proceeds
 
$
219.8

Net assets sold:
 
 
Investments
 
3,925.6

Cash and cash equivalents
 
50.0

Present value of future profits and deferred acquisition costs
 
54.8

Reinsurance receivables
 
159.6

Income tax assets, net
 
91.0

Other assets
 
65.3

Liabilities for insurance products
 
(3,234.1
)
Other liabilities
 
(33.1
)
Investment borrowings
 
(383.5
)
Accumulated other comprehensive income
 
(197.2
)
Net assets sold
 
498.4

Estimated loss before taxes
 
(278.6
)
Tax expense related to tax gain on sale
 
13.2

Previously unrecognized tax benefit now recognized as a result of the gain
 
(7.4
)
Valuation allowance release related to the gain
 
(5.8
)
Valuation allowance increase related to the decrease in projected future taxable income
 
19.4

Estimated net loss
 
$
(298.0
)

Because the tax basis of CLIC is lower than the estimated cash proceeds, the transaction will generate a taxable gain and estimated tax expense of $13.2 million (subject to further adjustments for changes in the estimated cash proceeds and CLIC's tax basis at the closing date). Fully offsetting the tax is $7.4 million of previously unrecognized tax benefits (pertaining to a corporate matter unrelated to the sale of CLIC) which may now be recognized and $5.8 million of a valuation allowance release pertaining to net operating loss carryforwards ("NOLs") which may now be utilized. However, the disposition of CLIC is expected to result in a reduction to CNO's taxable income in future periods which also requires us to establish a valuation allowance of $19.4 million.



10

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


The assets and liabilities of the CLIC business being sold have been segregated in the consolidated balance sheet as of March 31, 2014 (the period in which the business was classified as held for sale). The following summarizes the assets and liabilities held for sale as of March 31, 2014 (dollars in millions):


 
 
March 31, 2014
Investments
 
$
3,925.6

Cash and cash equivalents - unrestricted
 
50.0

Accrued investment income
 
47.7

Present value of future profits
 
15.8

Deferred acquisition costs
 
39.0

Reinsurance receivables
 
159.6

Income tax assets, net
 
91.0

Other assets
 
17.6

Assets of subsidiary being sold
 
$
4,346.3

 
 
 
Liabilities for insurance products
 
$
3,234.1

Other liabilities
 
33.1

Investment borrowings
 
383.5

Loss accrual
 
471.9

Liabilities of subsidiary being sold
 
$
4,122.6


The Stock Purchase Agreement also provides that, at the closing, Bankers Life and Casualty Company ("Bankers Life"), an indirect wholly owned subsidiary of CNO, will enter into an agreement pursuant to which Bankers Life will recapture the life insurance business written by Bankers Life that is currently reinsured by Wilton Re.  The entry into this recapture agreement is conditioned on the concurrent consummation of the closing and will be recognized in our consolidated financial statements upon completion.


11

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


OUT-OF-PERIOD ADJUSTMENTS

In the three months ended March 31, 2014, we recorded the net effect of an out-of-period adjustment related to the calculation of incentive compensation accruals which increased other operating costs and expenses by $2.4 million, decreased tax expense by $.8 million and increased our net loss by $1.6 million (or 1 cent per diluted share). In the three months ended March 31, 2013, we recorded the net effect of an out-of-period adjustment which increased our insurance policy benefits by $6.7 million, increased amortization expense by $2.5 million, decreased tax expense by $3.2 million and decreased our net income by $6.0 million (or 2 cents per diluted share). We evaluated these adjustments taking into account both qualitative and quantitative factors and considered the impact of these adjustments in relation to each period, as well as the periods in which they originated. The impact of recognizing these adjustments in prior years was not significant to any individual period. Management believes these adjustments are immaterial to the consolidated financial statements and all previously issued financial statements.

INVESTMENTS

We classify our fixed maturity securities into one of two 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); or (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)).

Our trading securities include: (i) investments purchased with the intent of selling in the near term to generate income; 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.  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 gains (losses).  Our trading securities totaled $235.5 million and $247.6 million at March 31, 2014 and December 31, 2013, 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 March 31, 2014 and December 31, 2013, were as follows (dollars in millions):

 
March 31,
2014
 
December 31,
2013
Net unrealized appreciation (depreciation) on fixed maturity securities, available for sale, on which an other-than-temporary impairment loss has been recognized
$
(4.1
)
 
$
6.5

Net unrealized gains on all other investments
1,701.0

 
1,322.6

Adjustment to present value of future profits (a)
(162.0
)
 
(47.7
)
Adjustment to deferred acquisition costs
(337.2
)
 
(137.0
)
Unrecognized net loss related to deferred compensation plan
(6.8
)
 
(7.1
)
Deferred income tax liabilities
(424.7
)
 
(405.5
)
Accumulated other comprehensive income
$
766.2

 
$
731.8

________
(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 Conseco, Inc., an Indiana corporation (our "Predecessor"), emerged from bankruptcy.

At March 31, 2014, adjustments to the present value of future profits, deferred acquisition costs and deferred tax assets included $(138.8) million, $(126.5) million and $94.3 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 the sales of such assets were invested at then current yields.


12

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


At March 31, 2014, 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
$
12,313.9

 
$
1,345.6

 
$
(52.2
)
 
$
13,607.3

 
$

United States Treasury securities and obligations of United States government corporations and agencies
143.9

 
2.7

 
(.4
)
 
146.2

 

States and political subdivisions
1,929.5

 
157.5

 
(16.2
)
 
2,070.8

 

Asset-backed securities
1,288.7

 
76.0

 
(3.7
)
 
1,361.0

 

Collateralized debt obligations
282.7

 
5.7

 
(.6
)
 
287.8

 

Commercial mortgage-backed securities
1,151.1

 
81.0

 
(2.2
)
 
1,229.9

 

Mortgage pass-through securities
8.4

 
.5

 

 
8.9

 

Collateralized mortgage obligations
1,347.4

 
85.5

 
(1.0
)
 
1,431.9

 
(3.8
)
Total fixed maturities, available for sale
$
18,465.6

 
$
1,754.5

 
$
(76.3
)
 
$
20,143.8

 
$
(3.8
)
Fixed maturities of CLIC being sold
$
3,456.0

 
$

 
$

 
$
3,456.0

 
$


The following table sets forth the amortized cost and estimated fair value of fixed maturities, available for sale, at March 31, 2014, 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
$
118.8

 
$
120.9

Due after one year through five years
1,719.2

 
1,889.3

Due after five years through ten years
3,042.5

 
3,307.6

Due after ten years
9,506.8

 
10,506.5

Subtotal
14,387.3

 
15,824.3

Structured securities
4,078.3

 
4,319.5

Total fixed maturities, available for sale
$
18,465.6

 
$
20,143.8



13

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


Net Realized Investment Gains (Losses)

The following table sets forth the net realized investment gains (losses) for the periods indicated (dollars in millions):

 
Three months ended
 
March 31,
 
2014
 
2013
Fixed maturity securities, available for sale:
 
 
 
Gross realized gains on sale
$
41.5

 
$
16.6

Gross realized losses on sale
(5.5
)
 
(2.0
)
Impairments:
 
 
 
Total other-than-temporary impairment losses

 

Other-than-temporary impairment losses recognized in accumulated other comprehensive income

 

Net impairment losses recognized

 

Net realized investment gains from fixed maturities
36.0

 
14.6

Commercial mortgage loans

 
.7

Impairments of mortgage loans and other investments
(11.9
)
 

Other
(.7
)
 

Net realized investment gains
$
23.4

 
$
15.3


During the first three months of 2014, we recognized net realized investment gains of $23.4 million, which were comprised of $32.8 million of net gains from the sales of investments (primarily fixed maturities) with proceeds of $.8 billion, the increase in fair value of certain fixed maturity investments with embedded derivatives of $2.5 million and $11.9 million of writedowns of investments for other than temporary declines in fair value recognized through net income.

During the first three months of 2013, we recognized net realized investment gains of $15.3 million, which were comprised of $19.8 million of net gains from the sales of investments (primarily fixed maturities) with proceeds of $.5 billion and the decrease in fair value of certain fixed maturity investments with embedded derivatives of $4.5 million.

At March 31, 2014, fixed maturity securities in default or considered nonperforming had an aggregate amortized cost and a carrying value of nil and $.5 million, respectively.

Our fixed maturity investments are generally purchased in the context of various long-term strategies, including funding 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 first three months of 2014, the $5.5 million of realized losses on sales of $86.9 million of fixed maturity securities, available for sale, included:  (i) $.5 million of losses related to the sales of securities issued by state and political subdivisions; and (ii) $5.0 million of additional losses related to various corporate securities.  Securities are generally sold at a loss following unforeseen issue-specific events or conditions or shifts in perceived risks.  These reasons include but are 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.

During the first three months of 2014, we recognized $11.9 million of impairment losses recorded in earnings which included: (i) a $3.9 million writedown of a commercial mortgage loan related to a property which recently lost a major tenant; and (ii) an $8.0 million impairment related to two legacy private company investments where earnings and cash flows have not met the expectations assumed in our previous valuations.

14

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


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 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 March 31, 2014, other-than-temporary impairments included in accumulated other comprehensive income of $3.8 million (before taxes and related amortization) related to structured securities.


15

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 months ended March 31, 2014, and 2013 (dollars in millions):

 
Three months ended
 
March 31,
 
2014
 
2013
Credit losses on fixed maturity securities, available for sale, beginning of period
$
(1.3
)
 
$
(1.6
)
Add:  credit losses on other-than-temporary impairments not previously recognized

 

Less:  credit losses on securities sold

 
.1

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
$
(1.3
)
 
$
(1.5
)
__________
(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.


16

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 March 31, 2014 (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
 
$
19.2

 
$
(.4
)
 
$

 
$

 
$
19.2

 
$
(.4
)
States and political subdivisions
 
186.2

 
(11.6
)
 
63.5

 
(4.6
)
 
249.7

 
(16.2
)
Corporate securities
 
980.5

 
(35.7
)
 
196.3

 
(16.5
)
 
1,176.8

 
(52.2
)
Asset-backed securities
 
229.7

 
(2.9
)
 
35.3

 
(.8
)
 
265.0

 
(3.7
)
Collateralized debt obligations
 
26.9

 
(.6
)
 

 

 
26.9

 
(.6
)
Commercial mortgage-backed securities
 
77.1

 
(2.2
)
 

 

 
77.1

 
(2.2
)
Mortgage pass-through securities
 
.9

 

 
.4

 

 
1.3

 

Collateralized mortgage obligations
 
102.2

 
(.6
)
 
5.2

 
(.4
)
 
107.4

 
(1.0
)
Total fixed maturities, available for sale
 
$
1,622.7

 
$
(54.0
)
 
$
300.7

 
$
(22.3
)
 
$
1,923.4

 
$
(76.3
)
Equity securities
 
$
41.0

 
$
(2.2
)
 
$

 
$

 
$
41.0

 
$
(2.2
)

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, 2013 (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
 
$
23.8

 
$
(.6
)
 
$

 
$

 
$
23.8

 
$
(.6
)
States and political subdivisions
 
473.6

 
(30.3
)
 
79.2

 
(8.7
)
 
552.8

 
(39.0
)
Corporate securities
 
2,406.1

 
(132.8
)
 
170.3

 
(20.8
)
 
2,576.4

 
(153.6
)
Asset-backed securities
 
308.4

 
(6.5
)
 
32.5

 
(.7
)
 
340.9

 
(7.2
)
Collateralized debt obligations
 
46.7

 
(.5
)
 

 

 
46.7

 
(.5
)
Commercial mortgage-backed securities
 
161.8

 
(5.8
)
 

 

 
161.8

 
(5.8
)
Mortgage pass-through securities
 
1.6

 

 
1.6

 

 
3.2

 

Collateralized mortgage obligations
 
121.8

 
(1.6
)
 
2.2

 

 
124.0

 
(1.6
)
Total fixed maturities, available for sale
 
$
3,543.8

 
$
(178.1
)
 
$
285.8

 
$
(30.2
)
 
$
3,829.6

 
$
(208.3
)
Equity securities
 
$
26.8

 
$
(4.9
)
 
$

 
$

 
$
26.8

 
$
(4.9
)

Based on management's current assessment of investments with unrealized losses at March 31, 2014, 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,

17

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


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):

 
Three months ended
 
March 31,
 
2014
 
2013
Net income (loss) for basic earnings per share
$
(228.0
)
 
$
11.9

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

 
1.2

Net income (loss) for diluted earnings per share
$
(228.0
)
 
$
13.1

Shares:
 

 
 

Weighted average shares outstanding for basic earnings per share
220,307

 
222,081

Effect of dilutive securities on weighted average shares:
 

 
 

7.0% Debentures

 
16,591

Stock options, restricted stock and performance units

 
2,828

Warrants

 
1,967

Dilutive potential common shares

 
21,386

Weighted average shares outstanding for diluted earnings per share
220,307

 
243,467


In the first quarter of 2014, 5,803,000 equivalent common shares (comprised of 2,537,000 shares related to stock options, restricted stock and performance units and 3,266,000 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 resulting from the sale of CLIC.

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 units) 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 and performance units) 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 and performance units). Initially, the 7.0% Debentures were convertible into 182.1494 shares of our common stock for each $1,000 principal amount of 7.0% Debentures, which was equivalent to an initial conversion price of approximately $5.49 per share. The conversion rate was subject to adjustment following the occurrence of certain events (including the payment of dividends on our common stock) in accordance with the terms of the an indenture dated as of October 16, 2009. On July 1, 2013, the Company issued a conversion right termination notice to holders of the 7.0% Debentures and the right to convert the 7.0% Debentures into shares of its common stock was terminated effective July 30, 2013.



18

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


BUSINESS SEGMENTS

Prior to 2014, the Company managed 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.  As a result of the planned sale of CLIC expected to be completed mid-year 2014 and the coinsurance agreements to cede certain long-term care business effective December 31, 2013 (as further described in the note to the consolidated financial statements entitled "Reinsurance"), management has changed the manner in which it disaggregates the Company's operations for making operating decisions and assessing performance. In periods prior to 2014: (i) the results in the Washington National segment have been adjusted to include the results from the business in the Other CNO Business segment that are being retained; (ii) the Other CNO Business segment included only the long-term care business that was ceded effective December 31, 2013 and the overhead expense of CLIC that is expected to continue after the completion of the sale; and (iii) the CLIC business being sold is excluded from our analysis of business segment results. Beginning on January 1, 2014: (i) the overhead expense of CLIC that is expected to continue after the completion of the sale has been reallocated primarily to the Bankers Life and Washington National segments; (ii) there is no longer an Other CNO Business segment; and (iii) the CLIC business being sold continues to be excluded from our analysis of business segment results. After the completion of the sale of CLIC: (i) the Bankers Life segment will include the results of certain life insurance business that will be recaptured from Wilton Re; and (ii) the revenues and expenses associated with a transition services agreement and a special support services agreement with Wilton Re will be included in our non-operating earnings. Our prior period segment disclosures have been revised to reflect management's current view of the Company's operating segments.

We measure segment performance by excluding the loss on the operations of CLIC being sold, the earnings of CLIC being sold, net realized investment gains (losses), fair value changes in embedded derivative liabilities (net of related amortization), equity in earnings of certain non-strategic investments and earnings attributable to variable interest entities ("VIEs"), loss on extinguishment of debt and income taxes ("pre-tax operating earnings") 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 net realized investment gains (losses), and a long-term focus is necessary to maintain profitability over the life of the business.

The loss on the operations of CLIC being sold, the earnings of CLIC being sold, net realized investment gains (losses), fair value changes in embedded derivative liabilities (net of related amortization), equity in earnings of certain non-strategic investments and earnings attributable to VIEs and loss on extinguishment of debt depend on market conditions or represent unusual items that do not necessarily relate to the underlying business of our segments.  Net realized investment gains (losses) and fair value changes in embedded derivative liabilities (net of related amortization) 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.

19

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
 
March 31,
 
2014
 
2013
Revenues:
 
 
 
Bankers Life:
 
 
 
Insurance policy income:
 
 
 
Annuities
$
7.5

 
$
7.9

Health
330.5

 
332.6

Life
78.3

 
77.5

Net investment income (a)
224.4

 
261.7

Fee revenue and other income (a)
5.3

 
3.7

Total Bankers Life revenues
646.0

 
683.4

Washington National:
 

 
 

Insurance policy income:
 

 
 

Annuities
1.0

 
1.5

Health
148.9

 
145.4

Life
5.7

 
6.0

Net investment income (a)
69.0

 
77.9

Fee revenue and other income (a)
.2

 
.2

Total Washington National revenues
224.8

 
231.0

Colonial Penn:
 

 
 

Insurance policy income:
 

 
 

Health
1.0

 
1.1

Life
59.5

 
55.8

Net investment income (a)
10.7

 
9.9

Fee revenue and other income (a)
.2

 
.2

Total Colonial Penn revenues
71.4

 
67.0

Other CNO Business:
 

 
 

Insurance policy income - health

 
6.2

Net investment income (a)

 
8.4

Total Other CNO Business revenues

 
14.6

Corporate operations:
 

 
 

Net investment income
7.0

 
10.1

Fee and other income
1.4

 
1.7

Total corporate revenues
8.4

 
11.8

Total revenues
950.6

 
1,007.8


(continued on next page)


20

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


(continued from previous page)
 
Three months ended
 
March 31,
 
2014
 
2013
Expenses:
 
 
 
Bankers Life:
 
 
 
Insurance policy benefits
$
415.0

 
$
470.5

Amortization
48.2

 
54.5

Interest expense on investment borrowings
1.9

 
1.4

Other operating costs and expenses
96.7

 
94.9

Total Bankers Life expenses
561.8

 
621.3

Washington National:
 

 
 

Insurance policy benefits
131.8

 
137.7

Amortization
16.3

 
17.1

Interest expense on investment borrowings
.4

 
.5

Other operating costs and expenses
45.2

 
41.7

Total Washington National expenses
193.7

 
197.0

Colonial Penn:
 

 
 

Insurance policy benefits
44.7

 
43.0

Amortization
4.0

 
3.7

Other operating costs and expenses
28.9

 
25.7

Total Colonial Penn expenses
77.6

 
72.4

Other CNO Business:
 

 
 

Insurance policy benefits

 
15.6

Other operating costs and expenses

 
6.3

Total Other CNO Business expenses

 
21.9

Corporate operations:
 

 
 

Interest expense on corporate debt
11.1

 
15.1

Interest expense on investment borrowings

 
.1

Other operating costs and expenses
14.4

 
8.7

Total corporate expenses
25.5

 
23.9

Total expenses
858.6

 
936.5

Pre-tax operating earnings by segment:
 

 
 

Bankers Life
84.2

 
62.1

Washington National
31.1

 
34.0

Colonial Penn
(6.2
)
 
(5.4
)
Other CNO Business

 
(7.3
)
Corporate operations
(17.1
)
 
(12.1
)
Pre-tax operating earnings
$
92.0

 
$
71.3

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

21

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



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

 
Three months ended
 
March 31,
 
2014
 
2013
Total segment revenues                                                                                            
$
950.6

 
$
1,007.8

Net realized investment gains                                               
21.3

 
13.2

Revenues related to certain non-strategic investments and earnings attributable to VIEs
6.3

 
6.9

Revenues of CLIC being sold
106.5

 
114.7

Consolidated revenues                                                                                       
1,084.7

 
1,142.6

 
 
 
 
Total segment expenses                                                                                            
858.6

 
936.5

Insurance policy benefits - fair value changes in embedded derivative liabilities
15.2

 
(3.1
)
Amortization related to fair value changes in embedded derivative liabilities
(4.2
)
 
1.0

Amortization related to net realized investment gains
.4

 
.8

Expenses related to certain non-strategic investments and earnings attributable to VIEs
9.6

 
8.8

Loss on extinguishment of debt

 
57.7

Loss on sale of subsidiary
278.6

 

Expenses of CLIC being sold
96.1

 
106.3

Consolidated expenses                                                                                       
1,254.3

 
1,108.0

Income (loss) before tax
(169.6
)
 
34.6

Income tax expense:
 
 
 
Tax expense on period income
39.0

 
33.2

Valuation allowance for deferred taxes and other tax items
19.4

 
(10.5
)
Net income (loss)
$
(228.0
)
 
$
11.9



22

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


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 offset or 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 (losses) related to fixed index products were $5.4 million and $57.9 million in the three months ended March 31, 2014 and 2013, respectively. These amounts were substantially offset by a corresponding change to insurance policy benefits.  The estimated fair value of these options was $128.5 million (including $4.3 million classified as "Assets of subsidiary being sold") and $156.2 million at March 31, 2014 and December 31, 2013, 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 Company purchases options to hedge liabilities for the next policy period approximately 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 earnings as a component of insurance policy benefits.  The fair value of these derivatives, which are classified as "policyholder account balances", was $930.8 million and $903.7 million at March 31, 2014 and December 31, 2013, respectively. We recognized an increase (decrease) to earnings of $11.0 million and $(2.1) million in the three months ended March 31, 2014 and 2013, respectively, from the volatility caused by the accounting requirements to record embedded options at fair value.

If the counterparties for the call options we hold fail to meet their obligations, we may have to recognize a loss.  We limit our exposure to such a loss by diversifying among several counterparties believed to be strong and creditworthy.  At March 31, 2014, substantially all of our counterparties were rated "BBB+" or higher by Standard & Poor's Corporation ("S&P").

Certain of our reinsurance payable balances contain embedded derivatives.  Such derivatives had an estimated fair value of $3.4 million and $1.8 million at March 31, 2014 and December 31, 2013, respectively.  We record the change in the fair value of these derivatives as a component of investment income (classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios).  We maintain the investments related to these agreements in our trading securities account, which we carry at estimated fair value with changes in such value recognized as investment income (also classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios).  The change in value of these trading securities offsets the change in value of the embedded derivatives.

We purchase certain fixed maturity securities that contain embedded derivatives that are required to be bifurcated from the instrument and held at fair value on the consolidated balance sheet. For certain of these securities, we have elected the fair value option to carry the entire security at fair value with changes in fair value reported in net income for operational ease. Such securities totaled $186.5 million (including $23.8 million classified as "Assets of subsidiary being sold") and $180.6 million at March 31, 2014 and December 31, 2013, respectively.

REINSURANCE

The cost of reinsurance ceded totaled $52.1 million and $52.0 million in the first quarters of 2014 and 2013, respectively.  We deduct this cost from insurance policy income.  Reinsurance recoveries netted against insurance policy benefits totaled $59.6 million and $53.6 million in the first quarters of 2014 and 2013.

From time-to-time, we assume insurance from other companies.  Any costs associated with the assumption of insurance are amortized consistent with the method used to amortize deferred acquisition costs described above.  Reinsurance premiums assumed totaled $10.9 million and $13.7 million in the first quarters of 2014 and 2013, respectively.  Reinsurance premiums included amounts assumed pursuant to marketing and quota-share agreements with Coventry Health Care ("Coventry") of $6.8 million and $8.9 million in the first quarters of 2014 and 2013, respectively. In August 2013, we received a notice of Coventry's intent to terminate the Medicare Part D prescription drug plan ("PDP") quota-share reinsurance agreement whereby

23

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


we assumed a portion of the risk related to the PDP business sold through our Bankers Life segment. The PDP premiums received in the first quarter of 2014 represent adjustments on such business related to periods prior to the termination of the agreement. We continue to receive distribution income from Coventry for PDP business sold through our Bankers Life segment.

In December 2013, two of our insurance subsidiaries with long-term care business in the Other CNO Business segment entered into 100% coinsurance agreements ceding $495 million of long-term care reserves to Beechwood Re Ltd. ("BRe"). Pursuant to the agreements, the insurance subsidiaries paid an additional premium of $96.9 million to BRe and an amount equal to the related net liabilities. The insurance subsidiaries' ceded reserve credits are secured by assets in market-value trusts subject to a 7% over-collateralization, investment guidelines and periodic true-up provisions. Future payments into the trusts to maintain collateral requirements are the responsibility of BRe.

See the note entitled "Accounting for Derivatives" for a discussion of the derivative embedded in the payable related to certain modified coinsurance agreements.


INCOME TAXES

The Company's interim tax expense is based upon the estimated annual effective tax rate for the respective period. Under authoritative guidance, certain items are required to be excluded from the estimated annual effective tax rate calculation. Such items include changes in judgment about the realizability of deferred tax assets resulting from changes in projections of income expected to be available in future years, and items deemed to be unusual, infrequent, or that can not be reliably estimated. In these cases, the actual tax expense or benefit applicable to that item is treated discretely and is reported in the same period as the related item. Discrete items include: (i) the loss on the sale of CLIC of $278.6 million in the first three months of 2014; and (ii) the loss on extinguishment of debt of $57.7 million in the first three months of 2013. The components of income tax expense are as follows (dollars in millions):

 
Three months ended
 
March 31,
 
2014
 
2013
Current tax expense
$
2.2

 
$
2.7

Deferred tax expense
36.8

 
31.0

Income tax expense calculated based on estimated annual effective tax rate
39.0

 
33.7

Income tax expense (benefit) on discrete items:
 
 
 
Related to the sale of CLIC:
 
 
 
Tax expense related to tax gain on sale
13.2

 

Previously unrecognized tax benefit recognized as a result of the gain
(7.4
)
 

Valuation allowance release related to the gain
(5.8
)
 

Valuation allowance increase related to the decrease in projected future taxable income
19.4

 

Valuation allowance reduction applicable to utilization of capital loss carryforwards

 
(10.5
)
Deferred tax benefit related to loss on extinguishment of debt

 
(.5
)
Total income tax expense
$
58.4

 
$
22.7



24

CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
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A reconciliation of the U.S.