CNO FINANCIAL GROUP, INC., 10-Q filed on 5/3/2017
Quarterly Report
DOCUMENT AND ENTITY INFORMATION
3 Months Ended
Mar. 31, 2017
Apr. 20, 2017
Document and Entity Information [Abstract]
Entity Registrant Name
CNO Financial Group, Inc.
Entity Central Index Key
0001224608
Document Type
10-Q
Document Period End Date
Mar. 31, 2017
Current Fiscal Year End Date
--12-31
Document Fiscal Year Focus
2017
Document Fiscal Period Focus
Q1
Entity Filer Category
Large Accelerated Filer
Amendment Flag
false
Entity Common Stock, Shares Outstanding
171,311,512
CONSOLIDATED BALANCE SHEET (unaudited)(USD $)
In Millions, unless otherwise specified
Mar. 31, 2017
Dec. 31, 2016
Investments:
Fixed maturities, available for sale, at fair value (amortized cost: March 31, 2017 - $19,880.3; December 31, 2016 - $19,803.1)
$21,378.4
$21,096.2
Equity securities at fair value (cost: March 31, 2017 - $571.3; December 31, 2016 - $580.7)
587.8
584.2
Mortgage loans
1,788.5
1,768.0
Policy loans
112.4
112.0
Trading securities
341.1
363.4
Investments held by variable interest entities
1,514.5
1,724.3
Other invested assets
665.2
589.5
Total investments
26,387.9
26,237.6
Cash and cash equivalents - unrestricted
530.2
478.9
Cash and cash equivalents held by variable interest entities
354.5
189.3
Accrued investment income
258.2
239.6
Present value of future profits
388.8
401.8
Deferred acquisition costs
1,028.5
1,044.7
Reinsurance receivables
2,241.1
2,260.4
Income tax assets, net
697.8
789.7
Assets held in separate accounts
4.6
4.7
Other assets
535.8
328.5
Total assets
32,427.4
31,975.2
Liabilities for insurance products:
Policyholder account balances
10,975.1
10,912.7
Future policy benefits
11,057.2
10,953.3
Liability for policy and contract claims
498.1
500.6
Unearned and advanced premiums
292.8
282.5
Liabilities related to separate accounts
4.6
4.7
Other liabilities
798.0
611.4
Investment borrowings
1,647.2
1,647.4
Borrowings related to variable interest entities
1,634.2
1,662.8
Notes payable direct corporate obligations
913.4
912.9
Total liabilities
27,820.6
27,488.3
Commitments and Contingencies
  
  
Shareholders' equity:
Common stock ($0.01 par value, 8,000,000,000 shares authorized, shares issued and outstanding: March 31, 2017 172,103,802; December 31, 2016 173,753,614)
1.7
1.7
Additional paid-in capital
3,177.1
3,212.1
Accumulated other comprehensive income
729.6
622.4
Retained earnings
698.4
650.7
Total shareholders' equity
4,606.8
4,486.9
Total liabilities and shareholders' equity
$32,427.4
$31,975.2
CONSOLIDATED BALANCE SHEET (unaudited) (Parenthetical)(USD $)
In Millions, except Share data, unless otherwise specified
Mar. 31, 2017
Dec. 31, 2016
Investments:
Fixed maturities, available for sale, amortized cost
$19,880.3
$19,803.1
Equity securities cost
$571.3
$580.7
Shareholders' equity:
Common stock, par value (in dollars per share)
$0.01
$0.01
Common stock, shares authorized (in shares)
8,000,000,000
8,000,000,000
Common stock, shares issued (in shares)
172,103,802
173,753,614
Common stock, shares outstanding (in shares)
172,103,802
173,753,614
CONSOLIDATED STATEMENT OF OPERATIONS (unaudited)(USD $)
In Millions, except Share data in Thousands, unless otherwise specified
3 Months Ended
Mar. 31, 2017
Mar. 31, 2016
Revenues:
Insurance policy income
$663.8
$644.4
Net investment income:
General account assets
312.0
291.0
Policyholder and other special-purpose portfolios
75.2
11.7
Realized investment gains (losses):
Net realized investment gains (losses), excluding impairment losses
16.3
9.1
Impairment losses recognized
(8.4)
(10.0)
Total realized gains (losses)
7.9
(0.9)
Fee revenue and other income
11.8
14.2
Total revenues
1,070.7
960.4
Benefits and expenses:
Insurance policy benefits
669.3
619.0
Interest expense
30.8
27.7
Amortization
63.5
62.1
Other operating costs and expenses
210.4
211.1
Total benefits and expenses
974.0
919.9
Income before income taxes
96.7
40.5
Income tax expense (benefit):
Tax expense on period income
34.4
15.0
Valuation allowance for deferred tax assets
0
(20.0)
Net income
$62.3
$45.5
Basic:
Weighted average shares outstanding (in shares)
173,431
180,350
Net income (loss) (in dollars per share)
$0.36
$0.25
Diluted:
Weighted average shares outstanding (in shares)
175,065
182,128
Net income (loss) (in dollars per share)
$0.36
$0.25
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (unaudited)(USD $)
In Millions, unless otherwise specified
3 Months Ended
Mar. 31, 2017
Mar. 31, 2016
Statement of Comprehensive Income [Abstract]
Net income
$62.3
$45.5
Other comprehensive income, before tax:
Unrealized gains for the period
215.8
431.1
Adjustment to present value of future profits and deferred acquisition costs
7.8
(45.2)
Amount related to premium deficiencies assuming the net unrealized gains (losses) had been realized
(52.0)
(168.0)
Reclassification adjustments:
For net realized investment (gains) losses included in net income
(5.1)
(4.9)
For amortization of the present value of future profits and deferred acquisition costs related to net realized investment gains (losses) included in net income
0
0.1
Unrealized gains on investments
166.5
213.1
Change related to deferred compensation plan
0
0.6
Other comprehensive income before tax
166.5
213.7
Income tax expense related to items of accumulated other comprehensive income
(59.3)
(76.0)
Other comprehensive income, net of tax
107.2
137.7
Comprehensive income
$169.5
$183.2
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (unaudited)(USD $)
In Millions, unless otherwise specified
Total
Common stock and additional paid-in capital [Member]
Accumulated other comprehensive income [Member]
Retained earnings [Member]
Balance, beginning of period at Dec. 31, 2015
$4,138.5
$3,388.6
$402.8
$347.1
Increase (Decrease) in Stockholders' Equity [Roll Forward]
Net income
45.5
45.5
Change in unrealized appreciation (depreciation) of investments and other (net of applicable income tax expense)
137.7
137.7
Cost of common stock repurchased
(90.0)
(90.0)
Dividends on common stock
(12.6)
(12.6)
Stock options, restricted stock and performance units
7.5
7.5
Balance, end of period at Mar. 31, 2016
4,226.6
3,306.1
540.5
380.0
Balance, beginning of period at Dec. 31, 2016
4,486.9
3,213.8
622.4
650.7
Increase (Decrease) in Stockholders' Equity [Roll Forward]
Net income
62.3
62.3
Change in unrealized appreciation (depreciation) of investments and other (net of applicable income tax expense)
106.1
106.1
Change in noncredit component of impairment losses on fixed maturities, available for sale (net of applicable income tax expense)
1.1
1.1
Cost of common stock repurchased
(43.0)
(43.0)
Dividends on common stock
(14.0)
(14.0)
Stock options, restricted stock and performance units
7.1
7.1
Balance, end of period at Mar. 31, 2017
$4,606.8
$3,178.8
$729.6
$698.4
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (unaudited) (Parenthetical)(USD $)
In Millions, unless otherwise specified
3 Months Ended
Mar. 31, 2017
Mar. 31, 2016
Statement of Stockholders' Equity [Abstract]
Change in unrealized appreciation (depreciation) of investments, applicable income tax expense (benefit)
$58.7
$76.0
Change in noncredit component of impairment losses on fixed maturities, available for sale, applicable income tax expense (benefit)
$0.6
CONSOLIDATED STATEMENT OF CASH FLOWS (unaudited)(USD $)
In Millions, unless otherwise specified
3 Months Ended
Mar. 31, 2017
Mar. 31, 2016
Cash flows from operating activities:
Insurance policy income
$640.1
$617.3
Net investment income
289.7
285.8
Fee revenue and other income
11.8
14.2
Insurance policy benefits
(511.8)
(487.4)
Interest expense
(20.5)
(13.3)
Deferrable policy acquisition costs
(63.2)
(62.2)
Other operating costs
(203.6)
(209.7)
Income taxes
(1.5)
(1.1)
Net cash from operating activities
141.0
143.6
Cash flows from investing activities:
Sales of investments
403.0
1,181.5
Maturities and redemptions of investments
849.3
349.6
Purchases of investments
(1,166.4)
(1,524.9)
Net sales (purchases) of trading securities
35.6
(21.7)
Change in cash and cash equivalents held by variable interest entities
(165.2)
174.3
Other
(12.1)
(3.8)
Net cash provided (used) by investing activities
(55.8)
155.0
Cash flows from financing activities:
Issuance of common stock
2.9
0.4
Payments to repurchase common stock
(39.8)
(96.9)
Common stock dividends paid
(14.0)
(12.7)
Amounts received for deposit products
359.5
340.1
Withdrawals from deposit products
(312.9)
(305.3)
Issuance of investment borrowings:
Related to variable interest entities
8.7
2.9
Payments on investment borrowings:
Federal Home Loan Bank
(0.2)
(0.2)
Related to variable interest entities and other
(38.1)
(23.5)
Net cash used by financing activities
(33.9)
(95.2)
Net increase in cash and cash equivalents
51.3
203.4
Cash and cash equivalents, beginning of period
478.9
432.3
Cash and cash equivalents, end of period
$530.2
$635.7
BUSINESS AND BASIS OF PRESENTATION
BUSINESS AND BASIS OF PRESENTATION
BUSINESS AND BASIS OF PRESENTATION

The following notes should be read together with the notes to the consolidated financial statements included in our 2016 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 2017 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, 2016, 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.
INVESTMENTS
INVESTMENTS
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 other special-purpose portfolios)).

Our trading securities include: (i) investments purchased with the intent of selling in the near term to generate income; (ii) investments supporting certain insurance liabilities (including investments backing the market strategies of our multibucket annuity products); and (iii) certain fixed maturity securities containing embedded derivatives for which we have elected the fair value option.  The change in fair value of the income generating investments and investments supporting insurance liabilities is recognized in income from policyholder and other special-purpose portfolios (a component of net investment income). The change in fair value of securities with embedded derivatives is recognized in realized investment gains (losses). Investment income related to investments supporting certain insurance liabilities is substantially offset by the change in insurance policy benefits related to certain products.

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, 2017 and December 31, 2016, were as follows (dollars in millions):

 
March 31,
2017
 
December 31,
2016
Net unrealized appreciation (depreciation) on fixed maturity securities, available for sale, on which an other-than-temporary impairment loss has been recognized
$
.8

 
$
(1.1
)
Net unrealized gains on all other investments
1,520.7

 
1,311.9

Adjustment to present value of future profits (a)
(104.9
)
 
(106.2
)
Adjustment to deferred acquisition costs
(253.7
)
 
(223.5
)
Adjustment to insurance liabilities
(28.8
)
 
(13.5
)
Deferred income tax liabilities
(404.5
)
 
(345.2
)
Accumulated other comprehensive income
$
729.6

 
$
622.4

________
(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, emerged from bankruptcy.

At March 31, 2017, adjustments to the present value of future profits, deferred acquisition costs, insurance liabilities and deferred tax assets included $(93.2) million, $(134.0) million, $(28.8) million and $91.0 million, respectively, for premium deficiencies that would exist on certain blocks of business (primarily long-term care 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.

At March 31, 2017, 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, and equity securities 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
$
12,688.6

 
$
1,203.6

 
$
(90.1
)
 
$
13,802.1

 
$
(3.6
)
United States Treasury securities and obligations of United States government corporations and agencies
173.1

 
20.7

 

 
193.8

 

States and political subdivisions
1,844.6

 
193.7

 
(9.4
)
 
2,028.9

 
(3.0
)
Debt securities issued by foreign governments
44.3

 
1.5

 
(.1
)
 
45.7

 

Asset-backed securities
2,692.4

 
113.2

 
(11.3
)
 
2,794.3

 

Collateralized debt obligations
212.6

 
1.8

 

 
214.4

 

Commercial mortgage-backed securities
1,411.1

 
34.2

 
(21.7
)
 
1,423.6

 

Mortgage pass-through securities
2.3

 
.2

 

 
2.5

 

Collateralized mortgage obligations
811.3

 
63.4

 
(1.6
)
 
873.1

 
(1.3
)
Total fixed maturities, available for sale
$
19,880.3

 
$
1,632.3

 
$
(134.2
)
 
$
21,378.4

 
$
(7.9
)
Equity securities
$
571.3

 
$
21.1

 
$
(4.6
)
 
$
587.8

 
 


The following table sets forth the amortized cost and estimated fair value of fixed maturities, available for sale, at March 31, 2017, 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.  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
$
332.1

 
$
337.5

Due after one year through five years
2,242.9

 
2,400.7

Due after five years through ten years
1,539.0

 
1,625.6

Due after ten years
10,636.6

 
11,706.7

Subtotal
14,750.6

 
16,070.5

Structured securities
5,129.7

 
5,307.9

Total fixed maturities, available for sale
$
19,880.3

 
$
21,378.4



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,
 
2017
 
2016
Fixed maturity securities, available for sale:
 
 
 
Gross realized gains on sale
$
7.0

 
$
98.5

Gross realized losses on sale
(2.7
)
 
(81.0
)
Impairments:
 
 
 
Total other-than-temporary impairment losses
(3.2
)
 
(6.3
)
Other-than-temporary impairment losses recognized in accumulated other comprehensive income

 

Net impairment losses recognized
(3.2
)
 
(6.3
)
Net realized investment gains (losses) from fixed maturities
1.1

 
11.2

Equity securities
1.9

 
.1

Commercial mortgage loans
1.0

 

Impairments of other investments
(5.2
)
 
(3.7
)
Other (a)
9.1

 
(8.5
)
Net realized investment gains (losses)
$
7.9

 
$
(.9
)

_________________
(a)
Changes in the estimated fair value of trading securities that we have elected the fair value option (and are still held as of the end of the respective periods) was $3.0 million and $(3.4) million for the three months ended March 31, 2017 and 2016, respectively.

During the first three months of 2017, we recognized net realized investment gains of $7.9 million, which were comprised of: (i) $12.9 million of net gains from the sales of investments; (ii) the increase in fair value of certain fixed maturity investments with embedded derivatives of $2.7 million; (iii) the increase in fair value of embedded derivatives related to a modified coinsurance agreement of $.7 million; and (iv) $8.4 million of writedowns of investments for other than temporary declines in fair value recognized through net income.

During the first three months of 2016, we recognized net realized investment losses of $.9 million, which were comprised of: (i) $10.9 million of net gains from the sales of investments; (ii) the decrease in fair value of certain fixed maturity investments with embedded derivatives of $3.6 million; (iii) the increase in fair value of embedded derivatives related to a modified coinsurance agreement of $1.8 million; and (iv) $10.0 million of writedowns of investments for other than temporary declines in fair value recognized through net income.

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 2017, the $2.7 million of gross realized losses on sales of $95.3 million of fixed maturity securities, available for sale included: (i) $1.5 million related to various corporate securities; (ii) $.9 million related to commercial mortgage-backed securities; and (iii) $.3 million related to various other investments. 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 portfolio cash flows.

During the first three months of 2017, we recognized $8.4 million of impairment losses recorded in earnings which included: (i) $3.2 million of writedowns on fixed maturities of a single issuer in the energy sector; and (ii) $5.2 million of writedowns related to a real estate investment. Factors considered in determining the writedowns of investments in the first three months of 2017 included changes in the estimated recoverable value of the assets related to each investment and the timing of and complexities related to the recovery process.

During the first three months of 2016, we recognized $10.0 million of impairment losses recorded in earnings which included: (i) $6.3 million of writedowns on fixed maturities of a single issuer in the energy sector; and (ii) $3.7 million of writedowns on a direct loan due to borrower specific events.

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, 2017, other-than-temporary impairments included in accumulated other comprehensive income totaled $7.9 million (before taxes and related amortization).

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, 2017 and 2016 (dollars in millions):

 
Three months ended
 
March 31,
 
2017
 
2016
Credit losses on fixed maturity securities, available for sale, beginning of period
$
(5.5
)
 
$
(2.6
)
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
$
(5.4
)
 
$
(2.6
)
__________
(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.

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, 2017 (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
 
$
17.7

 
$

 
$

 
$

 
$
17.7

 
$

States and political subdivisions
 
185.4

 
(6.8
)
 
18.5

 
(2.6
)
 
203.9

 
(9.4
)
Debt securities issued by foreign governments
 
10.4

 
(.1
)
 

 

 
10.4

 
(.1
)
Corporate securities
 
1,395.2

 
(39.2
)
 
486.9

 
(50.9
)
 
1,882.1

 
(90.1
)
Asset-backed securities
 
599.3

 
(7.0
)
 
219.8

 
(4.3
)
 
819.1

 
(11.3
)
Collateralized debt obligations
 
15.5

 

 
9.0

 

 
24.5

 

Commercial mortgage-backed securities
 
406.0

 
(14.1
)
 
123.0

 
(7.6
)
 
529.0

 
(21.7
)
Collateralized mortgage obligations
 
37.9

 
(.5
)
 
36.9

 
(1.1
)
 
74.8

 
(1.6
)
Total fixed maturities, available for sale
 
$
2,667.4

 
$
(67.7
)
 
$
894.1

 
$
(66.5
)
 
$
3,561.5

 
$
(134.2
)
Equity securities
 
$
108.8

 
$
(4.6
)
 
$

 
$

 
$
108.8

 
$
(4.6
)

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, 2016 (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
 
$
8.0

 
$

 
$

 
$

 
$
8.0

 
$

States and political subdivisions
 
176.3

 
(7.8
)
 
18.3

 
(1.8
)
 
194.6

 
(9.6
)
Debt securities issued by foreign governments
 
18.9

 
(.4
)
 

 

 
18.9

 
(.4
)
Corporate securities
 
1,907.6

 
(75.5
)
 
559.6

 
(63.5
)
 
2,467.2

 
(139.0
)
Asset-backed securities
 
692.9

 
(8.5
)
 
262.5

 
(7.0
)
 
955.4

 
(15.5
)
Collateralized debt obligations
 
38.3

 
(.1
)
 
30.8

 
(.2
)
 
69.1

 
(.3
)
Commercial mortgage-backed securities
 
525.2

 
(16.6
)
 
154.0

 
(11.3
)
 
679.2

 
(27.9
)
Collateralized mortgage obligations
 
73.6

 
(.6
)
 
34.6

 
(1.0
)
 
108.2

 
(1.6
)
Total fixed maturities, available for sale
 
$
3,440.8

 
$
(109.5
)
 
$
1,059.8

 
$
(84.8
)
 
$
4,500.6

 
$
(194.3
)
Equity securities
 
$
239.4

 
$
(8.0
)
 
$

 
$

 
$
239.4

 
$
(8.0
)


Based on management's current assessment of investments with unrealized losses at March 31, 2017, the Company believes the issuers of the securities will continue to meet their obligations (or with respect to equity-type securities, the investment value will recover to its cost basis).  While we do not have the intent to sell securities with unrealized losses and it is not more likely than not that we will be required to sell securities with unrealized losses prior to their anticipated recovery, our intent on an individual security may change, based upon market or other unforeseen developments.  In such instances, if a loss is recognized from a sale subsequent to a balance sheet date due to these unexpected developments, the loss is recognized in the period in which we had the intent to sell the security before its anticipated recovery.
EARNINGS PER SHARE
EARNINGS PER SHARE
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,
 
2017
 
2016
Net income for basic and diluted earnings per share
$
62.3

 
$
45.5

Shares:
 

 
 

Weighted average shares outstanding for basic earnings per share
173,431

 
180,350

Effect of dilutive securities on weighted average shares:
 

 
 

Stock options, restricted stock and performance units
1,634

 
1,778

Weighted average shares outstanding for diluted earnings per share
175,065

 
182,128



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 were exercised and restricted stock was vested.  The dilution from options and restricted shares is calculated using the treasury stock method.  Under this method, we assume the proceeds from the exercise of the options (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 (or the vesting of the restricted stock and performance units).
BUSINESS SEGMENTS
BUSINESS SEGMENTS
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; and corporate operations, comprised of holding company activities and certain noninsurance company businesses. In the fourth quarter of 2016, we began reporting the long-term care block recaptured from Beechwood Re Ltd ("BRe") effective September 30, 2016, as an additional business segment.

We measure segment performance by excluding net realized investment gains (losses), fair value changes in embedded derivative liabilities (net of related amortization), fair value changes in the agent deferred compensation plan, income taxes and other non-operating items consisting primarily of earnings attributable to variable interest entities ("VIEs") ("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 net realized investment gains (losses), fair value changes in embedded derivative liabilities (net of related amortization), fair value changes in the agent deferred compensation plan and other non-operating items consisting primarily of earnings attributable to VIEs 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.
Operating information by segment was as follows (dollars in millions):

 
Three months ended
 
March 31,
 
2017
 
2016
Revenues:
 
 
 
Bankers Life:
 
 
 
Insurance policy income:
 
 
 
Annuities
$
6.0

 
$
4.8

Health
311.6

 
311.1

Life
101.5

 
97.3

Net investment income (a)
272.9

 
214.2

Fee revenue and other income (a)
10.6

 
6.6

Total Bankers Life revenues
702.6

 
634.0

Washington National:
 

 
 

Insurance policy income:
 

 
 

Annuities
.6

 
.5

Health
159.8

 
155.5

Life
6.7

 
6.1

Net investment income (a)
67.4

 
60.6

Fee revenue and other income (a)
.3

 
.3

Total Washington National revenues
234.8

 
223.0

Colonial Penn:
 

 
 

Insurance policy income:
 

 
 

Health
.6

 
.7

Life
72.4

 
68.4

Net investment income (a)
10.9

 
11.0

Fee revenue and other income (a)
.2

 
.4

Total Colonial Penn revenues
84.1

 
80.5

Long-term care in run-off:
 
 
 
Insurance policy income - health
4.6

 

Net investment income (a)                                                                                           
9.7

 

Total Long-term care in run-off revenues
14.3

 

Corporate operations:
 

 
 

Net investment income
10.4

 
4.0

Fee and other income
2.4

 
2.5

Total corporate revenues
12.8

 
6.5

Total revenues
1,048.6

 
944.0



(continued on next page)

(continued from previous page)
 
Three months ended
 
March 31,
 
2017
 
2016
Expenses:
 
 
 
Bankers Life:
 
 
 
Insurance policy benefits
$
451.2

 
$
397.0

Amortization
46.3

 
51.5

Interest expense on investment borrowings
4.2

 
2.9

Other operating costs and expenses
111.2

 
105.0

Total Bankers Life expenses
612.9

 
556.4

Washington National:
 

 
 

Insurance policy benefits
146.7

 
133.5

Amortization
14.3

 
15.1

Interest expense on investment borrowings
1.3

 
.8

Other operating costs and expenses
49.0

 
47.3

Total Washington National expenses
211.3

 
196.7

Colonial Penn:
 

 
 

Insurance policy benefits
52.7

 
50.5

Amortization
4.0

 
3.9

Interest expense on investment borrowings
.2

 
.1

Other operating costs and expenses
27.5

 
32.8

Total Colonial Penn expenses
84.4

 
87.3

Long-term care in run-off:
 
 
 
Insurance policy benefits                                                                                 
13.2

 

Other operating costs and expenses                                                                                 
.7

 

Total Long-term care in run-off expenses
13.9

 

Corporate operations:
 

 
 

Interest expense on corporate debt
11.5

 
11.4

Other operating costs and expenses
21.7

 
14.6

Total corporate expenses
33.2

 
26.0

Total expenses
955.7

 
866.4

Pre-tax operating earnings by segment:
 

 
 

Bankers Life
89.7

 
77.6

Washington National
23.5

 
26.3

Colonial Penn
(.3
)
 
(6.8
)
Long-term care in run-off
.4

 

Corporate operations
(20.4
)
 
(19.5
)
Pre-tax operating earnings
$
92.9

 
$
77.6

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

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

 
Three months ended
 
March 31,
 
2017
 
2016
Total segment revenues                                                                                            
$
1,048.6

 
$
944.0

Net realized investment gains (losses)                                           
7.9

 
(.9
)
Revenues related to certain non-strategic investments and earnings attributable to VIEs
14.2

 
12.3

Fee revenue related to transition and support services agreements

 
5.0

Consolidated revenues                                                                                       
1,070.7

 
960.4

 
 
 
 
Total segment expenses                                                                                            
955.7

 
866.4

Insurance policy benefits - fair value changes in embedded derivative liabilities
5.5

 
38.0

Amortization related to fair value changes in embedded derivative liabilities
(1.1
)
 
(8.5
)
Amortization related to net realized investment gains

 
.1

Expenses related to certain non-strategic investments and expenses attributable to VIEs
13.9

 
12.9

Fair value changes related to agent deferred compensation plan


6.0

Expenses related to transition and support services agreements

 
5.0

Consolidated expenses                                                                                       
974.0

 
919.9

Income before tax
96.7

 
40.5

Income tax expense (benefit):
 
 
 
Tax expense on period income
34.4

 
15.0

Valuation allowance for deferred tax assets

 
(20.0
)
Net income
$
62.3

 
$
45.5

ACCOUNTING FOR DERIVATIVES
ACCOUNTING FOR DERIVATIVES
ACCOUNTING FOR DERIVATIVES

Our freestanding and embedded derivatives, which are not designated as hedging instruments, are held at fair value and are summarized as follows (dollars in millions):

 
 
Fair value
 
 
March 31,
2017
 
December 31, 2016
Assets:
 
 
 
 
Other invested assets:
 
 
 
 
Fixed index call options
 
$
132.1

 
$
111.9

Reinsurance receivables
 
(3.5
)
 
(4.2
)
Total assets
 
$
128.6

 
$
107.7

Liabilities:
 
 
 
 
Future policy benefits:
 
 
 
 
Fixed index products
 
$
1,159.2

 
$
1,092.3

Total liabilities
 
$
1,159.2

 
$
1,092.3



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.  The Company accounts for the options attributed to the policyholder for the estimated life of the contract as embedded derivatives. These accounting requirements often create volatility in the earnings from these products. 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.  The notional amount of these options was $2.6 billion and $2.5 billion at March 31, 2017 and December 31, 2016, respectively.

From time to time, we utilize United States Treasury interest rate futures primarily to hedge interest rate risk related to anticipated mortgage loan transactions.

We are required to establish an embedded derivative related to a modified coinsurance agreement pursuant to which we assume the risks of a block of health insurance business. The embedded derivative represents the mark-to-market adjustment for approximately $130 million in underlying investments held by the ceding reinsurer.

We purchase certain fixed maturity securities that contain embedded derivatives that are required to be held at fair value on the consolidated balance sheet. We have elected the fair value option to carry the entire security at fair value with changes in fair value reported in net income.

The following table provides the pre-tax gains (losses) recognized in net income for derivative instruments, which are not designated as hedges for the periods indicated (dollars in millions):

 
 
Three months ended
 
 
March 31,
 
 
2017
 
2016
Net investment income from policyholder and other special-purpose portfolios:
 
 
 
 
Fixed index call options
 
$
44.5

 
$
(9.0
)
Net realized gains (losses):
 
 
 
 
Interest rate futures
 

 
(1.0
)
Embedded derivative related to modified coinsurance agreement
 
.7

 
1.8

Total
 
.7

 
.8

Insurance policy benefits:
 
 
 
 
Embedded derivative related to fixed index annuities
 
2.3

 
(34.9
)
Total
 
$
47.5

 
$
(43.1
)


Derivative Counterparty Risk

If the counterparties to the call options fail to meet their obligations, we may 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, 2017, all of our counterparties were rated "A-" or higher by S&P Global Ratings ("S&P").

We also enter into exchange-traded interest rate future contracts. The contracts are marked to market and margined on a daily basis. The Company has minimal exposure to credit-related losses in the event of nonperformance.

The Company and its subsidiaries are parties to master netting arrangements with its counterparties related to entering into various derivative contracts. Exchange-traded derivatives require margin accounts which we offset.

The following table summarizes information related to derivatives with master netting arrangements or collateral as of March 31, 2017 and December 31, 2016 (dollars in millions):

 
 
 
 
 
 
 
 
 
Gross amounts not offset in the balance sheet
 
 
 
 
 
Gross amounts recognized
 
Gross amounts offset in the balance sheet
 
Net amounts of assets presented in the balance sheet
 
Financial instruments
 
Cash collateral received
 
Net amount
March 31, 2017:
 
 
 
Fixed index call options
 
$
132.1

 
$

 
$
132.1

 
$

 
$

 
$
132.1

December 31, 2016:
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed index call options
 
111.9

 

 
111.9

 

 

 
111.9

REINSURANCE
REINSURANCE
REINSURANCE

The cost of reinsurance ceded totaled $26.3 million and $33.6 million in the first quarters of 2017 and 2016, respectively.  We deduct this cost from insurance policy income.  Reinsurance recoveries netted against insurance policy benefits totaled $24.1 million and $40.4 million in the first quarters of 2017 and 2016, respectively.

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.  Reinsurance premiums assumed totaled $8.0 million and $8.8 million in the first quarters of 2017 and 2016, respectively.
INCOME TAXES
INCOME TAXES
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. The components of income tax expense are as follows (dollars in millions):

 
Three months ended
 
March 31,
 
2017
 
2016
Current tax expense
$
20.6

 
$
4.1

Deferred tax expense
13.8

 
10.9

Income tax expense calculated based on estimated annual effective tax rate
34.4

 
15.0

Income tax expense on discrete items:
 
 
 
Change in valuation allowance

 
(20.0
)
Total income tax expense (benefit)
$
34.4

 
$
(5.0
)


A reconciliation of the U.S. statutory corporate tax rate to the estimated annual effective rate, before discrete items, reflected in the consolidated statement of operations is as follows:
 
 
Three months ended
 
March 31,
 
2017
 
2016
U.S. statutory corporate rate
35.0
 %
 
35.0
%
Non-taxable income and nondeductible benefits, net
(1.1
)
 
.8

State taxes
1.7

 
1.2

Estimated annual effective tax rate
35.6
 %
 
37.0
%


The components of the Company's income tax assets and liabilities are summarized below (dollars in millions):

 
March 31,
2017
 
December 31,
2016
Deferred tax assets:
 
 
 
Net federal operating loss carryforwards
$
884.5

 
$
882.9

Net state operating loss carryforwards
12.2

 
12.3

Tax credits
.3

 
.7

Investments
15.9

 
17.8

Insurance liabilities
675.8

 
668.4

Other
59.9

 
65.6

Gross deferred tax assets
1,648.6

 
1,647.7

Deferred tax liabilities:
 

 
 

Present value of future profits and deferred acquisition costs
(275.9
)
 
(277.8
)
Accumulated other comprehensive income
(403.9
)
 
(344.1
)
Gross deferred tax liabilities
(679.8
)
 
(621.9
)
Net deferred tax assets before valuation allowance
968.8

 
1,025.8

Valuation allowance
(255.9
)
 
(240.2
)
Net deferred tax assets
712.9

 
785.6

Current income taxes prepaid (accrued)
(15.1
)
 
4.1

Income tax assets, net
$
697.8

 
$
789.7



Our income tax expense includes deferred income taxes arising from temporary differences between the financial reporting and tax bases of assets and liabilities and net operating loss carryforwards ("NOLs"). Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which temporary differences are expected to be recovered or paid.  The effect of a change in tax rates on deferred tax assets and liabilities is recognized in earnings in the period when the changes are enacted.

A reduction of the net carrying amount of deferred tax assets by establishing a valuation allowance is required if, based on the available evidence, it is more likely than not that such assets will not be realized. In assessing the need for a valuation allowance, all available evidence, both positive and negative, shall be considered to determine whether, based on the weight of that evidence, a valuation allowance for deferred tax assets is needed. This assessment requires significant judgment and considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of carryforward periods, our experience with operating loss and tax credit carryforwards expiring unused, and tax planning strategies. We evaluate the need to establish a valuation allowance for our deferred income tax assets on an ongoing basis. The realization of our deferred tax assets depends upon generating sufficient future taxable income of the appropriate type during the periods in which our temporary differences become deductible and before our NOLs expire.

Based on our assessment, it appears more likely than not that $712.9 million of our net deferred tax assets of $968.8 million will be realized through future taxable earnings. Accordingly, we have established a deferred tax valuation allowance of $255.9 million at March 31, 2017 ($245.9 million of which relates to our net federal operating loss carryforwards and $10.0 million relates to state operating loss carryforwards). We will continue to assess the need for a valuation allowance in the future. If future results are less than projected, an increase to the valuation allowance may be required to reduce the deferred tax asset, which could have a material impact on our results of operations in the period in which it is recorded.
 
We use a deferred tax valuation model to assess the need for a valuation allowance. Our model is adjusted to reflect changes in our projections of future taxable income including changes resulting from investment strategies, the impact of the sale or reinsurance of business and the recapture of business previously ceded. Our estimates of future taxable income are based on evidence we consider to be objective and verifiable.

Our projection of future taxable income for purposes of determining the valuation allowance is based on our adjusted average annual taxable income which is assumed to increase by 3 percent for the next five years, and level taxable income is assumed thereafter. In the projections used for our analysis, our adjusted average taxable income of approximately $335 million consisted of $85 million of non-life taxable income and $250 million of life taxable income.

Recovery of our deferred tax asset is dependent on achieving the level of future taxable income projected in our deferred tax valuation model and failure to do so could result in an increase in the valuation allowance in a future period.  Any future increase in the valuation allowance may result in additional income tax expense and reduce shareholders' equity, and such an increase could have a significant impact upon our earnings in the future.

The Internal Revenue Code (the "Code") limits the extent to which losses realized by a non-life entity (or entities) may offset income from a life insurance company (or companies) to the lesser of:  (i) 35 percent of the income of the life insurance company; or (ii) 35 percent of the total loss of the non-life entities (including NOLs of the non-life entities).  There is no similar limitation on the extent to which losses realized by a life insurance entity (or entities) may offset income from a non-life entity (or entities). This limitation is the primary reason a valuation allowance for NOLs is required.

Section 382 of the Code imposes limitations on a corporation's ability to use its NOLs when the company undergoes an ownership change.  Future transactions and the timing of such transactions could cause an ownership change for Section 382 income tax purposes.  Such transactions may include, but are not limited to, additional repurchases under our securities repurchase program, issuances of common stock and acquisitions or sales of shares of CNO stock by certain holders of our shares, including persons who have held, currently hold or may accumulate in the future five percent or more of our outstanding common stock for their own account.  Many of these transactions are beyond our control.  If an additional ownership change were to occur for purposes of Section 382, we would be required to calculate an annual restriction on the use of our NOLs to offset future taxable income.  The annual restriction would be calculated based upon the value of CNO's equity at the time of such ownership change, multiplied by a federal long-term tax exempt rate (2.09 percent at March 31, 2017), and the annual restriction could limit our ability to use a substantial portion of our NOLs to offset future taxable income.  We regularly monitor ownership change (as calculated for purposes of Section 382) and, as of March 31, 2017, we were below the 50 percent ownership change level that would trigger further impairment of our ability to utilize our NOLs.

As of March 31, 2017, we had $2.5 billion of federal NOLs (all of which were non-life NOLs). The following table summarizes the expiration dates of our loss carryforwards (dollars in millions):

 
 
Net operating loss
Year of expiration
 
carryforwards
2023
 
$
1,940.4

2025
 
85.2

2026
 
149.9

2027
 
10.8

2028
 
80.3

2029
 
213.2

2030
 
.3

2031
 
.2

2032
 
44.4

2033
 
.6

2034
 
.9

2035
 
.8

Total federal NOLs
 
$
2,527.0



We also had deferred tax assets related to NOLs for state income taxes of $12.2 million and $12.3 million at March 31, 2017 and December 31, 2016, respectively.  The related state NOLs are available to offset future state taxable income in certain states through 2025.

All of the additional life NOLs were utilized by December 31, 2016. Accordingly, we began making estimated federal tax payments equal to the prescribed federal tax rate applied to 65 percent of our life insurance company taxable income due to the limitations on the extent to which we can use non-life NOLs to offset life insurance company taxable income. We will continue to pay tax on 65 percent of our life insurance company taxable income until all non-life NOLs are utilized or expire.

The Internal Revenue Service ("IRS") is also conducting an examination of 2011 through 2014. In connection with this exam, we have agreed to extend the statute of limitations for 2011 through 2013 to September 30, 2018. The Company’s various state income tax returns are generally open for tax years beginning in 2013, based on individual state statutes of limitation. Generally, for tax years which generate NOLs, capital losses or tax credit carryforwards, the statute remains open until the expiration of the statute of limitations for the tax year in which such carryforwards are utilized. The outcome of tax audits cannot be predicted with certainty. If the Company’s tax audits are not resolved in a manner consistent with management’s expectations, the Company may be required to adjust its provision for income taxes.

Effective January 1, 2017, the Company adopted new authoritative guidance related to several aspects of the accounting for share-based payment transactions, including the income tax consequences. Under the new guidance, any excess tax benefits are recognized as an income tax benefit in the income statement. The new guidance is applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings for all tax benefits that were not previously recognized because the related tax deduction had not reduced taxes payable. The Company had NOL carryforwards of $15.7 million related to deductions for stock options and restricted stock on the date of adoption. However, a corresponding valuation allowance of $15.7 million was recognized as a result of adopting this guidance. Therefore, there was no impact to our consolidated financial statements related to this provision of the new guidance.
NOTES PAYABLE - DIRECT CORPORATE OBLIGATIONS
NOTES PAYABLE - DIRECT CORPORATE OBLIGATIONS
NOTES PAYABLE - DIRECT CORPORATE OBLIGATIONS

The following notes payable were direct corporate obligations of the Company as of March 31, 2017 and December 31, 2016 (dollars in millions):

 
March 31,
2017
 
December 31,
2016
4.500% Senior Notes due May 2020
$
325.0

 
$
325.0

5.250% Senior Notes due May 2025
500.0

 
500.0

Revolving Credit Agreement (as defined below)
100.0

 
100.0

Unamortized debt issue costs
(11.6
)
 
(12.1
)
Direct corporate obligations
$
913.4

 
$
912.9



Revolving Credit Agreement

On May 19, 2015, the Company entered into a revolving credit agreement, with KeyBank National Association, as administrative agent (the "Agent"), and the lenders from time to time party thereto (the "Revolving Credit Agreement"). On May 19, 2015, the Company made an initial drawing of $100.0 million under the Revolving Credit Agreement, resulting in $50.0 million available for additional borrowings. The Revolving Credit Agreement matures on May 19, 2019.

The interest rates with respect to loans under the Revolving Credit Agreement are based on, at the Company's option, a floating base rate (defined as a per annum rate equal to the highest of: (i) the federal funds rate plus 0.50%; (ii) the "prime rate" of the Agent; and (iii) the eurodollar rate for a one-month interest period plus an applicable margin of initially 1.00% per annum), or a eurodollar rate plus an applicable margin of initially 2.00% per annum. At March 31, 2017, the interest rate on the amounts outstanding under the Revolving Credit Agreement was 2.98 percent. In addition, the daily average undrawn portion of the Revolving Credit Agreement accrues a commitment fee payable quarterly in arrears. The applicable margin for, and the commitment fee applicable to, the Revolving Credit Agreement, will be adjusted from time-to-time pursuant to a ratings based pricing grid.

The Revolving Credit Agreement requires the Company to maintain (each as calculated in accordance with the Revolving Credit Agreement): (i) a debt to total capitalization ratio of not more than 30.0 percent (such ratio was 19.5 percent at March 31, 2017); (ii) an aggregate ratio of total adjusted capital to company action level risk-based capital for the Company's insurance subsidiaries of not less than 250 percent (such ratio was estimated to be 446 percent at March 31, 2017); and (iii) a minimum consolidated net worth of not less than the sum of (x) $2,674 million plus (y) 50.0% of the net equity proceeds received by the Company from the issuance and sale of equity interests in the Company (the Company's consolidated net worth was $3,877.2 million at March 31, 2017 compared to the minimum requirement of $2,682.2 million).

Scheduled Repayment of our Direct Corporate Obligations

The scheduled repayment of our direct corporate obligations was as follows at March 31, 2017 (dollars in millions):

Year ending March 31,
 
2018
$

2019

2020
100.0

2021
325.0

2022

Thereafter
500.0

 
$
925.0

INVESTMENT BORROWINGS
INVESTMENT BORROWINGS
INVESTMENT BORROWINGS

Three of the Company's insurance subsidiaries (Washington National Insurance Company ("Washington National"), Bankers Life and Casualty Company ("Bankers Life") and Colonial Penn Life Insurance Company ("Colonial Penn")) are members of the Federal Home Loan Bank ("FHLB").  As members of the FHLB, our insurance subsidiaries have the ability to borrow on a collateralized basis from the FHLB. We are required to hold certain minimum amounts of FHLB common stock as a condition of membership in the FHLB, and additional amounts based on the amount of the borrowings.  At March 31, 2017, the carrying value of the FHLB common stock was $71.2 million.  As of March 31, 2017, collateralized borrowings from the FHLB totaled $1.6 billion and the proceeds were used to purchase fixed maturity securities.  The borrowings are classified as investment borrowings in the accompanying consolidated balance sheet.  The borrowings are collateralized by investments with an estimated fair value of $2.0 billion at March 31, 2017, which are maintained in a custodial account for the benefit of the FHLB.  Substantially all of such investments are classified as fixed maturities, available for sale, in our consolidated balance sheet.  

The following summarizes the terms of the borrowings from the FHLB by our insurance subsidiaries (dollars in millions):

Amount
 
Maturity
 
Interest rate at
borrowed
 
date
 
March 31, 2017
$
50.0

 
January 2018
 
Variable rate – 1.365%
50.0

 
January 2018
 
Variable rate – 1.381%
50.0

 
February 2018
 
Variable rate – 1.344%
50.0

 
February 2018
 
Variable rate – 1.127%
22.0

 
February 2018
 
Variable rate – 1.384%
100.0

 
May 2018
 
Variable rate – 1.433%
50.0

 
July 2018
 
Variable rate – 1.509%
50.0

 
August 2018
 
Variable rate – 1.159%
10.0

 
December 2018
 
Variable rate – 1.421%
50.0

 
January 2019
 
Variable rate – 1.443%
50.0

 
February 2019
 
Variable rate – 1.127%
100.0

 
March 2019
 
Variable rate – 1.423%
21.8

 
July 2019
 
Variable rate – 1.466%
15.0

 
October 2019
 
Variable rate – 1.550%
50.0

 
May 2020
 
Variable rate – 1.432%
21.8

 
June 2020
 
Fixed rate – 1.960%
25.0

 
September 2020
 
Variable rate – 1.782%
100.0

 
September 2020
 
Variable rate – 1.642%
50.0

 
September 2020
 
Variable rate – 1.643%
75.0

 
September 2020
 
Variable rate – 1.272%
100.0

 
October 2020
 
Variable rate – 1.109%
50.0

 
December 2020
 
Variable rate – 1.530%
100.0

 
July 2021
 
Variable rate – 1.572%
100.0

 
July 2021
 
Variable rate – 1.542%
28.2

 
August 2021
 
Fixed rate – 2.550%
57.7

 
August 2021
 
Variable rate - 1.564%
125.0

 
August 2021
 
Variable rate – 1.462%
50.0

 
September 2021
 
Variable rate – 1.592%
25.2

 
March 2023
 
Fixed rate – 2.160%
20.5

 
June 2025
 
Fixed rate – 2.940%
$
1,647.2

 
 
 
 


The variable rate borrowings are pre-payable on each interest reset date without penalty.  The fixed rate borrowings are pre-payable subject to payment of a yield maintenance fee based on prevailing market interest rates.  At March 31, 2017, the aggregate yield maintenance fee to prepay all fixed rate borrowings was $3.4 million.

Interest expense of $5.7 million and $3.8 million in the first three months of 2017 and 2016, respectively, was recognized related to total borrowings from the FHLB.
CHANGES IN COMMON STOCK
CHANGES IN COMMON STOCK
CHANGES IN COMMON STOCK

Changes in the number of shares of common stock outstanding were as follows (shares in thousands):

Balance, December 31, 2016
173,754

 
Treasury stock purchased and retired
(2,086
)
 
Stock options exercised
320

 
Restricted and performance stock vested
116

(a)
Balance, March 31, 2017
172,104

 
____________________
(a)
Such amount was reduced by 62 thousand shares which were tendered to the Company for the payment of required federal and state tax withholdings owed on the vesting of restricted and performance stock.

In the first three months of 2017, we repurchased 2.1 million shares of common stock for $43.0 million under our securities repurchase program (including $4.5 million of repurchases settled in the second quarter of 2017). The Company had remaining repurchase authority of $209.7 million as of March 31, 2017.

In the first three months of 2017, dividends declared on common stock totaled $14.0 million ($0.08 per common share).
SALES INDUCEMENTS
SALES INDUCEMENTS
SALES INDUCEMENTS

Certain of our annuity products offer sales inducements to contract holders in the form of enhanced crediting rates or bonus payments in the initial period of the contract.  Certain of our life insurance products offer persistency bonuses credited to the contract holders balance after the policy has been outstanding for a specified period of time.  These enhanced rates and persistency bonuses are considered sales inducements in accordance with GAAP.  Such amounts are deferred and amortized in the same manner as deferred acquisition costs.  Sales inducements deferred totaled $.5 million and $1.0 million during the three months ended March 31, 2017 and 2016, respectively.  Amounts amortized totaled $2.1 million and $1.7 million during the three months ended March 31, 2017 and 2016, respectively.  The unamortized balance of deferred sales inducements was $47.8 million and $49.4 million at March 31, 2017 and December 31, 2016, respectively.  The balance of insurance liabilities for persistency bonus benefits was $.5 million and $.5 million at March 31, 2017 and December 31, 2016, respectively.
RECENTLY ISSUED ACCOUNTING STANDARDS
RECENTLY ISSUED ACCOUNTING STANDARDS
RECENTLY ISSUED ACCOUNTING STANDARDS

Pending Accounting Standards

In May 2014, the Financial Accounting Standards Board (the "FASB") issued authoritative guidance for recognizing revenue from contracts with customers. Certain contracts with customers are specifically excluded from this guidance, including insurance contracts. The core principle of the new guidance is that an entity should recognize revenue when it transfers promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires additional disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. In March 2016, the FASB issued amendments that clarify the implementation guidance on principal versus agent considerations. In July 2015, the guidance was updated and will now be effective for the Company on January 1, 2018 and permits two methods of transition upon adoption; full retrospective and modified retrospective. Under the full retrospective method, prior periods would be restated under the new revenue standard, providing for comparability in all periods presented. Under the modified retrospective method, prior periods would not be restated. Instead, revenues and other disclosures for pre-2017 periods would be provided in the notes to the financial statements as previously reported under the current revenue standard. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements, however, the Company is continuing its assessment of the guidance.

In January 2016, the FASB issued authoritative guidance related to the recognition and measurement of financial assets and financial liabilities which made targeted improvements to GAAP as follows:

(i)
Require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer.
(ii)
Simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value.
(iii)
Eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet.
(iv)
Require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes.
(v)
Require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments.
(vi)
Require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements.
(vii)
Clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets.

An entity should apply this guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption of the guidance. The guidance will be effective for the Company for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption of the guidance is not permitted; except that item (v) above is permitted to be adopted early as of the beginning of the fiscal year of adoption. The Company is currently assessing the impact the guidance will have upon adoption.

In February 2016, the FASB issued authoritative guidance related to accounting for leases, requiring lessees to report most leases on their balance sheets, regardless of whether the lease is classified as a finance lease or an operating lease. For lessees, the initial lease liability is equal to the present value of future lease payments, and a corresponding asset, adjusted for certain items, is also recorded. Expense recognition for lessees will remain similar to current accounting requirements for capital and operating leases. The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The guidance will be effective for the Company for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact the guidance will have upon adoption.

In June 2016, the FASB issued authoritative guidance related to the measurement of credit losses on financial instruments. The new guidance replaces the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to form credit loss estimates. The guidance will be effective for the Company for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently assessing the impact the guidance will have upon adoption.

In August 2016, the FASB issued authoritative guidance related to how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The guidance addresses eight specific cash flow issues including debt prepayment or debt extinguishment costs, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees, and others. The guidance will be effective for the Company for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact the guidance will have upon adoption.

In November 2016, the FASB issued authoritative guidance to address the diversity in practice that currently exists regarding the classification and presentation of changes in restricted cash on the statement of cash flows. The new guidance requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. Entities will also be required to disclose information about the nature of their restricted cash and restricted cash equivalents. Additionally, if cash, cash equivalents, restricted cash and restricted cash equivalents are presented in more than one line item in the statement of financial position, entities will be required to present a reconciliation, either on the face of the statement of cash flows or disclosed in the notes, of the totals in the statement of cash flows to the related line item captions in the statement of financial position. The guidance will be effective for the Company for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The adoption of this guidance is expected to impact the presentation of our consolidated statement of cash flows and related cash flow disclosures. The guidance will not impact our consolidated financial position or results of operations.

In March 2017, the FASB issued authoritative guidance related to the premium amortization on purchased callable debt securities. The guidance shortens the amortization period for certain callable debt securities held at a premium. Specifically, the new guidance requires the premium to be amortized to the earliest call date. The guidance does not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The guidance will be effective for the Company for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the guidance in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The guidance should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company is currently assessing the impact the guidance will have upon adoption.

Adopted Accounting Standards

In March 2016, the FASB issued authoritative guidance that clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the assessment under this guidance is required to assess the embedded call (put) options solely in accordance with a four-step decision sequence. The guidance is effective for the Company on January 1, 2017. The adoption of this guidance had no effect on our consolidated financial statements.
In March 2016, the FASB issued authoritative guidance related to several aspects of the accounting for share-based payment transactions, including the income tax consequences, accounting policy for forfeiture rate assumptions, classification of awards as either equity or liabilities and classification on the statement of cash flows. The new guidance requires all income tax effects of stock-based compensation awards to be recognized in the income statement when the awards vest or are settled. The new guidance also allows an employer to withhold shares upon settlement of an award to satisfy the employer's tax withholding requirements up to the highest marginal tax rate applicable to employees, without resulting in liability classification of the award. Current guidance strictly limits the withholding to the employer's minimum statutory tax withholding requirement. The guidance is effective for the Company on January 1, 2017. The impact of adoption was as follows (dollars in millions):
 
January 1, 2017
 
 
 
Effect of Adoption of Authoritative Guidance
 
 
 
Amounts prior to effect of adoption of authoritative guidance
 
Election to account for forfeitures as they occur
 
Recognition of excess tax benefits
 
As adjusted
 
 
 
 
 
 
 
 
Income tax assets
$
1,029.9

 
$
.3

 
$
15.7

 
$
1,045.9

Valuation allowance for deferred income tax assets
(240.2
)
 

 
(15.7
)
 
(255.9
)
Income tax assets, net
789.7

 
.3

 

 
790.0

Total assets
31,975.2

 
.3

 

 
31,975.5

 
 
 
 
 
 
 
 
Additional paid-in capital
3,212.1

 
.9

 

 
3,213.0

Retained earnings
650.7

 
(.6
)
 

 
650.1

Total shareholders' equity
4,486.9

 
.3

 

 
4,487.2

 
 
 
 
 
 
 
 
Total liabilities and shareholders' equity
31,975.2

 
.3

 

 
31,975.5


 
Three months ended
 
March 31, 2016
 
Amounts prior to effect of adoption of authoritative guidance
 
Effect of adoption of authoritative guidance
 
As adjusted
Cash flows from operating activities:
 
 
 
 
 
Other operating costs
$
(212.9
)
 
$
3.2

 
$
(209.7
)
Net cash flow from operating activities
140.4

 
3.2

 
143.6

 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
Payments to repurchase common stock
(93.7
)
 
(3.2
)
 
(96.9
)
Net cash used by financing activities
(92.0
)
 
(3.2
)
 
(95.2
)
 
 
 
 
 
 
Net increase in cash and cash equivalents
203.4

 

 
203.4



In October 2016, the FASB issued authoritative guidance to amend the consolidation guidance on how a reporting entity that is the single decision maker of a VIE should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE. The guidance is effective for the Company on January 1, 2017. The adoption of this guidance had no impact on our consolidated financial statements.
CONSOLIDATED STATEMENT OF CASH FLOWS
CONSOLIDATED STATEMENT OF CASH FLOWS
CONSOLIDATED STATEMENT OF CASH FLOWS

The following disclosures supplement our consolidated statement of cash flows.

The following reconciles net income to net cash from operating activities (dollars in millions):

 
Three months ended
 
March 31,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
62.3

 
$
45.5

Adjustments to reconcile net income to net cash from operating activities:
 
 
 

Amortization and depreciation
70.0

 
68.2

Income taxes
32.9

 
(6.1
)
Insurance liabilities
131.6

 
103.7

Accrual and amortization of investment income
(97.5
)
 
(16.9
)
Deferral of policy acquisition costs
(63.2
)
 
(62.2
)
Net realized investment (gains) losses
(7.9
)
 
.9

Other
12.8

 
10.5

Net cash from operating activities
$
141.0

 
$
143.6



Other non-cash items not reflected in the investing and financing activities sections of the consolidated statement of cash flows (dollars in millions):

 
Three months ended
 
March 31,
 
2017
 
2016
Stock options, restricted stock and performance units
$
6.3

 
$
10.2

INVESTMENTS IN VARIABLE INTEREST ENTITIES
INVESTMENTS IN VARIABLE INTEREST ENTITIES
INVESTMENTS IN VARIABLE INTEREST ENTITIES

We have concluded that we are the primary beneficiary with respect to certain VIEs, which are consolidated in our financial statements.  In consolidating the VIEs, we consistently use the financial information most recently distributed to investors in the VIE.

All of the VIEs are collateralized loan trusts that were established to issue securities to finance the purchase of corporate loans and other permitted investments.  The assets held by the trusts are legally isolated and not available to the Company.  The liabilities of the VIEs are expected to be satisfied from the cash flows generated by the underlying loans held by the trusts, not from the assets of the Company.  The Company has no financial obligation to the VIEs beyond its investment in each VIE.

Certain of our insurance subsidiaries are noteholders of the VIEs.  Another subsidiary of the Company is the investment manager for the VIEs.  As such, it has the power to direct the most significant activities of the VIEs which materially impacts the economic performance of the VIEs.

The following tables provide supplemental information about the assets and liabilities of the VIEs which have been consolidated in accordance with authoritative guidance (dollars in millions):

 
March 31, 2017
 
VIEs
 
Eliminations
 
Net effect on
consolidated
balance sheet
Assets:
 
 
 
 
 
Investments held by variable interest entities
$
1,514.5

 
$

 
$
1,514.5

Notes receivable of VIEs held by insurance subsidiaries

 
(204.3
)
 
(204.3
)
Cash and cash equivalents held by variable interest entities
354.5

 

 
354.5

Accrued investment income
2.3

 
(.1
)
 
2.2

Income tax assets, net
6.8

 

 
6.8

Other assets
106.4

 
(1.7
)
 
104.7

Total assets
$
1,984.5

 
$
(206.1
)
 
$
1,778.4

Liabilities:
 

 
 

 
 

Other liabilities
$
162.6

 
$
(5.7
)
 
$
156.9

Borrowings related to variable interest entities
1,634.2

 

 
1,634.2

Notes payable of VIEs held by insurance subsidiaries
203.3

 
(203.3
)
 

Total liabilities
$
2,000.1

 
$
(209.0
)
 
$
1,791.1


 
December 31, 2016
 
VIEs
 
Eliminations
 
Net effect on
consolidated
balance sheet
Assets:
 
 
 
 
 
Investments held by variable interest entities
$
1,724.3

 
$

 
$