Conseco, Inc., Q2 2008 Earnings Call Transcript

Aug.13.08 | About: CNO Financial (CNO)

Conseco, Inc. (NYSE:CNO)

Q2 2008 Earnings Call Transcript

August 12, 2008 1:00 pm ET

Executives

Scott Galovic - Director of IR

Jim Prieur - CEO

Ed Bonach - EVP and CFO

Scott Goldberg - SVP, Bankers

John Wells - SVP, Long-Term Care, President, Senior Health Insurance

Eric Johnson - CIO

Analysts

Jimmy Bhullar - J.P.Morgan

Randy Binner - FBR Capital Markets

Jukka Lipponen - KBW

Andrew Kligerman - Analyst

Mark Finkelstein - FPK

Jeff Bronchick - RCB Investment

Operator

Good afternoon. My name is Rodney and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter 2008 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. (Operator Instructions) Thank you. Mr. Galovic, you may begin your conference, sir.

Scott Galovic

Thank you. Good afternoon, and thank you for joining us on Conseco's second quarter 2008 earnings conference call. Today's presentation will include remarks from Jim Prieur Conseco's CEO; Ed Bonach, Chief Financial Officer; Scott Goldberg, Senior Vice President, Bankers Life, John Wells, Senior Vice President Long Term Care, and Eric Johnson, our Chief Investment Officer.

Following the presentation, we will also have several other business leaders available for the question and answer period including Steve Stecher, who has recently been named President Conseco Insurance Group, and Scott Perry President of Bankers Life, who will be joining us for questions and answers but will not be presenting due to some technical difficulties.

During this call, we will be referring to information contained in this morning's press release. You can obtain the release by visiting the Company's news section of our website at www.conseco.com.

During the conference call, we will be referring to a presentation that can also be obtained and viewed from the Company's website. This presentation was filed in a Form 8-K this morning. We expect to file our Form 10-Q for second quarter 2008 on Wednesday, August 13, and it will also be available through the investor section of our website.

Let me remind you that the forward looking statements being made today are subject to a number of factors which may cause actual results to be materially different than those contemplated by the statements. Please refer to this morning's press release for additional information concerning the forward looking statements and related factors. The presentation to which we will be referring today contains a number of non-GAAP measures. These measures should not be considered as substitutes for the most directly comparable GAAP measures. The appendix to presentation contains the reconciliation of the GAAP measures with the non-GAAP measures and now I would like to turn the call over to Conseco's CEO Jim Prieur.

Jim Prieur

Thanks Scott. Yesterday, we announced that Conseco plans to transfer Conseco senior health insurance company to an independent trust. This transfer is subject to regulatory approval by the Pennsylvania Insurance Department. This is obviously a very significant transaction for the Company moving forward. The run-off block has cost the Company almost $1 billion over the last decade or so. It has been the most significant factor in determining the credit rating of the Company.

We have talked about looking at and considering strategic alternatives while there may be other strategic moves that we make, there is unlikely to be any single strategic move in the near term that approaches the significance of transferring the bulk of the run-off block to a trust for a contribution of $175 million.

Although, profitability was down in the second quarter of 2008 versus the second quarter of 2007 for bankers and for CIG, we are pleased that the second quarter results showed operating earnings in all of the segments with each segment improving over the first quarter 2008 results.

Sales at bankers excluding PFFS were up 9% and Colonial Penn had sales growth of 29% over the second quarter of last year. Overall, CIG sales were down but specified disease sales were up 29%. We also had a record quarter of agent recruitment at the wholly owned marketing organization PMA. So, the sales story has been consistent over the last four quarters. There were also positive results in the LTC closed block with GAAP income from operations of over $12 million for the quarter. We have now had four consecutive quarters of steadily improving results from this block, as we prepare it for separation.

Earnings at Bankers on the other hand, were disappointing. Some of this is due to normal fluctuations like [invest up], some of it is due to the change in estimates of prior period claims by Coventry for f the PFFS block. And some of this is due to a second quarter of poor results from Bankers LTC business. The higher than expected claims in Bankers LTC is a problem that we know how to address and we will continue to address it by improving claims management and putting in re-rates.

In investments, we did have impairments which we will provide quite a bit of detail on shortly. These losses after adjusting for the charges related to the proposed separation transaction announced yesterday were less than what was experienced by most other insurers as a percentage of assets. The results for Conseco continue to improve and stabilize. However, this isn't readily apparent with the inclusion of the charges related to the planned transfer of CSHI and its LTC business to an independent trust as we announced yesterday.

Second quarter financials include $504 million of charges related to this proposed separation transaction. Net offering income before the valuation allowance on the other hand, was $0.18 per diluted share. And points to note are that there were no significant out of period accounting adjustments, no extraordinary [doc] of over charges, it was the fourth consecutive stable quarter for the LTC closed block and the Chicago facilities consolidation was completed in the second quarter resulting in the pre-tax charge of approximately $9.6 million with ongoing annual savings of $5 million.

Next up is, our CFO, Ed Bonach, who will take us through the financial data. Ed?

Ed Bonach

Thanks, Jim. Let me start by covering second quarter 2008 results. Turning to slide 6, collected premiums on a trailing four quarters basis continue to grow. Increases at Bankers and Colonial Penn were partially offset by a slight decrease at CIG, primarily due to the sale of the annuity block in 2007 and a focus on more profitable business.

For the second quarter of 2008, the net loss applicable to common stock was $487.1 million, which includes $370 million of valuation allowance for deferred tax assets and $150.5 million of net realized investment losses. This equate to a net loss of $2.64 per diluted share, including $2 per diluted share of valuation for deferred tax assets and $0.82 per share of net realized investment losses largely driven by our proposed transfer of Conseco's senior health and its long-term care business to an independent trust. Our net operating income before valuation allowance for deferred tax assets of $33.4 million equated to $0.18 per diluted share for the second quarter of 2008 compared to a net operating loss of $49.7 million in the second quarter of 2007 or a loss of $0.29 per share.

Slide 8 provides a breakdown of the impact of the proposed Conseco Senior health transaction in order to separately display our operating earnings. Operating earnings excluding the impact of the CSHI separation transaction charges recorded in the second quarter and also they are excluding net realized investment losses, which in total brings the operating earnings to $33.4 million or as previously mentioned $0.18 of earnings per diluted share.

Turning to slide 9, as Jim said earlier the Company had operating income in all four segments with each improving over the first quarter of 2008. Although, year-over-year results are mixed with bankers the most significant negative comparison, total segment EBIT improved to $66.6 million in Q2 of '08 compared to a loss of $52.8 million a year earlier, which included $110 million of long-term care reserve strengthening in our other business and run off segment and $35 million of expense related to a litigation expense settlement.

In our Bankers Life segment pre-tax operating earnings were $34.6 million in Q2 of ' 08 compared to $70.5 million in Q2 of ' 07. Results for the second quarter of 2008 were affected by several items.

Our long-term care products experienced a reduction in earnings of approximately $25 million primarily resulting from higher claim frequency. Second quarter 2008 results were also adversely affected by a net charge of approximately $3 million related to changes and estimates of prior period claims on the private fee for service business we write for Coventry and share in the economic results.

Earnings were also negatively impacted by approximately $3.3 million related to the FAS 133 impact on equity indexed annuity products. This variance primarily resulted from the change in the value of the embedded derivative related to future indexed benefits reported at estimated fair value in accordance with accounting requirements.

For Colonial Penn the pre-tax operating were $8.3 million in the second quarter of 2008 compared to $6.7 million in the second quarter of '07. Results for the second quarter of '08 were positively affected, primarily by the recapture in the fourth quarter of last year of previously reinsured life business and overall business growth.

In our Conseco Insurance Group or CIG segment pre-tax operating earnings were $30 million in the second quarter of '08 compared to $43.3 million in the second quarter of '07.

Results for the second quarter of 2008 were affected primarily by a reduction in earnings of approximately $9 million driven by higher incurred claim ratios on specified disease and Medicare supplement policies.

Second quarter 2007 earnings also included approximately $9 million in earnings from the annuity block, which was subsequently reinsured. These items are partially offset by a decrease in expenses of $6 million resulting from the refocusing of CIG sales and marketing that we completed in the fourth quarter of last year.

We are very pleased to report that the LTC runoff block was profitable in the second quarter, as we continued to improve its stability and performance. In our other business and run-off segment we achieved pre-tax operating income of $12.2 million in the second quarter of '08 compared to a loss of $130.3 million in the second quarter of '07.

Last year's second quarter included reserve strengthening of $110 million. These results for the second quarter of '08 show the progress that we continue to make towards restoring profitability through premium ray rates along with claims and expense management. The corporate segment included in the second quarter of 2008 the $9.6 million Chicago Mark's vacancy charge along with $2.3 million of expenses incurred through June related to the proposed separation transaction.

I just covered in the prior slide the separation transaction results in recognizing realized investment losses net of related amortization and taxes of $150.5 million in the second quarter of 2008, a $133.7 million of which were related to recognizing the losses on Conseco's senior health investment portfolio, as a result of the proposed separation transaction.

Excluding the transaction related losses, the net realized investment losses were $16.8 million, which is consistent with what we have seen throughout the industry and market. Gross realized losses before related amortization and taxes included $26 million of write-downs for securities we determined were subject to other than temporary impairment.

These operating results improved considerably compared to the first quarter of this year in spite of continuing challenging markets. Eric Johnson, our Chief Investment Officer will address this in more detail in the presentation.

Turning to slide 10, our trailing four quarters operating return on equity excluding the litigation charges, loss on co-insurance transaction and the increase of the deferred tax asset valuation allowance was 3.6% for the four quarters ended June 30, 2008, which improved noticeably from that reported in the last four quarters.

As a reminder, these segment GAAP ROE calculations are based on the methods described in the notes to this slide, which start by ascribing statutory capital to lines of business based on statutory risk based capital. As we have consistently stated our long-term goal is to improve ROE to 11% in 2009, which we believe is achievable. The separation transaction is expected to increase ROE for the Company and for this goal which I will now cover.

Given the questions in yesterday's call regarding how the CSHI separation transaction will impact our ROE and achievement of our 11% ROE goal in 2009, we have developed slide 11.

Let's first focus on the columns of this exhibit. The first column on the left of figures are incorporating the results which we reported for the second quarter of 2008. The second column includes the charges recorded in the second quarter of '08 from the proposed separation transaction. The middle column shows the results had we not recorded the pending transaction charges in Q2 which is column 1 factoring out column number 2. The fourth column includes the impact of the total expected transaction charges on equity with then in the far right column showing pro forma results incorporating the total impact of the transaction charges to GAAP equity.

If you now go along the middle of the page, you see the annualized return on equity or ROE derived by analyzing second quarter '08 earnings for the Company, which is expected to increase from 3.6% before the transaction charges as shown in the middle column, to 4.9% as shown in the far right column.

Our 11% ROE target for 2009 is based on equity adjusted to exclude accumulated other comprehensive loss and the NOL. These two amounts are adjusted out of the columns in the bottom half of this exhibit. The pro forma impact on this ROE measure is an increase of 1.7 percentage points as you can see in the lower right-hand corner. Net operating income for the second quarter of 2008 was $33.4 million or $0.18 per diluted share.

This compares with a net operating loss for the second quarter of 2007 of $49.7 million or a loss of $0.29 per diluted share. The Q2 '08 operating income excludes the $370 million valuation allowance for deferred tax assets and $150.5 million of net realized investment losses or a loss of $2.82 per diluted share. Including these items results in a net loss applicable to common stock per diluted share of $2.64, as compared to a $0.35 loss per share in the second quarter of 2007.

Slide 13, consolidates several of our more important indicators. Book value per diluted share excluding accumulated other comprehensive loss of $21.76 at June 30, 2008 is down from the year end 2007 value of $24.41.

The pro forma book value after reflecting the CSHI transaction is driven by charges from the proposed separation transaction. On a pro forma basis upon the close of the separation transaction, the book value per diluted share would decrease to $18.22. Our debt in preferred stock to total capital ratio also calculated excluding accumulated other comprehensive loss was just under 23% at June 30, 2008, compared to 21% at year end 2007.

The 2 percentage point increase is directly a result of recording $504 million in charges in the second quarter of 2008 related to the proposed separation of CSHI and its long-term care business. Again, on a pro forma basis upon completion of the separation transaction, this ratio would increase to 28% which is 2 percentage points below our debt covenant level. Risk based capital at our insurance Companies remains strong ending the second quarter at 271%. I will touch on this further in a moment.

Our investment portfolio continues to perform within expectation. Net investment income on general account assets for the second quarter reflected an earn yield of 5.82%. Investment quality remains high. We continue to have very limited financial exposure to sub prime asset backed securities.

Let's turn now to slide 14. Our consolidated risk based capital ratio has declined somewhat since year end 2007. The second quarter decline is primarily a result of the business growth from our sales, increases in reserves due to the long-term care statutory reserve dividend and the investment markets environment that increased some of the components of required capital and caused us to record certain impairments. However, on a pro forma basis after Conseco Senior Health has contributed to the independent trust Conseco's consolidated RBC is expected to rise by approximately 10 percentage points.

Maintaining the appropriate liquidity and capital levels is extremely important to our business especially in today's market, as is optimally deploying our capital. Our liquidity remains strong increasing in the quarter to over $104 million at the holding Company as of June 30, 2008, plus an untapped $80 million revolver. While some of the funds will be used as part of the CSHI transaction announced yesterday, we expect liquidity after the close of the separation transaction to be approximately equal to one year's interest expense on our debt.

Slide 15 details the major 2007 and year to date 2008 sources and uses of cash for the holding Company. It is important to note that this summary excludes any dividends that were paid up from the subsidiaries and also excludes any share repurchases.

We did not repurchase any shares in the first or second quarters of 2008.

Liquidity at the holding Company is impacted by the strength of our insurance subsidiaries. Our insurance companies currently are expected to generate approximately $150 million of statutory profits annually excluding extraordinary items. This is in excess of their capital needs to support their ongoing growth. Following the transfer of Conseco's Senior Health Insurance Company and its long-term care business to an independent trust, our statutory net income is expected to increase to approximately $200 million annually.

In addition to dividends from the insurance company the holding company also generates cash from interest payments on surplus notes, tax sharing payments, fees for investment and administrative services provided to the insurance company. Let me now turn it over to Scott Goldberg, Senior Vice President of Bankers to cover that segments results. Scott?

Scott Goldberg

Thanks, Ed. Although, showing improvement over Q1 Bankers earnings were disappointing and continue to be pressured by the performance of our LTC business. The increase in claim frequency we saw in Q1 did not significantly abate, leading to higher claims expense. As mentioned last quarter, LTC can be a volatile line and we expect the actions we have taken which I will detail in a few minutes, to lead to improved performance over time.

Also negatively impacting earnings performance, as Ed mentioned was a one-time adjustment related to our PFFS quota share agreement with Coventry of $3 million related to changes in estimates of prior period claims. Importantly, including this adjustment, results continue to meet or exceed pricing expectations on our individually sold PFFS plans.

We also experience a slight increase in our Medicare supplement loss ratio due to more low frequency high severity extended hospital stay claims which vary significantly from quarter to quarter combined with a decrease in premiums mostly as a result of premium refunds to policy holders in certain states due to favorable experience in prior periods. We expect Medicare supplement loss ratios to remain stable for the remainder for the year.

Finally, as Ed already discussed the FAS 133 accounting treatment for our EIA products resulted in a $3.3 million loss during the quarter. Sales for the quarter excluding PFFS were strong up 9% over Q2 '07 driven by strong annuity, net stop and life sales. Including PFFS for the quarter, the total math of $53 million is 30% below Q2 '07 which is predominantly due to last year's special extended open enrollment period for certain PFFS plans during which we recognized over $22 million in PFFS net.

Turning to slide 17, as we disclosed during the first quarter call, this quarter a number of important steps have been taken to improve the performance of the Bankers LTC block. We are well on our way to holistically addressing the four key fundamentals that drive this line's performance. In force pricing, claims management, underwriting and risk selection and new product design and pricing.

Since last quarter, we completed our pricing analysis for our legacy block of long-term care which represents half of our Bankers Long-Term Care business. As a result we have already begun the filing for an additional 35% rate increase affecting 155,000 policies. In total, by the end of Q3, we will submit filings for increases totaling approximately $100 million of which we expect to receive approvals of $70 million with an ultimate expected annual financial impact of approximately $50 million.

Filings began this month and we expect to begin implementing first approvals during the fourth quarter of this year. In addition to this new round three, we continue to make progress in pursuing over $10 million of in force premium impact on round 2 existing filings.

Now, an important distinction of Bankers LTC business is that it is more homogenous to Conseco's closed block LTC business. With significantly fewer policy forms at Bankers, actualizing LTC re-rates has been easier to accomplish in a shorter period of time.

Slide 19, during this quarter we made some important changes within our LTC claims organization. These changes include transferring two key operations people from the run-off block, reorganizing our claims management team to refine transparency and scope and we made strong progress on a protocol and process review assisted by the LTC Group. With these people and process changes we intend to ensure our LTC claims organization is properly organized, staffed and utilizing industry wide best practices for industry claims adjudication.

During the third quarter of '07, we announced the introduction of the EMST as an important tool used during the under writing progress to detect cognitive impairments. Early results indicate that this tool has been successful in allowing us to avoid possible future cognitive claims in our comprehensive policies.

Beginning in Q4, we will expand the utilization of the MST for use of the home healthcare applicants. Cognitive related claims are clearly the most significant category of claim risk and expansion of this tool enables us to continue to effectively perform prudent risk selection.

Finally, regarding product improvement in LTC beginning in early 2009, we will be introducing two new products. The first is an updated version of our existing stand alone LTC product. The second is an LTC annuity combo product slated for release in mid 2009. While we expect all of these actions over time to improve the Bankers LTC performance, clearly claims management and in force premium re-rates will provide the fastest and most noticeable improvements over the next upcoming quarters.

Moving on, I would like to comment on two industry developments that could affect Bankers. First, the FTC has proposed regulating the sale of equity indexed annuities which would mean net sales people would have to have securities licenses to sell EIAs.

The impact will be a reduction of EIA sales in the market. At Bankers, many of our top agents already have securities licenses through our retirement solutions network program and partnership with Linsco/Private Ledger, who will continue to be able to sell EIAs. Most of our branches today operate with one or more security specialists, who work alongside our non registered agents to facilitate the sale of registered and non registered asset accumulation products to clients. Additionally, nearly 50% of our annuity sales are fixed projects not subject to the FTC proposal.

So, in summary, we do not expect the proposed changed if enacted to significantly impact total annuity sales at Bankers. Secondly, unlike the SECs proposal the upcoming Medicare changes have been finalized and are going into affect. The new marketing guideline have already been incorporated into our sales models.

Through our partner Coventry we feel we are well positioned to respond to provider deeming requirements in 2011. Coventry anticipates that by 2011 given their current footprint and expansion efforts networks will be available for upwards of 80% of present private of fee for service ROE. In addition, it's estimated that 8% to 12% of enrollees are in rural areas where the network requirements will not apply.

Throughout our expansion in the Medicare Advantage PFFS market, we have also continued to grow our position, as a prominent player in the Medicare supplement market. Today, we are well positioned to capitalize on changes to Med Supp plan that will come with [Medi NAP] modernization.

We are currently developing strategies to enhance our position as a leading player in agent sold Medicare supplement after the plan changes go into affect in mid-2010 as part of the MIPA legislation.

Turning to slide 21, distribution highlights for the quarter include strong sales of annuities, up 30%. Med Supp up 16% and Life up 8% over Q2 '07. Our distribution fundamentals remain strong. Both total agent for size and agent force productivity grew during the quarter.

Productive agents grew 8%, new agents grew 8% and on a year to date basis total agent force size is up 5%. Current economic conditions are not impacting our ability to recruit and retain agents.

Additionally, during the quarter, we added another PFFS group quota share case that is expected to contribute an estimated $130 million in premium for 2008. As has been our practice, we have not included this amount in our NAP results.

Lastly, although total sales for the quarter of $53 million were down 30% over 2Q '07 it is important to consider the impact of the extended PFFS open enrollment in 2007 which was not permitted in 2008.

In addition, 2Q 2008 sales include an $8.7 million reduction in PFFS sales for the cancellation of sales reported in previous periods. We are pleased with our PFFS sales given the shorter permitted enrollment period in 2008. Factoring out this noise created by PFFS NAP continues to grow. And we continue to gain momentum and improve our position as a leading provider of health and financial security to middle America pre and post retirees.

On slide 23, we see the impact of the earnings items previously discussed. Producing an ROE on a trailing four quarters basis of 8.1%. I will now turn it back over to Ed to cover Colonial Penn and CIG results.

Ed Bonach

Thanks, Scott. Turning to slide 24, Colonial Penn sales is measured by new annualized premium or NAP increased 29% from 2Q '07 with essentially all of this growth arising from our life insurance marketing campaigns. Test activity in the second quarter of this year and last were immaterial.

The direct response PFFS campaigns, which generated approximately $4.2 million of sales net of charge backs during the first half of 2008 nevertheless failed to meet our internal targets and accordingly have been discontinued. Our mid space term life product testing is progressing but at lower levels relative to our core marketing campaigns. We are in the process of further analyzing these test results.

Turning to slide 25, Colonial Penn segment earnings are up approximately 24% from last year's second quarter. This earnings growth is largely the result of the recapture of the previously re-interred portion of the black and traditional life insurance policies that was completed in Q4 '07 coupled with organic earnings growth rising from our sales efforts. The positive affects of these two factors have been partially off set by increased life claims so far this year. Colonial Penn continues to demonstrate a capacity for increased lead development a key indicator for future sales for a direct marketing organization.

Turning now to CIG. CIG's overall NAP sales were down 9% from the second quarter of last year again with strong sales gains of 29% in specified disease offset by decreases in Medicare supplement and annuities. While CIG sales are down there continues to be greater focus on more profitable business with the contribution of profit from the new business higher than it was a year ago.

Improved mortality and reduced expenses drove earnings improvements in the second quarter compared to the first quarter of this year. The decrease in Q2 2008 earnings from Q2 '07 is primarily attributable from the increase in specified disease benefit ratios due to an increase in incurred claims and increased Medicare supplement claims. These increases were offset partially by lower expenses.

In addition, Q2 '07 results included profits from the annuity block that was subsequently reinsured during the latter part of 2007. The Q2 2008 earnings were improved from the first quarter of '08 earnings due primarily to favorable mortality on traditional life products and lower expenses.

Slide 28 illustrates the significant changes in CIG sales mix compared to the second quarter of 2007. Continuing a trend sales rose by 29% for the quarter in specified disease, which is CIG's highest margin product. The largest NAP sales decline was in annuity, which is CIG's lowest margin product line that was further influenced by an unfavorable interest rate environment.

CIG's Medicare supplement sales were negatively impacted by competing Met Advantage products.

Next, I will turn it over to John Wells, Senior Vice President Long-Term Care and President of Conseco's Senior Health Insurance Company that is in the process of being transferred to an independent trust, as we announced yesterday. John will cover our long term care run-off results and turnaround progress. John?

John Wells

Thanks, Ed, and good afternoon. As Jim mentioned yesterday we announced a plan to transfer the long-term care business of the Conseco Senior Health Insurance Company to an independent trust. The plan would transfer 86% of the liabilities or the LTC closed block to the trust and thereby increase Conseco's ability to focus on its active business. This planned separation of Conseco senior was deemed to be the most balanced solution of the alternatives available for all of Conseco's key stakeholders and pending approval of the Pennsylvania Insurance department we expect to complete the transaction in the fourth quarter.

From an earnings standpoint the trend of stabilized results continues with the Long-Term Care close block with second quarter and year to date financial results above breakeven, results for the quarter reflect continued favorable development of reserves, higher terminations and improvements related to the turn around program. With four consecutive quarters of stabilized and improving results on this block, it is evident that the turnaround program of active premium rate management, improved claims management and operating efficiency has taken hold.

Turning to slide 30, the chart depicts a trend of earnings stabilization and improvement since the significant strengthening of reserves in the second quarter of 2007. The metrics for revenues and collected premiums for the closed block also reflect stability and are related to our active management of premium rates. While we are pleased by the favorable trend over the past year the results for this product line can be volatile.

Results for the quarter net to a $12.2 million profit for the quarter versus $130.3 million loss in the prior year. Again, the second quarter 2007 loss was driven by reserve strengthening, which has led to a favorable verified incurred claim development in subsequent quarters. As I mentioned previously, we expect to consummate the transaction to transfer Conseco Senior to the business trust during the fourth quarter.

Next steps following the Form A statement filing include publication in the Pennsylvania bulletin, which is expected by August 23. This will commence a public comment period that is expected to run through September at the discretion of the Pennsylvania Insurance Department.

During the months of August and September, we anticipate that the Pennsylvania Insurance Department will consider the comments received as well as Conseco's response to these comments.

Following this review it is anticipated that the Pennsylvania insurance Department would approve the Form A allowing the transaction to be consummated in the fourth quarter.

To summarize, second quarter results for the LTC closed block reflect a continuation of the trend of stabilization and improved business fundamentals and we look forward to continuing to work with our regulators on the plan announced on Monday.

And now, I will hand it over to Eric Johnson our Chief Investment Officer, who will discuss the CNO investment portfolio. Eric?

Eric Johnson

Thank you, John. For the second quarter investment income increased to $356 million, that was an earned yield of 5.82% consistent with our expectations. This can be attributed to growth in invested assets and somewhat higher book yield due to wider book spreads.

Asset quality remains the whole ballgame. We are on slide 33 now and that depicts our below investment reallocations which remains satisfactory at about 6% of general account assets. The credit cycle is clearly exerting a certain degree of upward pressure on this ration but it is manageable.

We are now moving to slide 34, this depicts $231 million in gross impairments in the second quarter, this figure includes $205 million related to the CSHI transaction. The remaining $26 million substantially reflects wider spreads in corporates and mortgages. The market strongly influenced by higher than anticipated residential mortgage delinquencies.

We are now moving to slide 35, given the impact on our earnings from equity index products in both the Bankers and CIG segments, we thought we'd touch on how the accounting impacts our reported earnings. As we've told you in prior calls we fully hedge our exposure to the equity markets related to these products, the options we purchase are typically one year options that match the current equity indexed benefit embedded in the liabilities.

As policies terminate those liabilities terminate in the course of the year we quite commonly rebalance the related long options. This results from time-to-time in a modestly over hedged position between rebalancings. The value of this net position can increase or decrease market conditions. In general this does not itself generate major income variance in a given quarter. For example, representing approximately $1 million in the second quarter.

However, how we account for these products does create fluctuations as the liability portion of the benefit is valued on a different basis than the supporting options. This is driven by FAS 133.

FAS 133 requires us to reflect in current period income changes and the present value of future period estimated option costs for the life of our EIA life force. Obviously, this calculation has many variables and it is important to know that as future periods move to the current year the differences even out. As Ed mentioned earlier, this calculation was approximately $4 million in the second quarter, just over 3 of it at Bankers and the remainder at Conseco Insurance Group.

I am now moving to slide 36. Slide 36 depicts our structured securities portfolio. This portfolio remains very highly rated over 89% AAA. That includes our sub prime securities which are included in the ABS segment.

As slide 37 shows, we have continued to reduce our exposures to the sub prime market which now approximates $100 million which is less than a third its level 12 months ago. Our surveillance of this portfolio remains quite intensive. Our goal is to manage deal level support to a conservative cushion over projected losses in the pools. Including a healthy margin for error and adverse development.

As slide 38 shows sub prime represents only 42 basis points of our entire portfolio at book value. During the second quarter certainly we have all observed the market delinquencies and loss severities have been unfavorable. However, we remain satisfied with the credit support provided inherent in our collateral.

Slide 39 depicts our CMBS portfolio. This represents about $920 million or 4% of invested assets. This portfolio is also very highly rated approximately 70% in the AA and AAA categories, and we use single values when I say that. Our collateral performance reflects very low delinquencies and significant cushions for estimated losses. However, this is a sector that's sort of the high risk spread widening over the course of the year and like everybody else who owns any BBBs, those BBBs have reflect a sizable unrealized loss as depicted in the materials.

As a general comment, I believe, we will continue to meet our objectives for income yield and quality. It does seem likely that market volatility will persist and may lead to continued elevated impairments in the remainder of this year.

And with that, I will turn it back to Jim Prieur.

Jim Prieur

Thanks, Eric. One of the most significant take aways from the quarter is that the Company continues to show that it can grow at a very attractive rate. Bankers Life is continuing to grow at about 10% while Colonial Penn's business is growing at more than 20%.

CIG sales while down are producing more economic value from refocused sales efforts. In the balance of this year the year-over-year sales comparisons will become easier as the major shift in sales efforts really occurred about one year ago.

We have improved earnings stability and as we had predicted last year we actually produced a profit in the LTC closed block for the first half of this year. It is always easier to affect a transfer or sale of any business after it has been improved rather than before which is what we are doing with the runoff LTC block.

Bankers earnings have been disappointing. Some of the earnings shortfall is due to PFFS processing catch-ups and Med Supp quarter to quarter volatility. These variations even out over time. The Bankers LTC earnings issue is a bit more of a concern. After all we have had two quarters of quarter earnings from that. About the only good news about this problem is that we know how to fix this and that the Bankers block is much easier to manage and therefore easier to improve than the closed block.

We moved a couple of managers from the closed block to Bankers LTC to improve claims management. We are sharpening our claims management protocols and we're putting in rate increases.

Management is focused on improving shareholder value. The reason for looking at strategic alternatives is to improve the value of the Company, to reduce the gap between the intrinsic value of the Company and the share value.

Separating CSHI from CNO is the biggest step we could take to accomplish that. It is clear that the single biggest risk the Company has had has been the run-off LTC block. For more than a year and a half management has been seeing that the Company had to reduce its weighting in long-term care, that the long-term care exposure is too large for a Company our size and with our credit rating. This proposed transaction does just that.

This will not be the only strategic move we make in the next year or so but it will probably be the most significant. As we complete the separation transaction, we will be able to become even more focused on our base middle market franchise helping the senior middle market in America. It's the fastest growing demographic and the one with the greatest need.

And with that, we will now open it up for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Jimmy Bhullar with J.P.Morgan.

Jimmy Bhullar - J.P.Morgan

Thank you. I have a couple of questions. The first one is on slide 11, I think you are showing that the transaction is about 170 basis points accretive to ROE from 4.3% on a reported basis ex unusuals and on an adjusted basis 6%. The only question on that that I had is you are adjusting equity but it doesn't seem like you are adjusting the earnings and the closed block business that you are transferring I'm assuming it made some money. Is that right? Or is that not, can you comment on that and then I have a follow-up also.

Ed Bonach

Yes, Jimmy, thanks, this is Ed. We are aware of the fact that we did not adjust the numerator. This is for illustration purposes just as we don't think the $33 million is necessarily typical of what our earnings will be going forward. We used Q2 reported earnings times for the calculation just to simplify.

Jimmy Bhullar - J.P.Morgan

Okay. So do you have -- like this slide showing 170 basis points benefit to ROE. Do you have a number, the rough ballpark on how much the transaction is really accretive? It would obviously be, maybe a little bit less than this right?

Ed Bonach

Slightly less but not significantly because as you know up until this quarter the long-term care run-off block was producing losses.

Jimmy Bhullar - J.P.Morgan

Okay. And then, the second question that I have is just on your confidence in the roughly 14% or so of the LTC closed block LTC policies that you are retaining. Do you feel, you mentioned yesterday that behavior of those policies are similar to the block that you are reporting in runoff. Do you feel you are adequately reserved or is that something you are looking at the next few quarters? If you can you just comment on that?

Ed Bonach

No, we definitely believe that we are adequately and appropriately reserved. As you can see in the appendix to the presentation that is provided that our loss development continues to be in line with our expectations and most of the last four quarters have been positive slightly in their loss development. So, we believe our reserves are adequate and appropriate.

Jimmy Bhullar - J.P.Morgan

Okay, thank you.

Operator

Your next question comes from the line of Randy Binner with FBR Capital Markets.

Randy Binner - FBR Capital Markets

Thanks. Ed, I just wanted to clarify a few items and try and get to a core number. The $7 million that was referred to relating to Medicare at Bankers is that all -- is that the Coventry effect or is part of that the Coventry effect?

Ed Bonach

No, we have $3 million in the private fee for service which is Coventry.

Randy Binner - FBR Capital Markets

The Coventry was $3 million?

Ed Bonach

Right, net $3 million and that impacts the private fee for service results.

Randy Binner - FBR Capital Markets

That is $3 million net of tax?

Ed Bonach

That is pre-tax.

Randy Binner - FBR Capital Markets

Pre. And then the $4.2 million that you mentioned for indexed annuities, was that pre-tax as well?

Ed Bonach

Yes.

Randy Binner - FBR Capital Markets

Okay.

Ed Bonach

And just over $3 million of that was Bankers and just under $1 million of that was in CIG.

Randy Binner - FBR Capital Markets

And then, there was a reference to expenses associated with the transfer of CSHI, is that going to be a recurring in coming quarters? Or can you give us color on that?

Ed Bonach

Good question. It will not. In our total charged debt is anticipated for the separation transaction and the approximate $1.2 billion charge, we have put a $15 million provision in there for expected expenses going forward. So, the $2.3 million that was recorded in the second quarter should not recur other than once we do the closing of the transaction we will record all the expenses that we incur subsequent to Q2.

Randy Binner - FBR Capital Markets

Okay. And then, just a question on Bankers long-term care. You mentioned that claims management and re-rates were, among others, were going to be initiatives. I guess my understanding is this is on business that was previously written? Can you give us color on what actions years, or when this business was written and anything beyond re-rates that can be done retrospectively to be try and deal with the issue?

Ed Bonach

With regards to re-rates, once you have adverse loss development relative to the pricing and the loss ratios as submitted to the insurance departments, that is what gives you the justification to go back and apply for additional re-rates. The business that we aren't re-rating has been written primarily more than two years ago and some of that had been previously re-rated but some of it also had not been previously re-rated.

Randy Binner - FBR Capital Markets

How much of the overall Bankers Long-Term Care book is of that vintage more than two years ago?

John Wells

It is over 50% of the business or approximately 50.

Randy Binner - FBR Capital Markets

Okay. And then, just touching on Bankers real quick and I'll get back in the queue and maybe this question is for Jim. We were running below a rate that would have gotten us to $1.00, $1.20 per share in Bankers in particular in my model that had to run to high 60s or low 70s EBIT in the millions per quarter, so Jim, how do you feel that kind of run rate going forward looks after these quarters with the Long-Term Care? Thank you.

Jim Prieur

I would expect it will be back, it will be at that run rate in that range for the balance of the year at Bankers. That's where we should be. Some of the things, as I said earlier, were just natural fluctuations that come in stuff, I believe is just a natural fluctuation that we get. This PFFS was obviously one time and the LTC we are working on and it will start to -- the changes we are making will start to have an impact going forward.

Randy Binner - FBR Capital Markets

Thank you.

Operator

Your next question comes from the line of Jukka Lipponen with KBW.

Jukka Lipponen - KBW

Opt to that last question first, Jim, since the re-rates won't happen immediately, how do you get to the high 60s in dollars at earnings at Bankers in the third quarter?

Jim Prieur

Well, the change in the claims management. This business, the reason we say it is so volatile is when you look at the business, if you find yourself approving an extra hundred policies that might not be deserving of being approved, you are talking about a $5 million sort of impact. So, it is relatively sensitive to that.

Jukka Lipponen - KBW

And clarification, can you give us, what is the difference for the valuation allowance between the $330 million and the $298 million of the two numbers that were talked about? And also with respect to the RBC ratio, yesterday you showed a pro forma RBC ratio of 321% as of the end of the first quarter and now on a pro forma basis as the end of the second quarter it is 281%.

Ed Bonach

Yeah, Jukka, the difference between those two tax valuation numbers is the extra allowance on the impairments because as you probably recall on our realized losses we fully set up a tax valuation allowance against realized losses. So, that's the difference. As far as the risk based capital, yes, there is a difference. Part of that is Q2 risk based capital did decrease from Q1. The other is between yesterday and today, we did go to do a more complete factor by factor calculation on a pro forma basis and that estimate brought back increase to our RBC down somewhat.

Jukka Lipponen - KBW

So, is the RBC level a concern at all that -- would you potentially have to restrict or limit your growth?

Ed Bonach

No, because one thing, on a statutory basis the Conseco Senior Health Insurance Company and the Long-Term Care business in particular of that Company, which we are separating from because of the statutory reserve pivoting it actually is producing statutory losses because of that acceleration of increasing its reserves. So, post separation that will be a capital call or drain that we will no longer have on that business going forward.

Jukka Lipponen - KBW

Okay, I think I will take that off line. Last question to Jim, how do we map from here to the targeted 11% ROE in '09?

Jim Prieur

Well, I'm not sure that we have ever given precise guidance but you can see that the new value per share or value of the equity is lower and then start to apply $1.00 or $1.20 and then higher numbers and then you will get their fairly easily.

Jukka Lipponen - KBW

Thank you.

Operator

Your next question comes from the line of Andrew Kligerman.

Andrew Kligerman - Analyst

Good afternoon. On the investment portfolio, could you give a sense of how that will be split when CSHI is transferred?

Eric Johnson

Sure, Andrew. This is Eric Johnson. CSHI is a stand alone legal entity as exists today and it owns the bond it owns today and the great bulk of the securities that support the Long-Term Care block that is in CSHI will migrate to the new trust along with the liabilities. So, it is just kind of picking a Company up and moving it one ownership structure over.

Andrew Kligerman - Analyst

Is there any particular area or any particular concentration that we should be thinking about that is going to move to change the mix of the -- of what we see in the overall investment portfolio when we review the supplement?

Ed Bonach

Andrew, this is Ed, nothing significant because the assets that will come back to Conseco Insurance Company in order to support the non long-term liabilities that will be transferred to CSHI to Conseco Insurance Company are about $400 million and they are not appreciatively different than our overall investment portfolio of over $20 billion.

Andrew Kligerman - Analyst

Okay.

Ed Bonach

So, it will be negligible.

Andrew Kligerman - Analyst

And then, Eric mentioned in the presentation the elevated level of impairments through the rest of 2008. So, should we be thinking that the second quarter was probably a good run rate for impairments and what should we take away from it the fact that most of it was applied to the CSHI block?

Eric Johnson

I hesitate to speculate because that only sets me up to -- for the next quarter's questions but my view on it, today, is that if markets stay the way they are through the rest of the year, that the first couple of quarters of this year seem likely to play themselves out again, what the precise numbers will be is difficult to estimate from one quarter to the next but as you look over a longer periods, averaging things out tends to maybe be a better way of looking at it.

So, we look at the first half of the year as one period as a whole, I don't think spreads or volatility or liquidity or any of those factors is any better now than it was necessarily in first half of the year and in some measure perhaps maybe even more challenging. So, I think that's the world we are in. Having said that, to me $26 million, I don't go away from that because you know that is good. Let's do that again. It is no fun and people look at me funny here and I don't like that. So, I don't try to present that today as a good thing. I present it as what is and we want to do better and when the market lets us do better, we will.

Ed Bonach

Let me also, Andrew, just make sure it is clear to everyone that the impairment charges or the realized losses recorded because of the separation transaction at CSHI is marking that portfolio to market which is different than determining that are other than temporarily impaired. It is because we are intending to separate and no longer hold those securities until their market value recovers, so therefore we record them to market.

Andrew Kligerman - Analyst

Great. Yes, yesterday you had said that and then today it was written as an impairment and it kind of through me off a bit. Okay. And then, just in terms of, shifting over to Bankers on Medicare supplement, I guess, Scott had mentioned that the Med Supp loss ratio should remain stable for the year, for the balance of the year. Does that mean that it should be at the elevated level which we saw in the second quarter? Because it looked quite a bit higher than what we are used to?

Scott Goldberg

I think what we are trying to say is it is going to go back to what it normally would be. It has a tendency to revert to the mean.

Andrew Kligerman - Analyst

Okay. So, you would expect to go back to the mid 65, 67% range, somewhere in there?

Scott Goldberg

That's right.

Andrew Kligerman - Analyst

Got it. Thanks a lot.

Operator

Your next question comes from the line of Mark Finkelstein with FPK.

Mark Finkelstein - FPK

I guess, I'm curious about your termination experience and I guess, any impact on the loss ratio. What I'm trying to get at is are you seeing the scenario of the better lives lapsing with the higher rates, ending up with a block that has more adverse selection in it? If that's the case, how does that factor into the next round of re-rates?

Ed Bonach

Mark, which line are you talking about?

Mark Finkelstein - FPK

Bankers long-term care.

Ed Bonach

Okay. The termination rates at Bankers have been fairly stable. We have not seen any major shifts up or down there so they don't really factor in at all to the re-rates that we are planning to get and that we have been getting.

Mark Finkelstein - FPK

So, you aren't seeing any scenario where the better lives are lapsing with the higher rates and you are left with adverse selection on the block?

Ed Bonach

No, we have not seen a spike up in lapse rates which would be an indicator that potentially you are getting that antiselection. But lapse rates on Bankers have remained quite stable.

Mark Finkelstein - FPK

Okay. And then just thinking about the specified disease loss ratio in CIG. It has been elevated relative to historical for the last four quarters. I believe it is still favorable to pricing. But I'd like to get confirmation on that. And then secondly, how comfortable are you with pricing just knowing that that is where a lot of the growth is coming from in the CIG channel?

Jim Prieur

Well, certainly, in terms of the business that we do in CIG it is the most profitable line that we have got at CIG. It is continuing to grow and it is getting to be an older block, and so, in a way older blocks become more stable simply because you got a broader number of policy holders saying that they tend to get more of an average performance.

Mark Finkelstein - FPK

Okay. So, you are comfortable with the pricing at these current levels?

Jim Prieur

Yes, we are.

Mark Finkelstein - FPK

Okay. And then just thinking about the -- I had the same question on the RBC ratio going from 320 projected yesterday down to 280 with the 10 points. And it brings up the question you noted some of the issue because of first quarter to second quarter. I guess, I would be curious about what -- I know you didn't put it out in the supplement this morning. What are you looking at for stat earnings for the second quarter and what is your projected stat earnings for the back half of the year?

Ed Bonach

As far as projected stat earnings, we typically don't comment on that. Our stat earnings for the most part should be consistent with our GAAP earnings other than for the long-term care run-off, which on a quarterly basis generally run $20 million to $25 million less on a statutory basis.

Mark Finkelstein - FPK

Okay. I will follow-up. Thank you.

Operator

Your next question comes from the line of Jeff Bronchick with RCB Investment.

Jeff Bronchick - RCB Investment

Good afternoon guys. Just want to clarify a number of other things people said. You expect, Jim, that the third quarter as in the quarter coming up Bankers will be back on that $60 to $70 run rate of EBIT? Is that what I heard you say?

Jim Prieur

$70 million of EBIT per quarter. That's right.

Jeff Bronchick - RCB Investment

Okay. And so, you are expecting that in the third quarter and onward subject to the quarter?

Jim Prieur

Right.

Jeff Bronchick - RCB Investment

And if you look at the 11% ROE target, obviously CIG is really below that and Bankers is closer. What assumption are you making for CIG to get to 11% corporate?

Jim Prieur

I'm not sure we have broken it out that way. We are sort of expecting CIG's ROE should be going up obviously and that becomes sort of the next big job within the Company of fixing. We believe that Bankers should be able to produce an ROE that should be 11% to 12% and Colonial Penn should be even higher than that, even a little bit higher than that and the real challenge would be to improve the CIG ROE going forward.

Ed Bonach

And Jeff, I don't know, if this helps but we certainly see quarterly EBIT from CIG being closer to $40 million a quarter as opposed to 30.

Jeff Bronchick - RCB Investment

Okay. And you made a reference to "other strategic moves." What kinds of things would be on that table?

Jim Prieur

I think we have talked in the past about the notion of trimming other operations to -- all with the aim of improving the ROE of the business overall.

Jeff Bronchick - RCB Investment

So what is -- talking about pieces of CIG that don't fit?

Jim Prieur

That certainly could be something we could do, yes.

Jeff Bronchick - RCB Investment

And just lastly, back to Bankers for one second on the Long-Term Care. What vintage of policies are most of these issues coming from? And how, Bankers is growing, how are you comfortable that you are pricing it correctly now?

Jim Prieur

Yes, most of the re-rates are on business written prior to 2006 and one of the main reasons that we have confidence that we are underwriting and pricing the business correctly going forward is the with the advancements made in underwriting and the EMST test as a prime example of the cognitive impairment testing that we think prior to that, the risk selection wasn't necessarily in the industry nor at bankers as appropriate as it is now.

Jeff Bronchick - RCB Investment

So, you postulated in the past that we have perfectly reasonable businesses that will be improving and growing. We have this giant anchor around our necks. We need to do a strategic plan to remove that relevance to it and underneath this you will see us run a good Company. How much time and effort over the past year have you spent on Long-Term Care that has prevented you from reporting reasonable results in the core ongoing businesses? Is that a factor?

Jeff Bronchick - RCB Investment

Well, we certainly spent a lot of time on Long-Term Care and so sure, it must be a factor, yes.

Jeff Bronchick - RCB Investment

Thank you.

Operator

And there are no further questions at this time.

Jim Prieur

Well, thank you very much. We would like to thank you all for attending this conference call. Conseco is focused on the senior, middle income market in America, which is the fastest growing major segment in life insurance in America and we are committed to growing this segment successfully in the future. Thanks again.

Operator

This concludes today's second quarter 2008 earnings call. You may now disconnect.

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