Nov 2, 2007
Executives
Joseph P. Clarke - VP, Financial Planning & Analysis C.
James Prieur - CEO Edward J. Bonach - EVP and CFO John Wells - Sr.
VP, Long-Term Care Mark E. Alberts - EVP and Chief Actuary Eric R.
Johnson - President, 40/86 Advisors, Inc. Scott Perry - President of Bankers Life
Analysts
Tom Gallagher - Credit Suisse Nigel Dally - Morgan Stanley Jukka Lipponen - KBW Joan Zief - Goldman Sachs Josh Smith - CREF Randy Binner - Friedman, Billings, Ramsey Mark Finklestein - FPK
Operator
Good morning. My name is Valerie and I will be your conference operator today.
At this time, I would like to welcome everyone to Conseco’s third quarter investor conference 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].
I will now turn the call over to Joe Clarke, Conseco’s Vice President of Financial Planning and Analysis. Mr.
Clarke, you may begin your conference.
Joseph P. Clarke - Vice President, Financial Planning & Analysis
Thank you. Good morning and thank you for joining us on Conseco’s third quarter earnings conference call.
Several key Conseco executives are on the call with presentations today, including Jim Prieur, Conseco’s Chief Executive Officer; Ed Bonach, Chief Financial Officer; Eric Johnson, Chief Investment Officer; Mark Alberts, Chief Actuary; and John Wells senior Vice President of Long-Term Care. Also joining us for our question-and-answer session will be Scott Perry, President of Bankers Life; Greg Barstead, President of Colonial Penn Life; Mike Dubes, President of Conseco Insurance Group; and John Kline, Chief Accounting Officer.
During this call, we’ll be referring to information contained in yesterday’s earnings release. You can obtain the release by visiting the Conseco news section of our website at conseco.com.
During the conference call, we’ll be referring to a presentation that can also be obtained and viewed from the company’s website. This presentation was also filed in a Form 8-K earlier today.
The 10-Q will also be available through the investors section of our website when it is filed on November 7th. 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 forward-looking statements.
Please refer to yesterday’s earnings release for additional information concerning the forward-looking statements and related factors. The presentation to which we will be referring to 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 the presentation contains a reconciliation of the GAAP measures with the non-GAAP measures.
And now I will turn the call over to Conseco’s CEO, Jim Prieur. Jim?
C. James Prieur – Chief Executive Officer
Thank you, Joe. Q3 2007 was a very interesting quarter with a lot going on.
Overall, we continue to make progress on our plans to position Conseco for future growth. Earnings per share before expenses related to the litigation settlement and the previously announced loss on the annuity block reinsurance was 18 cents per share.
This quarter’s litigation costs represent the final expense for the R-Factor settlement. Slide 5 shows a breakdown of pre-tax operating earnings by segment.
Bankers Life and Colonial Penn’s earnings were strong again and you’ll be provided with more detail on these later in the presentation. Conseco Insurance Group had a rough quarter.
It had two unusual non-recurring items, expenses related to operational savings of $11 million and it also had an $18.3 million addition to reserves arising from the remediation of past errors. The expenses related to operational savings and consolidations consist of a write-off of software, which has been abandoned because we have continued to simplify our business and other costs that are associated with expense savings going forward.
You’ll recall that we had started a remediation program that is designed to identify all of the reserving issues that could result in future out-of-period adjustments. In the most recent quarter, this program discovered reserve mistakes made in specified disease reserves.
These are mistakes originating at the time of the block was acquired more than a decade ago. We’ve now fixed those, resulting in increase to reserves of $18.3 million.
Our remediation program is scheduled to be finished by year-end. However, our control weakness will not be fully remediated until our redesigned and improved controls have been operating for several quarters, after the completion of the remediation procedures.
The LTC Closed Block showed much more stable performance in the quarter with a loss of $2.9 million, although it did benefit from a catch-up in terminations during the quarter arising from mortality. In slide 6, overall the company had very strong results from Bankers and Colonial Penn.
CIG’s results were negatively affected by the item identified by our remediation procedures, as well as by the expenses related to the consolidation of operations and both of these are non-recurring and the second one will reduce expenses going forward. LTC run-off block is approaching breakeven as predicted and you will see the improved stability and the results later in this presentation.
From a capital perspective, the sale of the annuity block closed in October. We’ve effectively committed most of the proceeds to recapture the Colonial Penn block of life business.
The company also bought back 2.4 million shares of its common stock during the third quarter. Moving to new business, new business continues to be strong at Bankers and at Colonial Penn.
There was some slowdown in the third quarter at Bankers driven in part by the cessation of PFFS sales in the market. However, Bankers did pick up a very large reinsurance relationship with the PFFS product that will add a significant amount of premium and profit to our results, but does not appear in the sales number itself.
CIG sales were down 31% compared to last year, but the value of the new business actually increased both for the quarter and year-over-year. So, while the accrued sales measure of NAP didn’t show growth, we are adding value to our new sales activity.
Our year-to-date annualized operating return on equity, excluding the litigation charge and the loss from the coinsurance transaction from earnings, was only 1.6% for the last four quarters ended September 30th, 2007 and it’s been declining as you see on this chart on a trailing four-quarter basis principally due to the negative ROE in our run-off segment. As a reminder, these segment GAAP ROE calculations are based on the method described in the notes to the slide, which start by describing statutory capital to lines of business based on RBC.
The company has a long-term goal of improving its ROE to 11% for 2009, which is achievable. Next up is our CFO, Ed Bonach, who will take us through the financials.
Ed?
Edward J. Bonach – Executive Vice President and Chief Financial Officer
Thanks, Jim. Starting at the parent company level, slide 9 replicates the earnings table in the press release.
I will be commenting on each operating segment on separate slides. The net loss applicable to common stock for the third quarter was $53.7 million.
This included $28.1 million of net realized investment losses or 15 cents per diluted share, resulting in an operating loss per diluted share of 14 cents as compared to a 35-cent profit per share in the third quarter of 2006. The current quarter included two adjustments that need to be understood in comparing these results to expectations and earnings trends.
This quarter’s earnings were reduced by 26 cents per diluted share resulting from the loss related primarily to writing off intangibles pertaining to the annuity business reinsured with Swiss Re. The quarter’s results were also reduced 6 cents per share from increased expenses associated with the ultimate settlement of benefits as part of the R-Factor litigation, including the recent sale of shares at lower market prices than previously expected.
Adjusted operating expenses for the trailing four quarters are down more than $10 million comparing the third quarter of 2007 with the third quarter of 2006. We are on track to achieve our targeted cost reduction of $25 million annually commencing in 2008, resulting from our back office consolidation project.
Additionally, we will save $6 million annually from the right-sizing of CIG sales and marketing, which occurred in the third quarter of 2007 and an additional $2 million from the write-off of the software that Jim mentioned. I’ll comment further about this when I discuss the business segments.
Slide 12 consolidates several of our more important indicators. Book value per diluted share reflecting the conversion of preferred stock in May decreased from year-end to $24.77, reflecting principally the loss during the year.
Our debt and preferred stock to total capital ratio calculated, excluding accumulated other comprehensive income, was just over 20% at the end of the third quarter as compared to about 26% a year earlier and 29% at year-end 2006. Risk-based capital at our insurance companies remained very strong, ending the third quarter at approximately 330% based on our preliminary calculations.
Net investment income on general account assets for the third quarter reflect a strong earned yield of 5.88%. Investment quality remains high.
Although we have increased our below investment grade position modestly, credit quality is excellent. We have very limited financial exposure to sub-prime asset-backed securities and we significantly reduced our exposure during the quarter, now comprising less than six-tenths of 1% of our portfolio with most of it highly rated at “A” or better.
Eric Johnson, our Chief Investment Officer, will cover this in more detail later. As announced yesterday, we have reached an agreement with Swiss Re to recapture a block of Colonial Penn Life business reinsured in 2002, that comprises $50 million in annual life premium income.
This meaningfully increases our core business, simplifies our operations, and is accretive to earnings and return on equity. The transaction strategically redeploys cash received from the close of our annuity reinsurance transaction.
We expect the life insurance recapture to be complete by year-end. We’ll now turn to the segment results beginning with Bankers.
Year-to-date sales at Bankers have been driven by strong growth in life insurance and private-fee-for-service. Slightly lower earnings in the quarter compared to the third quarter of 2006 was driven by lower long-term care margins, mostly offset by improved spreads in a higher prescription drug program private-fee-for-service income, including the commencement of the reinsurance agreement on a sizeable group sold by Coventry that Jim mentioned.
Bankers’ annualized return on equity improved over the first half of the year and is at 10.4%. Turning to slide 16, business growth at Bankers is evident in quarterly revenues of almost $622 million, up 18% over a year ago.
Bankers’ results for the third quarter of 2007 improved over this year’s first two quarters, benefiting from the higher Medicare-related product margins. The Medicare supplement benefit ratio was slightly higher than in the third quarter of 2006, yet the trailing four-quarter average remains quite stable.
Benefit ratios for the PDP and PFFS lines of business reflect the seasonal pattern of claim results, and these results are consistent with our pricing expectations. Turning to slide 19, the long-term care interest-adjusted loss ratio has been increasing modestly impacted in part by higher persistency.
Some of the increase has been driven by claim experience, which is leading us to re-rate some of our business issued approximately three to five years ago that has not been previously re-rated. Moving now to Colonial Penn, earnings for Colonial Penn in the third quarter of 2007 produced a year-to-date annualized return on equity of 13.8%.
Our favorable trends continue at Colonial Penn. Earnings grew 4% over the prior quarter and are 52% better than the third quarter of 2006, due to business growth, expense management, and favorable mortality.
Quarterly revenues are up 10% over a year ago. Colonial Penn has consistently demonstrated a capacity for increased lead development, which is a key indicator of future sales for a direct marketing organization.
Moving to Conseco Insurance Group or CIG, CIG sales based on new annualized premium were down 31% from the third quarter of 2006, with strong sales gains in specified disease offset by decreases in Medicare supplement and annuity. While CIG sales are down, there is greater focus on more profitable business with the contribution to profit from the new business higher than it was a year ago.
Earnings decreased from the year-ago period due to adverse mortality on interest-sensitive life products, the reserve correction in specified disease identified by our remediation procedures that Jim mentioned, and expenses related to consolidation of operations and the right-sizing and focusing of sales and marketing into our core distributors of PMA, independent health distributors and worksites. CIG segment earnings exclude the after-tax charge of $49.7 million related to the closing of the annuity coinsurance transaction.
CIG’s earnings in the third quarter of 2007 results produced a year-to-date annualized return on equity of 3.7%. CIG’s third quarter pre-tax operating loss reflects the $18.3 million specified disease reserve correction, $11 million of consolidation expense charges that will result in expense run rate savings of over $8 million annually going forward, and an $11 million reduction in interest-sensitive life earnings from adverse mortality.
CIG’s Medicare supplement benefit ratio was 68.6% in the third quarter of 2007, consistent with expectations. Persistency on this business has been higher this year versus the prior.
CIG’s interest-adjusted specified disease benefit ratio was 70.3% in the third quarter of this year, reflecting the reserve correction. Adjusting for this and other similar items produces a more stable loss pattern as depicted by the solid line on slide 26.
Next, we are going to focus on our run-off long-term care block and I’ll call first on John Wells, Senior Vice President, Long-Term Care for a discussion of our turnaround progress. John?
John Wells - Senior Vice President, Long-Term Care
Thanks, Ed. Results for the third quarter reflect stability in reserves and improving business fundamentals related to our program for improvement.
The results of the turnaround program are providing real impacts that are increasingly evident in our results. With regard to rate increases, we are nearing completion of our $35 million re-rate program and making steady advances in a second $21 million round of re-rates.
In the area of claims management, we have implemented many of the major elements of our improvement plan. Our handling of initial and established claims significantly improved in comparison to processes in place during 2006.
We have implemented service improvements in our intake process, increased accuracy of initial claims decisions, expanded the use of case management and plans of care, and periodic re-certifications of previously approved claims. The estimated impact of these improvements on third quarter results is $5 million, and we expect these results to accelerate through the end of the year.
As discussed on the second quarter call, we are setting a proposal for system and operational solution for our run-off block from the Long-Term Care Group, also known as LTCG. LTCG is an industry leader within we are currently also working to implement best practices in our claims function.
We expect to make a decision on this proposal in the fourth quarter of 2007. On the regulatory front, the long-term care industry is currently seeing an increasing amount of interest in its activities.
It is a matter of significant public interest that policyholders receive assurance that the industry makes great efforts to pay eligible claims when they are due and that the state regulatory system is protecting them. To this end, Conseco initiated discussions with state departments of insurance earlier this year related to a multi-state examination of our current long-term care claims management practices.
This multi-state exam began on July 9th with over 35 states participating. We look forward to the opportunity to utilize this assessment in our ongoing improvement efforts in customer service and compliance.
Moving to slide 28, we would like to provide some additional updates on the re-rate program. As previously mentioned, we are approaching completion of our goal of an estimated $35 million in net revenue enhancement from a first round of rate increases initiated last year.
These metrics reflect activity through October 25th, 2007. As discussed in the previous call, we have obtained 100% of the $56 million goal in submitted filings to the states for their approval of this round of rate increases.
We have received approvals from the states totaling $37 million, this represents 90% of our $42 million goal. Approvals from a few key states remain in achieving this goal.
We have also completed system implementations of approved rate increases representing $30 million of enhanced revenue or 86% of our $35 million goal. These rate increases will take effect at the next premium billing date of the related policies.
Moving to slide 29, progress also continues on a second round of rate increases, which were initiated in 2007. As of October 25th, we have submitted $31 million in Round 2 rate increase filings to the states for their approval.
This represents 72% of our $43 million goal. We have also received approvals from the states totaling $8 million of the increases for this second round, and this represents 30% of our $26 million goal.
We have also completed systems implementations of approved rate increases representing $5 million of enhanced revenue and this represents 18% of our total goal of $21 million. In sum, our turnaround program is making solid progress and we expect these improvements to continue as we exit 2007.
And now, Mark Alberts, our Chief Actuary, will take us through a discussion of the closed block financials. Mark?
Mark E. Alberts - Executive Vice President and Chief Actuary
Thanks, John, and good morning. Results for the closed block segment were a loss of $2.9 million in the third quarter, an improvement of $10.1 million from the third quarter of 2006.
The earnings trend shows a marked improvement from prior periods, including $130 million improvement from the second quarter of ‘07 when we strengthened claim reserves by $110 million. As a result of this strengthening, the third quarter development of prior period-incurred claims was very stable, even developing a small redundancy in prior period reserves.
As John noted, results for the quarter also reflect the growing impacts of our improvement initiatives. Results for the quarter also benefited from the $6.6 million of active life reserve releases, further described on the next slide.
Incurred claims for the quarter were $112.9 million, flat from the third quarter of 2006, and much improved from each of the last three quarters, reflecting the stability in the claim reserves. The verified basis incurred claims are $116.2 million and are in line with the prior periods.
The favorable change in active life reserve reflects the adjustments discussed earlier. The first is a $20.1 million release of active life reserves related to prior period debts and terminations, which were identified in conjunction with our work to remediate our material control weakness.
This release was partially offset by an increase of $13.5 million to refine our active life reserve estimates for certain benefits. Beginning this quarter, we have also updated our active life reserve assumptions to reflect our rate increase program.
As mentioned in our Long-Term Care Conference Call in September, our active life reserve assumptions must remain fixed unless the reserve is determined to be inadequate or unless rate increases differ materially from those that are assumed. In a case of rate increases, the reserves are changed prospectively using a method called the pivot method.
Under the pivot method, there is no one-time reserve change, but a portion of the rate increase premium is accrued into the benefit reserves in all future periods. In the third quarter and in future periods, a portion of our rate increase premium is added to the active life reserves, which will favorably impact the margin in those reserves going forward.
On slide 33, the third quarter interest-adjusted benefit ratio of 75.1% demonstrates our progress in improving the business fundamentals and also reflects the favorable impact of our active life reserve changes. Slide 34 demonstrates the stability in our reserve balances in the current quarter.
On slide 35, which was introduced in our Long-Term Care Conference Call in late September, this slide is a bit busy, but clearly demonstrates the improvement and stability of claim results this quarter. The prior period development in the quarter is a positive $3.3 million compared with the deficiencies that arose in previous periods.
If we compare the 6/30/07 and 9/30/07 verified claim rows on this page, we see the stability and the incurred claim estimates for [inaudible] column. Prior to this quarter, those estimates of prior period claims had been consistently increasing.
The open claim count and policy trends continue to run in line with expectations. The increase in termination rates this quarter is due to the prior period debts and terminations we already discussed.
And now, I’ll hand it over to Eric Johnson, our Chief Investment Officer, who will discuss the CNO Investment Portfolio.
Eric R. Johnson – President, 40/86 Advisors, Inc.
Thank you, Mark, and good morning everyone. As Ed mentioned earlier, investment income for the quarter increased to $389.9 million, representing an earned yield of 5.88%, up from 5.72% in the third quarter of 2006.
We’ve been able to increase portfolio yield despite the low rate environment by shifting out the curve, some steepening has occurred, as well as through increased allocations through private placements and commercial mortgages. Asset quality remains a high priority.
Our below investment grade ratio remains satisfactory with some upward drift, due to LBO ratings migration. Below investment grade securities represent approximately 5.5% of general account assets.
This is a highly diversified portfolio, which receives careful attention. Moving to slide 38, slide 38 summarizes our structured securities portfolio.
This is a very highly rated portfolio, over 87% in the AAA category. It’s about 50% agencies, obviously involving basic risks related to volatility and prepayments, as well as credit and the other 50%.
Our sub-prime holdings are included in the ABS segment on this page. Moving to slide 39, slide 39 summarizes our sub-prime vintages.
During the third quarter, we materially reduced our sub-prime exposure with greatest emphasis on 2006 and 2007 vintages. We continue to evaluate dealer-level performance based on a range of projected macroeconomic conditions.
While we were satisfied that our entire portfolio had sufficient embedded coverage of projected losses, we wanted to increase our margin for adverse development and error. Slide 40 summarizes our sub-prime portfolio and market to market buy rating.
You are all aware of the very substantial recent volatility in the market for sub-prime securities. Because we’ve been fairly active transactionally, our remaining loss exposure is less than might otherwise be expected.
As slide 40 shows, sub-prime securities represent only 0.57% of our total portfolio, approximately $180 million of book value. We’ll all remember that at the end of the second quarter, it was over $300 million.
Moving to slide 41, recognizing this is and will remain a most volatile market, we’ll continue to exercise great analytic vigor. While Moody’s and S&P recently downgraded in excess of 40 billion in securities, we had a total of four holdings downgraded.
We do not own any ABS CDO investments or any hedge fund investments. And with that, I will turn it back to Jim Prieur.
C. James Prieur – Chief Executive Officer
Thanks, Eric. To summarize, Bankers Life and Colonial Penn have continued to have great results, they are focused on growth.
CIG is now much more focused on its distinctive capabilities, it’s focused on its PMA distribution system, health products distribution, and worksite. While sales of CIG have declined, the economic value of these sales has actually improved over the last year.
And some of the expenses incurred during the quarter will produce ongoing operating savings going forward. We’ve been saying for some time that fixing the run-off block would take quarters, not weeks or months.
It’s now been a few quarters and the results are becoming more visible. The claims reserve volatility has been reduced, re-rates have continued to come through, and there has been improvement in claims management.
We expect that this block will be profitable next year. We changed some of the pieces of the portfolio of businesses that we owned.
In this quarter, we closed the sale of the annuity block to Swiss Re and just announced that we’re recapturing the Colonial Penn block that the company had reinsured about five years ago. In doing that, we are [inaudible] out-of-surrender charge period annuity block and buying back a block that is part of our core business.
From a portfolio capital management perspective, we also bought back $34 million of stock during the quarter. On the operations side, most of our organizational changes have been completed.
Over the summer, customer service has been effectively moved to Carmel and that move was done relatively smoothly. We still have the real estate changes to make.
We actually have to do the physical move in Chicago before we can recognize the loss and this will happen in the first quarter of 2008. The annual expense saves related to the operations consolidation, which was originally estimated to be $25 million, will now exceed $30 million.
And now I think we will open it up for questions. Operator?
Question and Answer
Operator
[Operator Instructions]. Your first question comes from Tom Gallagher with Credit Suisse.
Tom Gallagher – Credit Suisse
Good morning. First question is on CIG.
How should we think about this business in the context of… I think it’s pretty clear that your core best quality operations are Bankers and Colonial Penn. And CIG seems to be showing pretty high levels of deterioration over the last several quarters.
Is this a business that eventually gets put in run-off or how do you think about this business strategically?
C. James Prieur – Chief Executive Officer
Okay. Thanks, Tom.
Thanks for the question. I mean it is clear that Bankers Life and Colonial Penn have got a very strong competitive position in their respective markets.
In the case of CIG, the underlying business at CIG is, I believe, quite strong. It’s just that our competitive edges have got to continue to be sharp and they are focused on a couple of areas, smaller areas.
So, PMA distribution, health products distribution, and we believe worksite longer term. Being sort of a general competitor in the independent distribution, annuity, and life market is not a place where CIG has got any competitive advantage at all.
The other thing to recognize is that the value of new business has been increasing on the CIG business overall. So, while the gross sales number looks pretty disappointing in terms of the incremental value from new sales, it’s actually going up.
And I think that this business focused on the areas where we have a competitive edge can do very well going forward. Obviously, the deterioration in the life earnings has been a disappointment.
And you’ll note that we haven’t talked about that as being a non-recurring event. We have some vulnerability there going forward.
Tom Gallagher – Credit Suisse
Okay. And two other questions.
One is, can you talk about how much of the earnings in the run-off business… in the run-off LTC block benefited from reserve releases that you put up last quarter? Because I believe the assumption that you had embedded last quarter in the reserve charge had contemplated some level of deterioration and it doesn’t look like we got deterioration this quarter?
Edward J. Bonach – Executive Vice President and Chief Financial Officer
Tom, this is Ed Bonach. The reserves that we strengthened in the second quarter, we did not release any of those reserves, so in essence maintained that margin and actually added to it by the positive loss development that was noted of $3.3 million.
Tom Gallagher – Credit Suisse
Okay, so that’s still out there as a potential cushion if you do have some deterioration.
Edward J. Bonach – Executive Vice President and Chief Financial Officer
That’s correct.
Tom Gallagher – Credit Suisse
Okay. And then last question, when you talk about the 11% ‘09 ROE goal, can you just remind us what exact book value you’re using that to calculate off of?
C. James Prieur – Chief Executive Officer
Sure. What we’re using is the actual book value per share less the NOL, so the NOL portion of the book value.
And the reason we do that is the NOL is a funny number. I mean it’s a GAAP number, but it’s an undiscounted number that in the fullness of time should get used up by our not paying taxes over time.
So, it’s book value less the current book value of what the NOL is.
Tom Gallagher – Credit Suisse
And those numbers, I believe, are what? Starting roughly 25 and is the DTA that we then need to deduct, is that $7 or $8?
C. James Prieur – Chief Executive Officer
Yes, it’s about $7.
Tom Gallagher – Credit Suisse
Okay. So, we’re talking about a book value right now starting at 18 and presumably when you forecast ROE that’s going to grow to some level by the beginning of ‘09.
C. James Prieur – Chief Executive Officer
That’s right, yeah. I mean because the other crazy thing about the NOL is that as we start to make more money, the NOL could grow a little bit from where it currently is, which would have the reverse effect of making the “E” on the ROE calculation go up temporarily.
So, what we’re really looking for is a better “E,” which is why we’re taking off the NOL.
Tom Gallagher – Credit Suisse
And sorry, last question for me, Jim. Do you think legitimately there’s $2 of earnings power underneath everything that’s going on right now?
C. James Prieur – Chief Executive Officer
Yes.
Tom Gallagher – Credit Suisse
Okay. Thanks.
Operator
Your next question comes from Nigel Dally with Morgan Stanley.
Nigel Dally – Morgan Stanley
Great, thank you. Good morning.
First, with regards to the remediation procedures, it seems like it’s resulting in sizeable charges every quarter. How far through this remediation process are you?
Is it now mostly complete? Or is there still the risk of further sizeable charges looking forward?
That’s first. Second, with sub-prime, I understand you reduced the exposure, but your market value of sub-prime versus book at 82% looks pretty low at least versus your peers.
Is it your intention to hold those remaining securities to maturity or should we expect further sales looking forward? Third question is on the rating agencies, how important is it for the company to get an upgrade?
How does that impact your outlook for stock buybacks looking forward? Thanks.
Edward J. Bonach – Executive Vice President and Chief Financial Officer
Nigel, this is Ed. I’ll start with addressing the remediation.
We are approximately halfway through the whole remediation process. And to give you a better understanding of this, we are going through over 2,000 different plan codes in our businesses of specified disease, long-term care, and life insurance.
And we are tracing those policies or selection of policies from those plan codes from the original application to the valuation system to make sure that the actuarial reserves are appropriately calculated. Those plan codes represent over 80% of our total reserves.
So, in that, they are not each at 50%. For example, specified disease were about two-thirds of the way through that.
And the way that GAAP requires us to account for this is to recognize these adjustments in the period we find them, even though we don’t expect the full remediation process to be completed until the end of the fourth quarter of this year.
C. James Prieur – Chief Executive Officer
On the sub-prime, maybe Eric can answer the question.
Eric R. Johnson – President, 40/86 Advisors, Inc.
Sure. With respect to the roughly $180 million book value at 9/30, we fully expect that amount to be recoverable with a solid margin for adverse development.
And while it’s possible that some minor amount of transactions could occur, we wouldn’t expect anything along the scale of last quarter. I think in general the market, the book on that is very moderate in the context of the current market.
And I think if one looks at the recent price action, even the 2006 and 2007 ABX indexes, this would rather be at the very higher end of that spectrum.
C. James Prieur – Chief Executive Officer
And with respect to the question about rating agencies, I mean I’d like it to be very clear that our long-term goal is to improve our ratings. We are keeping our capital structure at the level that an “A” rated company would have.
And so we anticipate that as we bring and continue to improve the long-term care block and produce more stable results, that eventually we’re going to get rating improvements. While it isn’t particularly important to us, in the short run it doesn’t seem to have very much of an impact on sales, nevertheless, being the only below investment grade significant insurance company in America thus makes us feel sort of lonely.
And so we are going to be aiming to improve our credit ratings over time.
Nigel Dally – Morgan Stanley
And what does that… with regards to that goal, what does that mean for capital management? Are you likely to hold increasing amounts of capital to try to accomplish that goal?
Or do you think it’s purely a purpose of – purely a function of improving the operating trends?
C. James Prieur – Chief Executive Officer
I mean, Nigel, our problem hasn’t been our capital structure. Our problem has been our earnings, and both stability of earnings and the quantity of earnings.
So, we’re going to be focused on that. And so that’s sort of going to be guarding us as we move forward.
I mean I’ve made the point before that most of our business is not ratings sensitive, but nevertheless longer term, we would be aiming to get a higher credit rating.
Nigel Dally – Morgan Stanley
Great. Okay, thanks a lot.
Operator
Your next question comes from Jukka Lipponen with KBW.
Jukka Lipponen - KBW
Good morning. First question, what are the agent recruiting and retention trends at Bankers Life?
And what is the agent count as of year-end ‘06 versus now?
C. James Prieur – Chief Executive Officer
Actually, I don’t know the exact number, but it’s around 4,500 agents at the end of the quarter and we’re up 5.5% since the beginning of the year.
Jukka Lipponen - KBW
And the recent trend, the downgrade impacting, are you losing agents to others?
C. James Prieur – Chief Executive Officer
The net figure is continued growth. The growth has been fairly steady throughout the whole year.
And that being said, there are always some… there’s always some noise in the channel. And we do lose people to other companies and we take people from other companies.
The overall impact is that we’re continuing to grow the agency force.
Jukka Lipponen - KBW
When do you expect the second round of re-rate approvals to be completed?
John Wells - Senior Vice President, Long-Term Care
Second round, Jukka, this is John Wells, actually the filings have started. And consistent with the last round of filings, they are already starting to come in.
Of course, the implementation will be on the next… as we put them in the system in the next billing date of the associated policies. So, they are already starting to come in, slowly.
And if you take a look at last year’s trends, even though the projected net revenue enhancement is going to be down because the book is in force, premium is down, you’ll see the trend is about the same and will follow the last round.
Jukka Lipponen - KBW
And lastly, did I hear you say that you have some kind of a new relationship for the PFFS business at Bankers?
C. James Prieur – Chief Executive Officer
Bankers is reinsuring some business that Coventry is doing in PFFS. So, it’s a Coventry Group’s contract.
So, it’s a fairly significant amount of volume, which will have an impact on profitability, actually it had an impact in Q3.
Jukka Lipponen - KBW
And this is something new incremental to your relationship with Coventry previously?
C. James Prieur – Chief Executive Officer
That’s right.
Jukka Lipponen - KBW
Okay, thank you.
Operator
Your next question comes from Joan Zief with Goldman Sachs.
Joan Zief – Goldman Sachs
Hi. I have two questions and I’m sorry I didn’t hear the last question.
So, in case I’m asking the exact same question, I apologize. All right.
So, my first question is on Bankers. Can you just review the product focus there, how you think the business might be shifting and whether that will shift margins that we should be thinking about?
And then the other question has to do with the charge related to the annuity reinsurance. And I just wanted to understand if that was similar to the press release.
Did that $76 million charge include the reversal of the earnings out of the first half of the year as well? So, I just want to make sure that I understand if there was anything different from what was announced previously?
C. James Prieur – Chief Executive Officer
Okay. With respect to… it’s Jim again.
With respect to Bankers and the products focus, there is always some shift of product depending upon market conditions. And so, life sales have been much stronger, annuity sales have been weaker.
During the third quarter, PFFS sales were sort of on hold basically, other than that one group contract. And med sales for the quarter were up a little bit in part because PFFS sales were down.
So, there’s no huge shift in the product mix, although on the margin there’s always shifts, but driven mostly by market conditions. And like in the annuities, it depends upon where CD rates are.
And with the increased volatility, equity indexed annuities are more expensive for the consumer because they are basically having to pay for the volatility in the option market that we’re passing on to them. With respect to the sale of the annuity block, you can trace it all back to the original number.
And in fact, we’ll have a schedule in the Q that will do that exactly quarter-to-quarter for you. And it’s all consistent and it was $65 million loss plus the profit on the block since January 1st.
And some of that was effectively taken in earlier quarters, which is why the numbers may appear different. But, you’ll be able to see it all.
Joan Zief – Goldman Sachs
Okay. And just going back to the Bankers product, so you are… there’s no plan by management to focus on one particular product versus another at this point in time, whatever gets sold gets sold.
C. James Prieur – Chief Executive Officer
Well, pretty much. Sometimes we might… you might run specials on one product versus another.
But there hasn’t been… there is really no shift. Most of the shift has been a shift on the part of the consumers between the product offerings that we offer them.
And that’s is just the regular kind of shift that you see from time to time in the marketplace.
Scott Perry – President of Bankers Life
And Jim, this is Scott. I can add a little bit to that, Joan.
As you know that the Bankers channel is a market-focused company, so and we offer the suite of products to our market. Key to that is that we appropriately price and that the margins are all relatively equal.
And that’s what we focus on. So as product sales do shift, given the market conditions, on a profitability basis we’re somewhat whole.
Joan Zief – Goldman Sachs
Thank you.
Operator
Your next question comes from Josh Smith with CREF.
Josh Smith - CREF
Thanks, Joan, pretty much asked it on the annuity deal. Can you just give a little more color on the benefits of this deal?
You are taking a $76 million loss, which is consistent with what you said earlier. And it’s freeing up, I don’t know, a couple hundred million of capital.
Is that the basic benefit of doing this deal?
Edward J. Bonach – Executive Vice President and Chief Financial Officer
Josh, this is Ed. The basic benefits are to free up capital from a lower returning business.
It was returning about 6%. And to redeploy that into higher returning core businesses and taking the vast majority of [inaudible] to recapture the Colonial Penn Life business is a perfect example of that redeployment into a core business with higher profitability.
Josh Smith - CREF
Great, thanks.
Operator
Your next question is from Randy Binner from Friedman, Billings, Ramsey.
Randy Binner - Friedman, Billings, Ramsey
Hi, everyone. Thanks.
Just wanted to dig into CIG a little bit more. Jim, you had mentioned the annuity and life, sales through independent distribution was not really a competitive advantage.
So, just to kind of put numbers around it, that would be roughly, I think, 38% of CIG’s business. What percentage of PMA’s distribution incorporates those products.
And how big a share of that overall is distributed by PMA?
C. James Prieur – Chief Executive Officer
Yeah, the basic PMA business is selling supplemental health or specified disease. And they are selling in rural America.
And they will sell life and annuity products on occasion. But, it’s really sort of like an incremental sale.
Their real focus is on the supplemental health side of the business.
Randy Binner - Friedman, Billings, Ramsey
Okay. And so what percentage of the overall CIG distribution does PMA represent?
C. James Prieur – Chief Executive Officer
It’s over 40% now.
Randy Binner - Friedman, Billings, Ramsey
Okay. And then is there independent agent distribution in those products outside of that 40%?
C. James Prieur – Chief Executive Officer
Yes, there is. That’s the health IMOs and the health IMOs are a significant part of the company’s sales and have been forever, I guess.
Pretty much.
Randy Binner - Friedman, Billings, Ramsey
Okay. And in that, the outlook for that is good as well.
So, I’m just trying to figure out what percent of CIG distribution still falls into, I guess, the good basket.
C. James Prieur – Chief Executive Officer
Well, and there are still some life and health distributors who have good relationships with us who sell the product and we’re quite happy to sell the product. We’ll continue to develop the product.
It’s just we’re not going to be focused as much on that side of the business. What we found was that basically our marketing expenses were disproportionately weighted to annuity and life sales.
And we’re not sure how much more the sales will go down even though we’ve cut back substantially on the amount of marketing expense that we have within CIG. So, this is really an attempt to focus on within CIG, those parts of the business where we have a clear competitive advantage either because we’ve been in the marketplace forever, because we’re known as a good manufacturer or we have longstanding distribution relationships that we can take advantage of.
Randy Binner - Friedman, Billings, Ramsey
Great, thanks. And just one other clarification on CIG.
The remediation there, is that $8 million annual expense savings are expected?
C. James Prieur – Chief Executive Officer
No. The remediation is the discovery of the $18.3 million additional reserve and it’s the $11 million of what we call related to consolidation.
That $11 million expense will generate more than… well, it’s an acceleration of things, which will create over $8 million of savings per year for the next few years.
Randy Binner - Friedman, Billings, Ramsey
Okay. Great.
So, we could expect that for full-year ‘08 in CIG.
C. James Prieur – Chief Executive Officer
Yes.
Randy Binner - Friedman, Billings, Ramsey
Great. And then another quick question on Bankers.
Is there any sensitivity to recruiting to a softer economic environment, meaning that if general unemployment increases, you may find it easier to recruit agents?
C. James Prieur – Chief Executive Officer
I will pass that to Scott.
Scott Perry – President of Bankers Life
Sure. There is some correlation.
And it really varies regionally, but in the past where we have had a softer job market, we find that the pool of recruits is larger and allows us to select a higher caliber of recruit.
Randy Binner - Friedman, Billings, Ramsey
Okay. Great.
Thank you.
Operator
[Operator Instructions]. Your next question comes from Mark Finklestein with FPK.
Mark Finklestein - FPK
Hi, good morning. If you’ve already addressed this, I’ll come back and look at the transcript.
I was just curious. With the rate increases at Bankers in the long-term care, the re-rate process, how do you expect that to influence Bankers’ sales going forward?
And I guess we were at negative 2% for the quarter. What would be the expectations as the re-rate process continues?
C. James Prieur – Chief Executive Officer
I’ll pass it on to Scott.
Scott Perry – President of Bankers Life
Sure. Hey, Mark.
On the rate increases, because we were pretty much… Round 1 was continually through ‘06 and that probably had the biggest impact because it was the largest portion of our business. The second round, I think, will… although it will create somewhat of a distraction as the rate increase is implemented in the particular state, because agents will be focused on securing that business and retaining the business, it will have a slight impact on their focus on new sales.
But, I don’t think nearly as significant as Round 1 did, just because it’s a smaller block. And the timing will be rolled out.
So, it will probably have a minimal impact on our numbers, a slight impact on long-term care sales. And I think we saw maybe just a little bit of that in the third quarter.
But, because we have over the last three years become less dependent on long-term care sales and we’ve diversified our product line and, as Jim mentioned, the emphasis in the increased improvement in life sales, the introduction of PFFS, and obviously we’re in open enrolment period now where we will be in for the entire fourth quarter and the first quarter. I think it will have a minimal impact on new sales.
Mark Finklestein - FPK
Okay. And then again, I’ll go back and look at it if you had talked about it already.
But, can you just talk about trends in agent growth?
Scott Perry – President of Bankers Life
Sure. Real quick, Jim did mention, we are up about 5% year-over-year on a year-to-date basis in total agent size.
But, a more significant number is our productive agent count is up over 15% year-over-year from about 1,700 to close to 2,000. And those are the percentage of agents or the number of agents within the 4,500 that are producing four or more… making four or more sales in any given month.
Mark Finklestein - FPK
Okay, thank you.
Operator
[Operator Instructions]. There are no further questions at this time.
C. James Prieur – Chief Executive Officer
Well, thank you, operator, and thanks to everyone on the call for your interest in Conseco and for the questions. Conseco is focused on the senior middle market in America, the fastest-growing major segment in the market.
We have a unique sales machine dedicated to the market, whether it’s through agents, direct or through brokers and we’re committed to growing this business successfully in the future. Thank you very much.
Operator
This concludes today’s conference call. You may now disconnect.