Mar 2, 2009
Executives
Scott Galovic – Investor Relations Claude James Prieur – Chief Executive Officer Edward J. Bonach – Chief Financial Officer Eric R.
Johnson – Chief Investment Officer
Analysts
Jukka Lipponen - Keefe, Bruyette & Woods Randy Binner - Friedman, Billings, Ramsey & Co. [Paul Saran] - FPK Unidentified Investor
Operator
Good morning. My name is [Adrianne] and I will be your conference operator today.
At this time I would like to welcome everyone to the preliminary fourth quarter 2008 earnings conference call. (Operator Instructions) Mr.
Scott Galovic, you may begin your conference.
Scott Galovic
Thank you operator. Good morning and thank you for joining us on Conseco’s preliminary fourth quarter 2008 earnings conference call.
Today’s presentation will include remarks from Jim Prieur, Conseco’s CEO; Ed Bonach, Chief Financial Officer; and Eric R. Johnson, our Chief Investment Officer.
Following the presentation we’ll also have several other business leaders available for the question-and-answer period. During this call we’ll be referring to information contained in this morning’s press release.
You can obtain the release by visiting the Company News section of our website at www.conseco.com. During the conference call we’ll be referring to this 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-K for 2008 on or before March 17, 2009 and it will also be available through the Investors 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 forward-looking statements. Please refer to this morning’s press release for additional information concerning the forward-looking statements and the related factors.
As stated in this morning’s press release all financial results described herein should be considered preliminary and are subject to change to reflect any necessary adjustments that are identified before the company completes its financial statements and files its annual report on Form 10-K for the year ended December 31, 2008. 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 the presentation contains a reconciliation of GAAP measures with the non-GAAP measures.
And now I’ll turn the call over to Conseco’s CEO, Jim Prieur. Jim.
Claude James Prieur
Thanks Scott. Today we announced that we plan to delay the filing of our annual report on Form 10-K until on or after – on or before, sorry, March 17, 2009.
And we’re delaying this for a couple of reasons. First we need additional time to finalize the analysis and disclosure related to our investment portfolio in light of unprecedented market conditions.
In addition, the company has been informed by our independent registered public accounting firm, Pricewaterhouse Coopers LLP, that without additional information and analysis from the company to satisfy their concerns regarding the company’s liquidity and its debt covenant margins, primarily those that could be impacted by a significant amount of additional realized losses in the investment portfolio, their audit opinion would include an explanatory paragraph regarding the company’s ability to continue as a going concern. If after considering the additional information to be provided by the company it is concluded that there is substantial doubt as to the company’s ability to continue as a going concern, then the auditors report on the consolidated financial statements will include an explanatory paragraph to that effect.
The inclusion of such a paragraph unless waived by the lenders would be a default under Conseco’s senior credit facility. Other than the potential for the auditor opinion qualification mentioned above, we expect our final audited financial statements to show compliance as of December 31, 2008 with all the covenants in our credit agreement, including those related to insurance subsidiary capital; the combined RBC ratio of the insurance companies; the company’s debt to capital ratio; and the company’s interest coverage ratio.
With respect to material control weakness, in 2008 significant improvements were made to the actuarial reporting internal control environment. This remediated the material control weakness related to the Bankers Life segment and our former other business and runoffs segment.
Although controls within the Conseco Insurance Group segment were also enhanced, we did find two reserve corrections totaling approximately $12 million through our material weakness remediation procedures. Therefore, additional system and actuarial process improvements are necessary before the material control weakness can be considered to be fully remediated.
We were pleased that the Q4 2008 results again showed operating earnings in all of our operating segments. Total earnings before interest and taxes exceeded $78 million in the fourth quarter.
Overall, new business volumes in Q4 2008 were up 16% over Q4 2007 with sales at Bankers up 25% and Colonial Penn sales up 16%, while CIG sales were down 9% from the previous year. Earnings at Bankers were somewhat disappointing although LTC earnings continued to perform within expectations.
PFFS margins there were negative as Coventry went through a management change and there was some impact from reinsurance transactions done in the fourth quarter which Ed will speak to later. During the quarter Conseco completed the previously announced transfer of Senior Health Insurance Company in Pennsylvania to an independent trust which had been approved of course by the Pennsylvania Insurance Department.
Ed will touch on the financial impact of this transaction as well in a little while. During the fourth quarter there was some additional capital moves that we made to bolster the capital position of the company.
One of the most significant of these moves relates to reinsuring a portion of the Bankers LTC business. We have entered into a traditional co-insurance agreement with Reinsurance Group of America, RGA, whereby we reinsure 2008, 2009 and future new business.
They are reinsuring 70% of Bankers 2008 LTC production and will reinsure 50% for 2009 and going forward. [Inaudible] into this Bankers LTC reinsurance, we did a number of other external and internal reinsurance transactions which impacted statutory capital to some degree.
Ed will touch on the financial impacts of this as well during his part of the presentation. During the fourth quarter we also withdrew from reinsuring a couple of Coventry’s Group PFFS contracts going forward, which of course was a non-core business for us.
This move will reduce required capital in the future. It had no 2008 impact.
Conseco also received approval for permitted practices from two states that allowed the company to recognize more than $50 million in deferred tax assets for statutory reporting as of year-end 2008. Finally on January 20 of this year our board of directors adopted a shareholders rights plan designed to protect the interests of all shareholders from the possibility of losing substantial value through additional limitations on the company’s ability to use its net operating loss carry forwards under Section 382 of the Internal Revenue Code.
This rights plan is similar to those adopted by other publicly held companies who have concerns about protecting their tax assets and it is not intended for defensive or anti-takeover purposes. We believe this is in the best interest of Conseco shareholders and it will be up for approval at the upcoming annual meeting.
The timing of the adoption of this plan was primarily influenced by the low spot price that Conseco has been trading at, as well as the increased market volatility that we continue to see. The Section 382, Annual Limitation, is a formula amount based on the value of the corporation immediately before an ownership change.
If the Section 382 limitation were tripped today, the company would be required to write-down its deferred tax asset by a very large amount. This rights plan will continue in effect until January 20, 2012 unless terminated earlier by the board of directors or if shareholders do not approve it at the May, 2009 meeting.
In investments we have impairments and realized losses which we’ll provide quite a bit of detail on shortly. These results were better than what has been experienced by most other insurers as a percentage of assets.
Our accumulated other comprehensive loss increased by approximately $633 million during the fourth quarter, primarily as a result of credit spread widening. The results for CNO continue to improve and stabilize.
However, this is not as readily apparent with the inclusion of the final charges related to our transfer of Senior Health and its LTC business to an independent trust. Fourth quarter financials include $360 million of charges related to the separation transaction.
To reiterate, other than the potential for the auditor opinion qualification mentioned earlier, we expect that our final audited financial statements will show compliance as of December 31, 2008 with all the covenants in our credit agreement. There continues to be a significant amount of concern and scrutiny on insurance companies and their capital and liquidity constraints in light of the tough capital markets that we have seen over the last few quarters.
As such, we think its crucial for us to share with you again why Conseco is different than a lot of the others in our sector. First, we do not depend on having the highest ratings to make new sales or to keep current customers so our core business tends to be stable during times of economic [inaudible] and ratings fluctuations.
You can see that in our ongoing growth even in these tough times. Second, unlike insurance companies that have big books to variable life and annuity business, we have virtually no variable business which means that we don’t have reduced asset values and revenue streams and no accelerated DAC write-offs.
Unlike insurance companies that sell large policies aimed at asset accumulation, most of our products are sold in small base amounts to protect against financial loss. Large scale withdrawals by Conseco customers are therefore less likely and they are not occurring.
We haven’t invested in many of the exotic securities and derivatives that are causing liquidity problems in many financial institutions. Our impairments over 2008 have been lower than most companies in the industry.
We’re finding many of the large companies are having problems that are related to their dynamic hedges of variable guaranteed benefits and equity index market exposures. They are not dealing with the [tail] of the distribution, requiring increased hedges at higher and higher prices.
And as I just mentioned we have virtually no variable business and we are very simply hedged on our equity index products. While we are fortunate in some respects, we don’t take our position for granted.
The key to success is straightforward. Its in our ability to deliver on the sound business plans and strategies that we have in place within all of our companies.
Next up is our CFO, Ed Bonach, who will take us through the financial data. Ed.
Edward J. Bonach
Thanks Jim. Let me start by covering fourth quarter 2008 results.
Turning to Slide 8, collective premiums on a trailing four quarters basis continued to grow with the growth accelerating in the most recent quarters. Increases at Bankers and Colonial Penn were partially offset by a slight decrease at CIG, primarily due to the sale with the annuity block in 2007 and a focus on more profitable business.
As Jim mentioned our core segment earnings were solid. As you can see on Slide 9, our net operating income of $48.7 million equated to $0.26 per diluted share for the fourth quarter of 2008 compared to net operating income before valuation allowance for deferred tax assets of $27.2 million in the fourth quarter of 2007, or $0.15 per diluted share.
For the fourth quarter of 2008, the net loss applicable to common stock was $406.8 million which includes $88 million of net realized investment losses and $367.5 million of losses on discontinued operations. The loss from discontinued operations is related to the transfer of Senior Health and its LTC business to an independent trust.
This equates to a net loss of $2.20 per diluted share including $0.47 per diluted share of net realized investment losses and $1.99 per diluted share of losses related to discontinued operations. Investment losses recognized in the fourth quarter of 2008 were not reduced by a tax benefit due to the establishment of a deferred tax valuation allowance which is consistent with prior periods accounting treatment as it is unlikely that the tax benefits related to the investment losses will be utilized to offset future taxable income.
Turning to Slide 10 as we said earlier the company had operating income in the three insurance segments with a small loss recorded in the corporate segment. Year-over-year results show improvement with total segments EBIT increasing to $78.1 million in Q4 of ’08 compared to $64.8 million a year earlier.
In our Bankers Life segment pretax operating earnings were $40 million in the fourth quarter of 2008 compared to $58.3 million in Q4 of ’07. Results for the fourth quarter of 2008 were affected primarily by lower than expected margins in PFFS and PDP, along with Medicare supplement.
Additionally, one of our risk in capital management transactions in the quarter was to reinsure approximately 70% of the Bankers LTC new business sold in 2008 which reduced earnings by about $3 million. I will provide more information on this and other transactions in a few minutes.
Earnings were also negatively impacted by approximately $2 million related to the FAS 133 impact on equity indexed annuity products. This variance primarily resulted from a change in the value of the embedded derivative related to future index benefits reported at estimated fair value in accordance with accounting requirements.
In addition, we recorded a $3 million negative return on our COLI investment in the segment. For Colonial Penn the pretax operating earnings were $6.7 million in the fourth quarter of 2008 compared to a pretax operating loss of $200 thousand in the fourth quarter of 2007.
Results for the fourth quarter of 2007 were primarily affected by $8.4 million of expenses related to the test marketing of Medicare Advantage products through this distribution channel which was subsequently ceased. In our Conseco Insurance Group segment pretax operating earnings were $31.5 million in the fourth quarter of 2008 compared to $9.6 million in the fourth quarter of 2007.
Results for the fourth quarter of 2008 improved primarily due to improved specified disease margins of approximately $7 million and the $12 million reduction in specified disease return to premium reserves from the correction Jim mentioned that was part of our material control weakness. These were partially offset by approximately $5 million of lower margins on the remaining closed block LTC business that has been folded back into the CIG segment after the Senior Health separation.
The corporate segment showed better results in Q4 ’08 primarily as the result of reduced expenses. The gain on extinguishment of debt relates to our repurchase of $37 million of face value convertible debentures for a price of $16 million which resulted in a gain of $21 million in the fourth quarter.
Net realized investment losses were $88 million which is better than what we have seen throughout the industry in the market. This included approximately $45 million of write downs for securities we determined were subject to either than temporary impairment.
Eric Johnson, our Chief Investment Officer, will address this in more detail later in the presentation. The company has determined that GAAP accounting requires the transfer of the stock of Senior Health to be reported as a discontinued operation in the financial statements prepared after November 12, 2008 or the date of the separation.
As a result, all Senior Health business previously included in our other business and runoff segment is now reported as discontinued operations. As I mentioned a bit earlier, it is important to note that the non-Senior Health long-term care business as well as the small amount of health business which were both previously part of the runoff segment have been clasped back into CIG results for reporting purposes.
Discontinued operations had a loss of $367.5 million in the fourth quarter of 2008 compared to a loss of $6.9 million in the fourth quarter of 2007. As part of the separation, Conseco recorded GAAP accounting charges totaling approximately $1 billion comprised of Senior Health’s equity as calculated in accordance with generally accepted accounting principles; an additional valuation allowance for deferred tax assets; the capital contribution to Senior Health and the results of its operations.
Conseco recorded $496 million of these charges in the quarter ended June 30, 2008; $157 million in the quarter ended September 30, 2008; and $368 million at the close of the transaction in the fourth quarter. The company recognized no deferred tax assets on such losses as it is more than likely that such tax benefits will not be utilized to offset future taxable income.
This completes the recording of charges resulting from the separation of Senior Health from Conseco. Turning now to Slide 11, our trailing four quarters operating return on equity, excluding loss on co-insurance transactions, increased to the deferred tax asset valuation allowance and losses relating to the Senior Health transfer increased to 5.5% for the four quarters ended December 31, 2008 which improved noticeably from that reported in the previous quarters.
We have stated in the past that our long term goal is to improve ROE to 11% in 2009. Although we do not believe that this goal will be achieved by the end of 2009, we are confident that improvement towards this goal will continue to be seen during the year.
Turning now to Slide 12, net operating income for the fourth quarter of 2008 was $48.7 million or $0.26 per diluted share. This compares with a net operating income before valuation allowance for deferred taxes in the fourth quarter of 2007 of $27.2 million or $0.15 per diluted share.
The Q4 ’08 operating income excludes $88 million of net realized investment losses and $367.5 million of losses from discontinued operations. Including these items results in a net loss applicable to common stock per diluted share of $2.20 for the fourth quarter of 2008 as compared to a $0.38 loss per share in the fourth quarter of 2007.
As we have stated in past quarters, in today’s volatile markets maintaining the appropriate liquidity and capital levels is extremely important to our business as is deploying capital wisely. Our overall liquidity decreased during the fourth quarter with approximately $59 million of liquidity at the holding company as of December 31.
Year-end 2008 liquidity also reflects the Senior Health separation capital contribution of $50 million. Our year-end liquidity was somewhat lower than expected due to the timing of payments on fees for services provided under inter-company agreements.
Our liquidity as of the end of February, 2009 was in excess of $108 million. During the fourth quarter we completed some transactions to improve our liquidity and capital positions.
As we previously reported, in October, 2008 we borrowed $75 million of the funds available under our revolver for additional flexibility and to confirm its availability. We paid down $20 million of the revolver in December which also helps satisfy the required principal payments on this facility in 2009.
Slide 13 details the major 2007 and 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; shares repurchased; and contributions to the capital of our subsidiary.
We did not repurchase any shares in 2008. As we have said previously, our liquidity at the holding company is impacted primarily by the strength of our insurance subsidiaries.
Subsequent to the transfer of Senior Health and its long-term care business, our insurance companies currently are expecting to generate approximately $200 million of statutory operating profits annually excluding extraordinary items. This is in excess of their capital needs to support ongoing growth.
The statutory dividend capacity of the insurance subsidiaries is in the range of $50 to $125 million annually based on statutory net income of $200 million per year, reflecting again our core earnings power. In addition to dividends from the insurance companies, the holding company also generates cash from interest payments on surplus notes; fees for investment services; and fees for administrative services provided to the insurance companies.
Slide 14 is a waterfall chart presentation of the major sources and uses of liquidity during the fourth quarter of 2008. Again let me remind you that the liquidity stands at approximately $108 million as of the end of February, 2009.
In order to further demonstrate our liquidity on Page 15 we have outlined the 2009 year-end forecast for cash. We are projecting a cash balance in excess of $70 million which is after the $55 million repayment of our revolver in June.
Turning now to Slide 16, as we indicated earlier other than the potential for the auditor opinion qualification mentioned earlier, we do expect our final audited financial statements to show compliance as of December 31, 2008 with all covenants in our credit agreement. Our debt to total capital ratio calculated excluding accumulated other comprehensive loss was 27.9% at December 31, 2008 compared to 20.9% at year-end 2007.
The 7 percentage point increase is primarily a result of recording the $1 billion in charges related to the separation of Senior Health and its long-term care business. Risk based capital at our insurance companies ended the fourth quarter at 258%.
I will touch on this further in a moment. In our third quarter earnings call we indicated that in October 2008 we repurchased $37 million of face amount of convertible debentures for $16 million and recognized a gain of $21 million.
The approximately half a percentage point improvement in the debt to capital ratio from our buyback in the convertibles in the fourth quarter highlights the positive impact management actions can have in maintaining compliance with their debt covenants and building back margins. And then finally as Jim and I mentioned earlier, we completed several strategic moves to bolster our capital position which I will cover in more detail shortly.
As indicated earlier, our consolidated RBC ratio has declined somewhat since year-end 2007 but improved 1 point in the fourth quarter of ’08 from the third quarter of ’08. The year-end 2008 RBC ratio was impacted by several different factors.
Positively impacting the ratio during the quarter was the Senior Health separation; our operating earnings on a statutory basis; the impact of permitted practices related to the deferred tax assets; and capital management actions. Offsetting these positive improvements were an increase in required capital due to the mortgage experience adjustment factor; the investment markets environment that increased some of the components of required capital; as well as having it caused us to record certain impairments and bond downgrades.
Slide 18 is a waterfall chart showing the major positive and negative impacts to RBC during the fourth quarter of 2008. The mortgage experience adjustment factor increased to 300% with the final phased in increase of the maximum 350% to be recorded in the first quarter of 2009.
As mentioned earlier, subsequent to the third quarter we completed several transactions to improve our liquidity and capital positions. One of the most significant of these moves relates to reinsuring a portion of the Bankers LTC business.
As Jim mentioned we entered into a traditional co-insurance agreement with RGA whereby we reinsured 2008, 2009 and future new long-term care business. The amount of new LTC business reinsured is 70% for 2008 and 50% for 2009 going forward.
In addition to the Bankers LTC reinsurance, we also have agreed with Coventry to not continue our reinsurance participation in two group FFS cases which is not our core business. One group’s reinsurance ended at December 31 and the other one will terminate on June 30, 2009.
As the trailing 12 months premium on these groups runoff over the next 6 quarters, RBC will steadily benefit with almost 8 points of improvement expected in 2009. Finally, we received approval from two of our domiciliary states with regard to a permitted practice related to admissibility of deferred tax assets.
The effect was to increase statutory capital by almost $62 million as of December 31, 2008. Slide 20 is a brief summary of the statutory financial impact, both total adjusted capital or TAC and RBC for 2008 and 2009 of the capital management initiatives completed since the third quarter.
Although these aforementioned actions were very positive for us from a statutory capital and RBC standpoint, there is a cost. Slide 21 provides the GAAP impact expected in 2009.
Turning now to segment performance, for the quarter Bankers earnings were $40 million which was lower than both third quarter ’08 and fourth quarter ’07. The main drivers adversely affecting earnings were reserve strengthening actions taken at Coventry on our PFFS, PDP quota share business; lower margins in Medicare supplement, attributable mainly to higher incurred claim levels; higher FAS 133 and COLI volatility charges; and charges related to the LTC and other reinsurance transactions previously discussed.
Partially offsetting these items was continued stabilization of our insurance adjusted benefit ratio in long-term care. Sales for the quarter were $73 million, which was up 25% over the fourth quarter of ’07, driven by strong annuity sales.
Excluding PFFS, NAP or new annualized premium was up 18% versus the prior year. More details of the quarterly sales are on the next slide.
The fourth quarter was highlighted by very strong sales of annuities, up 84% over the prior year. We are continuing to see a shift in sales between equity indexed annuities and fixed annuities, as consumers look to the stability and security fixed annuities provide.
We also saw gains in Medicare supplement sales versus the prior year of 21%. Slightly offsetting these gains were decreases in life sales of 13% and LTC sales of 27%.
The decline in these sales was consistent with the overall industry decline. Lastly, here we see the impact of earnings items previously discussed producing an ROE on a trailing four quarters basis of 7.1%.
Turning to Slide 25, Colonial Penn’s sales during the fourth quarter of 2008 increased 16% from the fourth quarter of 2007, with substantially all of this increase attributable to sales from our core life insurance marketing campaign. Although down slightly from the preceding quarter, sales were in line with our expectations and reflected an expected degree of seasonality, as well as direct competition for advertising inventory from political campaigns during 2008.
Examining sales activity for the full year, Colonial Penn’s sales from its core life insurance campaign exceeded 2007 by 18%. This increase reflects our continued successful marketing investment in this segment.
This increase excludes approximately $4.1 million of PFFS sales arising from Colonial Penn’s test marketing of PFFS in late 2007 and early 2008. As previously disclosed these tests did not meet our expectations and have been discontinued.
Colonial Penn’s segment earnings for the fourth quarter 2008 were $6.7 million, reversing a $200 thousand loss from the same period last year. The improvement from fourth quarter of 2007 is largely the result of the favorable impact on comparative expenses from the discontinued PFFS test just discussed; the favorable impact of the 2007 recapture of a book of life insurance previously [ceded]; and the cumulative impact of the increased new business written in 2008.
Taken together, these factors drove full year-over-year earnings growth of 39% in this segment, producing a return on equity of 12.4%. Turning now to CIG or Conseco Insurance Group, CIG’s overall NAP sales as shown in Slide 27 were down slightly from Q4 ’07 but showed sales gains of 6% in specified disease, offset by decreases in Medicare supplement and annuities.
While CIG sales are slightly down for the year, there continues to be greater focus on more profitable business with the contribution to profit from the new business being produced now higher than it was a year ago. This slide also illustrates the significant changes in CIG’s sales [inaudible] compared to the fourth quarter of 2007.
Continuing a trend, sales rose by 6% for the quarter in specified disease, which is CIG’s highest margin product. The largest NAP sales decline was in annuities, which is CIG’s lowest margin product line that was further influenced by an unfavorable interest rate environment.
Although CIG Medicare supplement sales were flat year-over-year, Q4 ’08 sales increased from Q3 ’08 sales. Looking at CIG’s earnings, higher specified disease and Medicare supplement margins during the fourth quarter of 2008 compared to the third quarter were offset by an intra-sensitive life and locking adjustment of approximately $7 million.
Earnings were also negatively impacted by some of the non-Senior Health long-term care business which is now being reported in the CIG results. We continue to expect earnings to be positively impacted going forward as we seek to restore margins through changes in non-guaranteed elements for some of our older life insurance policies.
CIG has been profitable now for 5 consecutive quarters with consistent results for the last 3 quarters of 2008. Insurance policy income has turned the corner with an increase in the fourth quarter over the third quarter of 2008.
CIG’s annualized fourth quarter 2008 return on equity was 3.7%. And now I’ll turn it over to Eric Johnson, our Chief Investment Officer, who will discuss the CNO investment portfolio.
Eric.
Eric R. Johnson
Thank you Ed and good morning everyone. Net interest income for the fourth quarter was approximately $320 million.
This met our expectations and it was favorably influenced by wider credit spreads. However, we realized $88 million in losses during the fourth quarter.
That included $43 million from the sale of investments and $45 million in impairments. The realized loss included $22 million from the liquidation of several [inaudible] mortgage loans in delinquent status that we felt offered lower recoveries on the longer term due to declining property values.
Impairments included approximately $18 million from three REITs taken liquidity issue. Our net unrealized loss increased to $3 billion approximately at the end of the year, principally driven by larger credit spreads.
During the quarter, net unrealized losses peaked at nearly $4 billion during mid to late October and reduced during the tail end of the quarter as [spreads] improved and that’s continued to improve to some degree during the first quarter, although it’s certainly a bit volatile. Going on to Slide 31, that breaks down our investment assets by ratings.
Our low investment grade allocation remains satisfactory at approximately 8%. 8% includes VIEs and it’s directly if not directly comparable to past presentations by us of this ratio.
Obviously our big ratio is being affected by the credit cycle, particularly in [inaudible] and securitized profit. The next slide provides a general overview of rapid allocation.
Our allocation is relatively common to the insurance industry. We have a somewhat higher allocation to corporate and somewhat lower to commercial mortgages and alternative investments in general and in non-marketable securities.
Our goal generally is to emphasize realized yields and investment income across the cycle. And as the table suggests, there’s been continued significant pressure on spreads and ratings in financials and in mortgages.
Going on to the next slide, you’ll see a mark-to-market breakdown by asset class. During the fourth quarter, particularly in the securitized area many products become illiquid and substantially inactive and as many companies have reported it became difficult in some particular instances to rely upon traditional pricing methods or pricing services to produce accurate values.
While clearly it would generate substantial losses to liquidate our portfolio, it would be true of most companies at this time. The nature of our liabilities doesn’t put us in the position to be a forced seller so we’re able to harvest the fundamental performance of underlying [collateral].
Going on to the next page which breaks down our CMO exposure, that remains almost evenly split amongst agencies and private label securities. The next slide breaks down our non-agencies which are generally in the prime jumbo and all day space.
Going on to Slide 36, Slide 36 breaks down our exposure to all day securities which is approximately 1.3% of invested assets. These securities are substantially all structured super-senior and [enhanced] significant credit support.
In general, this collateral has experienced substantially higher then expected delinquencies across the market. While our portfolio is considered an average qualitative, our performance character takes it to [inaudible] significant delinquencies, though less than market averages.
Market prices in this area reflect the conditions I described earlier and certainly reflect substantial mark-to-market declines. In addition opposite rating agencies are hard at work on reevaluating this sector and changing the standards by which they rate securities and we logically expect that this will have an impact on the ratings of our holdings in this area.
However, we continue to expect to recover our carrying values and will continue to closely monitor our holdings in this area. Going on to Slide 37, it really just shows that we continue to work very hard to reduce our sub-prime exposure which is now approximately $81 million which is about 32 basis points.
During the fourth quarter sub-prime performance trend continued to be favorable but not withstanding those trends its affecting our $80 million so we continue to be satisfied with the underlying collateral and how its performing. Going on to Slide 39, it breaks down our CMBX, our portfolio by vintage.
That’s approximately 3.7% of invested assets. It’s a highly rated portfolio, about 85% in the double A and triple A categories.
Our underlying collateral has very low delinquencies and significant credit support; still higher rates of spread widening in this area and it’s generated significant or sizable underlying loss, especially in the lower triple B’s, lower rating categories. Certainly rises in delinquencies are observable in the market as a whole and they will affect the collateral in the portfolio.
However, we do expect that in the long run this portfolio will produce earnings and cash flow originally expected. Slide 39, looking at the vintage, shows you that our portfolio has significant seasoning; very little 2007 exposure.
Going on to the next slide just shows a little picture of the underlying collateral which is a large number of underlying loans that are very diversified by type and geography. The next couple of slides you’ve seen before and they are a little busy but they show you how diversified our [inaudible] corporates are and our high yield corporate.
And I’ll make one quick general comment which is that there have been some recent trends suggesting that the credit crisis may be falling somewhat in terms of assets and liquidity, but certainly the market is still tentative and uncertain and consumers and corporations will continue to be pressured and access to capital will be limited for both. This is not an environment in which impairments are going to immediately be reduced to levels in 2006 and 2005.
Notwithstanding that circumstance, I think you’re in an appropriate position to meet the needs of this company. And with that I’ll turn it back to Jim.
Claude James Prieur
Thanks Eric. Some of the key differences between Conseco and the rest of the industry are increasingly evident in this time of market and economic stress.
Conseco’s sales are continuing to grow and indeed are growing very strongly. Our products are simple and straightforward and they entail less risk than products designed for the higher net worth customers.
Our market is sufficiently different from most insurers that these trends will probably continue. In spite of having lower loan losses than average, we are very tight to our covenants.
During Q4 we made a number of moves which strengthened capital. Some of those had an immediate impact and others will have an impact in future quarters, like exiting the Coventry reinsurance and doing the Bankers LTC new business reinsurance.
Of course these moves do reduce current income. We are keenly aware of where our debt covenants are and future moves to improve our capital position, such as giving additional reinsurance, will have the same sort of negative effect on current income that the moves in the fourth quarter had.
So what had been a long-term goal of hitting an 11% operating ROE in 2009 is no longer achievable. That goal will be deferred as we manage through this turbulent economy.
Conseco has a strong franchise in the consumer, senior and middle market with more than 4 million policyholders. It sells straightforward products to an under-served market and a market segment that is growing faster than the overall market.
We don’t have a lot of stock market exposure which others in the industry have, nor do we have any likely run of the bank risks that some of our more highly rated competitors have. So we will continue to be working on sales growth; continuing to make the business more efficient; and continuing to work on projects to improve our capital position going forward.
And with that, now we’ll open it up for your questions. Operator.
Operator
(Operator Instructions) Your first question comes from Jukka Lipponen - Keefe, Bruyette & Woods.
Jukka Lipponen - Keefe, Bruyette & Woods
To whatever extent you can, can you give us additional color in terms of what are the auditor’s specific concerns that basically they’re worried that the investment losses going forward could overshadow your operating earnings and hence make you violate your covenants?
Claude James Prieur
Yes, sure. The issues are liquidity at the holding company and concerns about potential losses in the investment portfolio.
For liquidity, I think if you turn to Slide 15, you can see, you know, its liquidity at the holding company that they’re concerned about. The insurance companies of course have a lot of liquidity.
The concern is that some of the dividends and the surplus note interest that are shown on the chart are subject to regulatory approval. So they are somewhat reluctant to count them as certain in looking at the holding company liquidity over the next year.
Since we have – you can see this little footnote that we have $46 million of dividends and interest that have been applied for, once we receive approval I think that concern will be substantially diminished. With respect to investments, what we have to do is do some additional stress tests on investments and take a look at how bad could it be?
Take the Moody’s numbers for you know their worse case scenario and run it through and do some additional work. And that work had not been completed yet and so we’ll have ongoing discussions.
Jukka Lipponen - Keefe, Bruyette & Woods
And with respect to the whole co-liquidity there was the item, the inter-company loans and other, what exactly are those?
Edward J. Bonach
The inter-company loans is that we do have in both, Jukka, the insurance companies but also in the non-insurance companies we have cash balances and we do put these inter-company loans in place to have the liquidity available as necessary up at the ultimate holding company.
Jukka Lipponen - Keefe, Bruyette & Woods
And with respect to capital, the other reinsurance in capital actions that helped the RBC I guess about 11 points, can you give us a little more color? How much is internal versus external and what kind of reinsurance are we talking about?
Edward J. Bonach
Yes, the primary driver of that was a financial reinsurance transaction to reinsure a significant part of Bankers Medicare supplement business. So for GAAP it is a financing accounting treatment, but for statutory it provides considerable capital relief on RBC and as illustrated by our slide.
Jukka Lipponen - Keefe, Bruyette & Woods
And lastly, how much of the for the PDP and private fee for service was a prior period adverse development?
Edward J. Bonach
It was primarily the current periods. The claim levels had been increasing and they looked largely at the trends there and factored that into their reserves for their incurred but not reported reserves in particular going forward.
Operator
Your next question comes from Randy Binner - Friedman, Billings, Ramsey & Co.
Randy Binner - Friedman, Billings, Ramsey & Co.
I just want to clarify one thing so that I’m sure I’m totally clear on the realized loss stress test comment with the auditors, that would not include in the fourth quarter, correct? It would all be forward-looking?
Claude James Prieur
That’s correct.
Randy Binner - Friedman, Billings, Ramsey & Co.
And then on the reinsurance programs, let’s just dig into that a little bit more. With the Bankers deal at RGA is there a way to quantify how much capital that frees up now and going forward?
In millions.
Claude James Prieur
Yes. That is on – let me just explain it to you real quickly, Randy.
It is if you look at Page 20, we got almost $7 million of total adjusted capital released in ’08 and we’ll have about the same amount in ’09.
Randy Binner - Friedman, Billings, Ramsey & Co.
With [access] capital generation we talked about $50 to $100 million annually which is what I think we’ve talked about in the past, how much of that is subject to regulatory approval? With dividends coming out.
Claude James Prieur
Yes, virtually all of it is subject to regulatory approval and as you see on Slide 15 we’re anticipating $60 million of dividends from the insurance companies in the course of 2009 with $25 million pending approval currently.
Randy Binner - Friedman, Billings, Ramsey & Co.
With the mortgage adjustment factor, the rest of the impact coming in the first quarter of ’09 is there any way – can you quantify that RBC impact in percentages – percentage impact on the RBC?
Claude James Prieur
It’s about a couple of points on the RBC negative in Q1. Now one other thing though, since you mentioned that, this is also something in managing our capital position not just currently but going forward that is not reflected in any of the information that we talked about today, but to the extent that we do have mortgages that we exit and terminate in an acceptable way that has a tremendous risk based capital relief for us.
And when there are opportunities to do that it is our plan that we will do some reductions in the course of the year. But our liquidity analysis, our projected margins on risk based capital do not include any of that from what we shared with you.
Operator
Your next question comes from [Paul Saran] – FPK.
Paul Saran - FPK
I’ve got a couple of questions and the first is with $75 million in liquidity projected for year-end ’09, how do you intend to address the credible debt in 2010?
Claude James Prieur
I mean, this is something that we’ve been looking at going forward and it does depend on what the market conditions are like at that point in time. I mean, it’s [put able] at the end of September of 2010 and we’ll have plans to address it well before then.
Paul Saran – FPK
And just again, what was the dividend [inaudible] from the statutory companies?
Edward J. Bonach
Yes, between $50 and $125 million annually and currently in our 2009 plan we are expecting $60 million of dividends as on Page 15.
Paul Saran – FPK
Can you tell us how impairments under the statutory accounting compared to impairments under debt for the year? Were they the same or?
Edward J. Bonach
They were comparable. They’re not identical because there are some differences and certainly if securities on a statutory basis are impaired and it is largely due to a market value being less than book value from interest rate changes, you do get some offsetting relief through the IMR.
But on the flip side, GAAP had some offsets in most cases with impairments in that you reduce oftentimes the amortization of intangibles. So those two offsets are not always equal between debt and statutory.
But the numbers forced statutory in 2008 were just a few million higher than the GAAP numbers.
Paul Saran – FPK
That’s before or after the offsets for?
Edward J. Bonach
That’s after the offsets.
Paul Saran – FPK
Okay, before offsets for DAC and intangibles?
Edward J. Bonach
They’re virtually the same.
Paul Saran – FPK
And then, do you have any updates on discussions you’ve been having with the state regulators around the Universal Life policies? Anything –
Claude James Prieur
Not really. I mean I think we’ve revealed in the past where we are with that is and just to remind everyone else, we had made some changes to NGEs in some of our policies and we had some discussions with Florida and Iowa.
And those discussions – and Indiana, those discussions are ongoing and we’re working our way through it with the regulators.
Paul Saran – FPK
What’s the capacity on inter-company borrowings and how much do you currently have out [stended] if any?
Edward J. Bonach
Well, the capacity is a hard one to answer definitively from the standpoint that it is inter-company, so there’s not like any typical limits that you would say of a 30% debt to cap, etc. The outstanding inter-company borrowings are about a couple hundred million dollars as of the year-end ’08.
Paul Saran – FPK
Is any of it subject to regulatory approval?
Edward J. Bonach
Well, not what’s outstanding. The interest payments on the surplus note debentures are subject to regulatory approval and we do pay those quarterly and none of our payments have ever been disapproved.
Paul Saran – FPK
But the inter-company loans you could increase those without regulatory approval?
Edward J. Bonach
If they’re non-insurance companies, yes. And we did have one put into place here recently.
Operator
Your next question comes from the line of Kathleen Seaman – Wachovia.
Unidentified Investor
Yes, this is Kathleen’s client and I hold a substantial amount of Conseco. My question would be if you get a negative ruling from your accountants and how would that impact the business and would that make an ongoing business a real issue, number one.
And number two, how much quality assets do you have and can you go to TARP in case you do get – if you do get not a run on business but if you do get difficulty for liquidity?
Claude James Prieur
I think I’ll handle those in reverse order. A number of insurance companies have applied for TARP.
We haven’t applied for TARP. I don’t think any of them have received TARP and there’s a question whether they will ever receive money from the TARP program.
With respect to the auditors’ opinion, if we had a qualified opinion that would result in a default under the regular credit agreement and we’d have to get a waiver of that provision in the loan agreement. So that’s the short term answer to the question.
Unidentified Investor
What are the chances that you do get a negative?
Claude James Prieur
Well, we’re very confident that we’ll be able to resolve the issue and provide more information which is what they’re asking for. They’re really asking for more information at this point and that’s what we’re going to be working on over the next few weeks.
Unidentified Investor
Okay. And then you said none of the insurance company have been able to tap TARP?
Edward J. Bonach
We haven’t attempted to tap TARP.
Claude James Prieur
And I was just stopping the comment that insurance companies generally have not had access to TARP yet.
Unidentified Investor
Okay. And is there a chance that you do be able to access TARP in case you need it?
Claude James Prieur
I don’t think so. I mean, I don’t think insurance companies generally will get them.
I would think that the government program is really aimed at the largest financial institutions that present some systemic risks to the economy and therefore, you know, it’s been focused on the banking system and not the insurance industry.
Scott Galovic
And operator, we’d like to take one more caller and then we’re going to wrap it up here as we’re over our hour, so.
Operator
Your next question comes from Jukka Lipponen - Keefe, Bruyette & Woods.
Jukka Lipponen - Keefe, Bruyette & Woods
A couple of follow-ups. How would you view yourselves, your core earnings power in the quarter when you adjust for whatever items need to be adjusted for?
Edward J. Bonach
Overall, Jukka, within expectations other than Bankers and the PFFS, PDP in particular, so we’d adjust them to closer to $50 million which we believe $60 million as we’ve talked before is more the quarter that we would expect. So we would say Bankers underperformed by about $10 million.
Colonial Penn and CIGs’ numbers for the whole segment for each of the segments came in line with expectations. There certainly were some pluses and minuses with CIG, but adjusting those somewhere around $30 million is what we would have expected.
Jukka Lipponen - Keefe, Bruyette & Woods
And did you allocate corporate expenses into the – into Bankers, CIG and Colonial Penn?
Edward J. Bonach
We always do that but actually the corporate segment I’ll say small lots or improvement in the fourth quarter was reducing our accruals for incentive payments because in line with our results we are not having incentive accruals at the levels that were expected had we performed more in line with expectations in the fourth quarter.
Jukka Lipponen - Keefe, Bruyette & Woods
Why were the operating expenses up sequentially at Bankers and CIG?
Edward J. Bonach
From the standpoint of the operating expenses they did have more activity in the fourth quarter in both of those segments, so that’s largely what drove it.
Jukka Lipponen - Keefe, Bruyette & Woods
And what were your statutory operating earnings and net income in the fourth quarter?
Edward J. Bonach
We’ll have to get back to you. I don’t have those right in front of me right now, Jukka, sorry.
Jukka Lipponen - Keefe, Bruyette & Woods
And then last question fixed annuities, how much of statutory’s strain is in your product on new sales?
Edward J. Bonach
On the traditional fixed it’s somewhere in the 5 to 10% of premium range at issue.
Jukka Lipponen - Keefe, Bruyette & Woods
So with the current sales trends you believe that you have sufficient capital to be able to continue to support those sales levels?
Edward J. Bonach
Yes, you know, again it’s the mix in total with long-term care sales being down, their strain is considerably higher at issue than the annuities so that mix that we had in the fourth quarter is fine to sustain.
Claude James Prieur
Spreads are also wider in the annuity business today than they were a year ago.
Claude James Prieur
Well, thank you very much. Thank you operator and thanks to everyone on the call for your interest in Conseco.
We continue to be focused on the senior middle market in America, the fastest growing market segment in the business. We’ve a unique sales machine dedicated to this market whether it’s through agents or directly through brokers.
Thank you very much.
Operator
This concludes today’s conference call. You may now disconnect.