Jul 29, 2013
Executives
Edward J. Bonach – Chief Executive Officer Frederick J.
Crawford – Chief Financial Officer & Executive Vice President Scott R. Perry – President, Bankers Life and Casualty Eric Johnson – Chief Investment Officer Erik Helding – Senior Vice President, Investor Relations
Analysts
Chris Giovanni – Goldman Sachs Humphrey Lee – UBS Randy Binner – FBR Capital Markets Mark Finkelstein – Evercore Partners Sean Dargan – Macquarie Ryan Krueger – Dowling & Partners
Operator
Good afternoon. My name is Karen and I will be your conference operator today.
At this time, I would like to welcome everyone to the Second Quarter 2013 Earnings Results 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) Mr.
Erik Helding, Senior Vice President, Investor Relations, you may begin your conference.
Erik Helding
Thank you. Good afternoon and thank you for joining us on CNO Financial Group’s second quarter 2013 earnings conference call.
Today’s presentation will include remarks from Ed Bonach, Chief Executive Officer; Scott Perry, Chief Business Officer and President of Bankers Life; and Fred Crawford, Chief Financial Officer. Following the presentation, we will also have several other business leaders, including Eric Johnson, our Chief Investment Officer available for the question-and-answer period.
During this conference call, we will be referring to information contained in yesterday’s press release. You can obtain the release by visiting the media section of our website at www.cnoinc.com.
This afternoon’s presentation is also available in the Investor section of our website and was filed in a Form 8-K earlier today. We expect to file our second quarter 2013 Form 10-Q and post it on our website by August 2.
Let me remind you that any forward-looking statements we make 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. Today’s presentation contains a number of non-GAAP measures, which should not be considered as substitutes for the most directly comparable GAAP measures.
You’ll find a reconciliation of the non-GAAP measures to the corresponding GAAP measures in the appendix. Throughout this presentation, we will be making performance comparisons and unless otherwise specified, any comparisons made will be referring to changes between second quarter 2012 and second quarter 2013.
And with that, I’ll turn the call over to Ed.
Edward Bonach
Thanks Erik and good afternoon everyone. The positive momentum in trajectory of our business continues.
Our operating performance was again solid as our businesses continued to perform well. Consolidated sales for the quarter increased 5% and collected premiums from our core segments were up 4%.
This momentum in sales and premiums drove an increase in operating earnings of nearly 18% excluding significant items for the quarter. We expect to build on this momentum as we invest in our businesses by increasing distribution, expanding our geographic reach and launching new products.
Our solid performance and strong fundamentals continued to drive shareholder value, evidenced by our year-to-date securities we purchased of $184 million and the year-to-date rise in our stock price of over 50%. We also increased our common stock dividend in the quarter by 50%.
In addition to returning value to shareholders, we also successfully re-priced our senior credit facility, lowering the interest rate and gaining additional financial flexibility. The ratings agencies continue to recognize these positive developments as well.
After receiving an upgrade from S&P in May, they announced the second upgrade of CNO just last week as a result of applying their new ratings criteria to the industry. On slide six, you can see the meaningful growth in earnings on a per share basis resulting from both strong earnings and effective capital deployment.
After taking into account significant items for the quarter, operating earnings per share were $0.27, up 42% over the prior year. Continued growth from the business, stable normalized earnings drivers and deployment of capital are effectively paving the way towards a 9% run rate ROE by the end of 2015.
In addition to deploying excess capital into securities repurchases, debt reduction and dividends, we are also continuing to invest in our businesses. We're investing in strategies that fuel our unique and valuable distribution at Bankers, develop opportunities in the voluntary worksite market at Washington National and advanced direct marketing distribution at Colonial Penn.
These investments are paying off. Consolidated sales increased, as I mentioned before, 5% and collected premiums from our core segments increased by 4%.
We are profitably growing the enterprise, outpacing the industry on several fronts. Our market focused business models, aligned with largely exclusive distribution to reach our market, coupled with products and service to meet our customers need, provides sustainable competitive advantage.
Let me now turn it over to Scott to discuss our core segment results in more detail. Scott?
Scott Perry
Thanks Ed. At Bankers, sales and distribution results were positive compared to the prior year.
Our agent force grew by 4% largely due to retention and strong recruiting efforts. We’ve also had continued success opening new locations.
We've have added nine year-to-date through June. Total sales were up 6%, primarily due to a 16% increase in sales of life insurance products.
After several quarters of weaker annuity sales, we saw conditions stabilize with annuity sales up 7%. In our health line, sales were down 1%, mainly due to continued strict pricing and underwriting discipline in long term care and lower policy premiums in Med Supp.
We also experienced a slight shift in the sale of Med Supp policies to the sale of MA policies during the quarter. We were able to meet fluctuating consumer preferences and serve the needs of new and existing customers by selling Medicare Advantage policies for other providers in exchange from marketing fees.
As you can see in the table, this approach provided $2.2 million of fee income, a 37% increase from last year. Lastly, sales of our new critical illness product continue to exceed expectations and be well received by our agents.
It is now essentially fully rolled out nationwide and we expect steady improvement as marketing efforts progress. Turning to Washington National, second quarter sales of core supplemental health and life products were up 5% over prior year.
Core product sales in our independent partners channel were up 21% for the quarter, with voluntary worksite sales up by more than 31%. Sales of supplemental health and life insurance in our PMA channel were up 1% for the quarter, with a 9% increase in individual consumer sales, offset by lower voluntary worksite sales.
We are in the process of making field leadership changes in PMA’s worksite marketing division to improve sales results. PMA new recruit activity has been strong, contributing to a 5% increase in producing agents for the quarter.
Supplemental health collected premiums for the quarter were up 6%, driven by strong sales and persistency. Moving on to Colonial Penn, sales were up 1%, below our ongoing expected rate of growth for this segment, but in line with the planned moderate advertising investment for the quarter and reflecting seasonal patterns.
We are very pleased with Colonial Penn’s collected premium growth of 7% which shows steady and consistent growth in our in force business. During this quarter, Colonial Penn made progress on several important initiatives.
We recently implemented significant organizational changes to reduce cost and increase efficiencies. And in late June, we introduced a New Simplified Issue Whole Life Product with face amounts up to $50,000.
Finally, we launched a new Spanish website to help support our efforts pursuing the fast growing Hispanic market. All these initiatives are focused on expanding Colonial Penn’s market and product reach and support our accelerated growth goals for this segment.
Our strategy is focused on the rapidly growing pre and post-retiree middle markets that are being fueled by the aging of the boomer generation. This market needs the simple, straightforward products that we offer to address the things they are most concerned with, healthcare expenses, outliving their retirement, and providing a legacy for their families.
Our segments are well-positioned to meet these important needs, whether through career agents, independent agents, after worksite or direct. The investments we are making are beginning to produce moderate growth levels, but more importantly, they are strengthening the business foundation that will support higher growth rates and build sustainable long-term enterprise value.
In all three segments, the initiatives we identify to accelerate organic growth are on track. Bankers will continue to increase the number of locations enabled by the manager trainee program, which will help continue to grow our agent force.
We expect to add 25 new locations in 2013, which will bring us to 300 locations by year-end, compared to 2050 locations at the beginning of 2012. Also, we are driving initiatives in 2013 to increase cross selling activity and build on our success in life insurance, with a focus on increasing premium per policy.
And our Top Gun Developing Agent Program is helping drive improved retention results. Lastly, we expect the positive momentum we are building to continue as the new locations we opened in the last two years ramp up to full productivity.
At Washington National, we expect a strong second half of the year as PMA field leadership changes take hold and we invest in additional recruiting, including new programs targeted to attract military veterans and experienced supplemental health insurance agents. Sales will also benefit from expanded product availability, including roll out of our next generation critical illness product ActiveCare.
ActiveCare sales in the initial states have exceeded expectations, with strong agent interest and higher average premium per policy. We also anticipate continued voluntary worksite growth as we focus resources on this important market opportunity.
This includes introduction of a new Washington National case management function, providing agents advanced support in acquiring small and mid-sized group accounts and cross selling life insurance in existing relationships. We anticipate making additional investments in our infrastructure and distribution capability to support supplemental health sales at the worksite, building upon current sales momentum and a growing opportunity under healthcare reform.
At Colonial Penn, we will continue to invest in new lead generation activities. During the second half of '13, we’re planning increased advertising investments using our disciplined approach on media buying.
We project this increased investment will translate in accelerated sales growth for the remainder of this year. In addition, we expect to capitalize on further improvements in sales productivity via further deployment of our new CRM system across our telesales units.
Also benefiting our second half of 2013 will be an incremental sales from our new simplified issue of whole life product and Hispanic market targeted efforts. Looking forward, we expect all of these initiatives contribute to long-term sales growth rates of 8% to 10% over time.
And with that, I’ll hand over to Fred who will discuss CNO's financial and investment results. Fred?
Frederick Crawford
Thanks Scott. CNO recorded another strong quarter on the earnings and capital front.
Our earnings continued to benefit from core in-force growth, relative strength in investment income and spreads with benefit ratios performing as expected when normalizing for significant items called out in our press release. If you adjust for the significant items in the quarter, we posted $0.27 per share, a considerable per share increase over prior years’ results.
Normalized EBIT improved a little over 7%, spread across the diluted share count down 21% as compared to the previous year's quarter. As impressive, core capital ratios continued to strengthen and our holding company liquidity position remains strong, while returning capital back to our shareholders.
We noted two meaningful subsequent developments in our press release, the additional upgrade from S&P and a positive tax development that I'll touch on in a moment. Turning to segment earnings, Bankers EBIT benefited from a $6 million reserve redundancy in Medicare supplement line, partially offset by a $3 million adjustment to long-term care reserves.
Bankers’ normalized results continue to build, driven by growth in the underlying business and strong annuity margins, the result of solid investment income, favorable option pricing and proactive management of in-force crediting rates. Washington National posted another solid quarter supported by strong collected premium growth, in part driven by our investment in distribution.
There was a small run up block of Medicare supplement business in Washington National, which also benefited from a modest reserve redundancy of $1.5 million. Washington supplemental health benefit ratios will fluctuate each quarter, but we expect over time to see solid earnings trend lines as we invest in this business segment and take advantage of emerging opportunities in the voluntary work site markets.
Colonial Penn’s results came in as expected and generated a small profit. Earnings improved over last year, in line with in-force growth rates.
OCB’s results are in line with our guidance for the year of $5 million to $20 million in EBIT. Corporate earnings benefited from a modest adjustment to the discount rate applied primarily to our agent deferred compensation liability.
This positive contribution to earnings somewhat reverses the loss taken last year as rates were falling. Drilling deeper into our underwriting margins, collected premium continues grow in both our Bankers Medicare Supplement and Washington National Supplemental health lines.
Long-term care premium reducing as sales slow, rating actions moderate and our mix shifts towards a lower risk and lower premium per policy offering. As noted earlier, Bankers Medicare Supplement benefit ratios were helped by favorable loss experienced in the quarter and redundancies in our prior period loss reserves.
When normalizing for the redundancy in the period, benefit ratios were consistent with our expectations at 71%. Bankers LTC benefit ratio included a small negative adjustment related to a refinement in our methodology of estimating reserves as it relates to voluntary lapses.
Our normalized interest adjusted benefit ratio was roughly 78%, a bit elevated but not outside our expected range. Washington National’s supplemental health benefit ratios were 53%, slightly higher than we have experienced in recent quarters, but again not outside our expectations.
Turning to investment results, we put new money to work at higher rates than our full year expectation of 4.75%. The recovery in rates and spreads has allowed us to dial-in acceptable yields without moving out on the risk curve.
After a string of quarters where prepayment and make-whole income benefited our results, this quarter was less impacted and likely a result of rate volatility in the quarter. Invested assets are up nicely year-over-year, driven by steady aggregate growth in our in-force business and tactically layering in FHLB spread product and new CLO structures.
We are measured in our approach to these strategies and view both as leveraging our strong investment teams at 4086 to help support investment income. Realized gains once again outpaced losses in impairments.
This resulted in a small release of our capital loss evaluation allowance. We have reduced portfolio turnover rates in order to fund yields, and as a result overall gain loss activity has slowed.
Credit performance continues to be strong, with negligible impairments in the quarter and no significant areas of concern. We ended the quarter with RBC ratio of 376%, increasing a full 10 percentage points during the quarter.
Leverage settled in at 18.9% and we expect this ratio to continue downward as we amortize debt and retain earnings. Note that we also expect our remaining $29 million of convertible debentures to convert into equity later this week, further reducing leverage.
We ended the quarter with $230 million of liquidity and investments at the holding company and would size our deployable capital at $80 million. We are dedicated to securing investment grade ratings over time.
We do not depend on these ratings to drive the business model, but over the long run, we see investment grade as important in efficiently managing a $3 billion financial service company. We believe we have as much value creation in lowering our risk profile and securing broader investment appeal as we do in purely building ROE.
So we have been on a steady march of delivering ROE improvement on a high quality capital base and have the cash flow to support our strategy. Turning then to cash flow, statutory earnings were strong at approximately $102 million and followed along with our solid GAAP results.
Capital generation in the first six months of the year totaled $263 million. We define capital generation as statutory earnings prior to surplus note interest and contractual payments made to the holding company.
We have been operating at or above a run rate of $500 million annually, generating considerable excess capital on a surplus base of a little over $1.8 billion. This slide provides a snapshot of sources and uses of excess capital and free cash flow year-to-date.
Together with drawing down holding company liquidity, we have deployed $280 million of capital. Securities repurchased have outsized, having tendered for our convertible securities in the first quarter.
With the recent refinancing of our senior secured debt, we amended our sweep provision. And as long as our leverage remains below 20%, we are not required to make sweep payments on our debt in concert with stock repurchase and common stock dividends.
From an ROE development standpoint, we continue to make progress towards our 2015 run rate goal of 9%. We calculate our reported ROE on a trailing four-quarter basis adjusted for AOCI and the carrying value of our tax assets.
As a result, litigation reserves and long-term interest rate assumption changes taken in the third quarter of 2012 served to drag down our reported ROE. Normalizing for significant items, our standalone second quarter is a fair representation of our current ROE power of the company.
If you simply annualize earnings in the quarter, our ROE came in at 8% and illustrates our run rate ROE. The second quarter is not particularly impacted by seasonality and our results were on balance in line with our internal expectations.
We think this helps with understanding the path from a reported ROE of 6.8% to a run rate target of 9% by 2015. If you follow our tax disclosures, you'll recall, that we have been working on two significant disputed items with the IRS, both of which we have full valuation allowances against.
Subsequent to the quarter end, we settled on one of these items with the IRS. In this case, their treatment of cancellation of indebtedness gains taken several years ago.
The settlement resulted in classifying some of these gains as non-life, therefore increasing our life NOLs where we can comfortably utilize the assets. The settlement is not insignificant, creating roughly $60 million of economic benefit is discounting the cash flows at 10%.
We'll be reducing our valuation allowance in the third quarter by approximately $70 million to reflect the final settlement. Note that this is separate and apart from our annual third quarter review of the valuation allowance as it pertains to earnings outlook and the likelihood of utilizing tax assets as we grow the company.
Turning to our outlook. As we move through the year, we gain more of a window into the core earnings drivers of the company and can provide greater clarity.
We expect our core benefit ratios to perform in line with our normalized results in the quarter and net investment income and spreads should continue their strong performance. The first two quarters have tracked well to our full year EBIT guidance for Colonial Penn and our OCB segment.
In terms of Colonial Penn, the third quarter tends to have heavier ad spend. So we would anticipate a modest EBIT loss of roughly $3 million to $5 million and moderating in the fourth quarter.
We see no material developments on the capital front, more a continuation of the trends you're seeing with RBC in the 375% range and steady reduction in leverage. We are maintaining our repurchase guidance for the year and expect to return to the markets in the third quarter.
We have developed a compelling per share story, having repurchased effectively 85 million shares since the beginning of 2011, deploying over $0.75 billion in capital at an average cost of $9 a share. We take a tactical approach to deploying our excess capital in a way that we believe secures attractive IRRs for our shareholders.
We will continue with that approach as we consider alternatives for excess capital and drive towards our long term ROE goals. And with that, I'll hand back to Ed for closing comments.
Edward Bonach
Thanks Fred. Our results for the first half of the year are solidly on track to deliver on our 2013 priority.
Organic growth initiatives we are executing on are leading to increased sales, premium income, distribution size and reach. We’ve also been successful and marketing our new products, as we strive to continue to meet the needs of our fast growing underserved middle income target market.
In support of driving toward efficiencies as we grow our businesses, we have successfully completed organizational changes, allowing us to leverage expertise even more broadly across the enterprise and have added talent in several key leadership positions including long-term care operations and IT. Continued growth in the businesses, strong earnings and deployment of capital are effectively paving the way toward a 9% run rate ROE by the end of 2015.
While we expect to reach our 9% ROE target organically, we continue to make improvements in our runoff segment OCB as volatility has managed down and cash flow is stabilized. In addition, we've made progress towards closure on outstanding litigation.
And as we have said before, these steps are important and that they provide us with more options going forward. With regards to the rating agencies, as noted earlier, we recently received a second upgrade within three months from S&P as they applied their new rating criteria to the industry.
We do not believe that we're done making progress with our ratings. Strong business fundamental, financial performance and credit metrics should lead the further ratings upgrade.
In short, we've made significant progress on our 2013 initiatives and are well on our way to meeting our 2015 milestone. We expect our strong business fundamental, coupled with solid earnings, cash flow generation and capital deployment to continue to power shareholder value.
And now, we'll open it up for your questions. Operator?
Operator
(Operator Instructions). And your first question comes from the line of Chris Giovanni with Goldman Sachs
Chris Giovanni – Goldman Sachs
I guess first question in terms of the updated outlook for '13, pointing to I guess normalized health benefit ratios. I think back in December you pointed to in Bankers 75% interest adjusted benefit ratio for LTC versus maybe the 79% that you'd been running at in the first half of this year.
So I guess is 79% what you’re pointing us to here in the back half or will we see some normalization back towards the 75?
Frederick Crawford
Yes. Hey Chris, it's Fred.
Yeah, in both the first quarter and second quarter of this year, we saw slightly elevated benefit ratios, interest adjusted benefit ratios in the 77% to 78% range, and we would expect that level to continue for the remainder of the year. In other words, we don't see anything necessarily abnormal in those results or giving us reason that those results would back off down to the 75% range.
It's a combination of the slowing down if you will of re-rating actions across the board and to some degree the low rate environment, et cetera. What I would say though, however is that we continue to manage it proactively every single day.
As you know and have been watching our press releases, we recently brought in some new leadership with significant long-term care background, Loretta Jacobs. She and her team continue to proactively look for ways in which to defend the margins in that business.
And so we'll continue to work that hard. But clearly the re-rating environment, the regulatory landscape in particular as it relates to re-rating has meant that it's more tactical in our approach to looking at where we can get rate increases.
So we prefer you to hold to this normalized loss ratio as we continue through the rest of the year.
Chris Giovanni – Goldman Sachs
And I guess on OCB, obviously doing a lot internally to get things in shape there. Can you give us some updated comments around litigation?
And then with New York looking at some of these financial buyers, has that changed at all the discussions that you’re having with potential people that may be sniffing around the OCB business?
Edward Bonach
I think in terms of litigation update, there is really two major class action litigation cases that we've been working on now for a few years and they're disclosed in our financials. The first is VLVT.
We sometimes refer to it as the U. Nicholas cases.
We received final judgment on July 8th on that case, that settlement process and there is an appeals period that goes out another month to August 8th at which time there is complete closure on that class action. The second and smaller of the class actions is on a separate blocks of business related to -- called Lifetrend.
That is at a point where the stipulation of agreement has been preliminarily approved in the courts here just this past July 12th and it now proceeds into the process of substantially similar process that we went through on the VLVT litigation. And if you recall, when we started to first announce the stipulation of agreement and taking charges on the VLVT, it was in the range of four months or so, 90 days to four months to bring that to closure.
These cases run a similar path although every case is different.
Edward Bonach
Chris, this is Ed. On the potential players in the acquisition marketplace, we've seen no significant or notable difference in activity.
And from the standpoint of OCB, there is a lot of traditional reinsurers and buyers there that could be interested given that our mix of business in OCB does have traditional life insurance, interest-sensitive life annuities and a small amount of one half long-term care. So there is a variety of business in that segment.
Chris Giovanni – Goldman Sachs
And then just one last quick one just one I guess capital returns. I mean obviously reiterating the securities purchases in the back half of the year.
Fred, you mentioned the run up in the share price. So just wanted to get your thoughts on if that changes at all, how you’re thinking about the mix of capital deployment maybe as we look out beyond just 2013.
Frederick Crawford
Chris, it's Fred. We don't give more specific guidance beyond 2013.
As we get near the end of this year, we’ll take a look at 2014 and make a judgment call on the type of guidance we give for deployment. But there is really two things you can bank on when it comes to our deployment strategy.
One is that we're going to be very tactical about it. And you've seen evidence of that in the various forms in which we brought diluted shares in and how we've approached that.
But that we're also going to be very balanced. We create this pie chart of deployment for a reason because we would expect it to be multi-colored in the sense that we're going to continue to buy back stock if we believe we can drive further valuation improvements in the company.
And certainly we believe over the long run we can do that. We also continue to trade at a modest discount to book value which suggest to us anyway that there is improvement that can take place if we continue to execute.
We've launched the dividend, increased that dividend in this past quarter by 50%. And as you know, we've talked about a 20% payout ratio over time and we want to make sure we can achieve that, but also lower the risk profile of the growth rate to a common stock dividend and that requires being careful about having ample excess liquidity and capital on hand at all times.
We want to go after investment grade as you know and that takes a while. But I would say this, that the continued reduction of debt, which is another use of our capital and modest building capital, we think aside from ratings improvement, it lowers the beta of the company and I -- we've had this conversation with our investors and with the analysts that we think there is as much upside in reducing the risk profile of our company as there is in driving ROE improvements, which is why I made those comments in my script.
And then obviously we want to grow the business. And so we're going to be retaining capital in order to grow the business.
So I run you through that laundry list because that's essentially the pie chart of deployable capital and I would expect we continue on that march. And we'll give further clarity or further guidance as we get near the yearend and head into 2014.
Operator
Your next question comes from the line of Randy Binner with FBR. It looks like Mr.
Binner recanted his question. Your next question comes from the line of Humphrey Lee with UBS.
Humphrey Lee – UBS
Just a question on the long-term care reserve refinement for this quarter. You mentioned it’s related to the voluntary lapse of assumption useful for the block.
Can you give a little more detail in terms of how much changes you applied to the last assumption change? And then just as a clarification, this has nothing to do with -- nothing related to the old healthcare adjustments from last quarter, correct?
Frederick Crawford
Yes. It has nothing to do with the adjustment last quarter.
This is really just a refinement of an estimate. And it just has to do with the dialing in of your estimated voluntary lapsation that comes from policyholders no longer making payments and how long of a grace period they have from policy-to-policy and how you dial that in.
It's very important to step back and realize we're talking about $4 billion worth of long-term care reserves where we made a $3 million adjustment. So I would be very cautious about playing too much up about a change in refinement related to lapses.
This was by any measure a tweak. But it's a refinement we're able to do in part because of the many improvements we've been making across our system and tracking various dynamics with the block.
Humphrey Lee – UBS
In terms of Bankers' annuities, so the first deposits for the fixed investment annuities were quite strong. How much would your stability increase in a quarter to expand the distribution in agent force versus the overall [secular] trend of greater adoption by consumers?
And going forward, how should we think about the growth for that line of business with Bankers?
Scott Perry
Humphrey, this is Scott. I'd say that the second quarter for Bankers really didn't benefit from the slight increase in crediting rates, and that really happened at the tail-end of the second quarter.
I would say that most of the improvement was -- we benefited from a relatively weak comparison period in the second quarter of last year when crediting rates really came in. The other thing is we have seen though consistent with the industry, we’ve seen a pretty dramatic shift to fixed index products and away from the straight fixed annuities.
So that's pretty consistent with the industry. I think the growth that we saw comes from just the normal organic increase of our agency force and the slight improvements we’ve seen in productivity.
Humphrey Lee – UBS
So such as there could be even a little bit more like to the growth for the coming quarters. And about the shift from medical supplemental to Medicare Advantage, should I consider the favorable research and development has anything to do with it or is it a separate issue?
And if it’s a separate issue, then what is the -- are you seeing in terms of your outcome, the clean experience on Med Supp?
Edward Bonach
No, it's not really related to reserve requirement dynamics related to Med Supp. It's really a series of other dynamics.
First of all realize from quarter-to-quarter we will see subtle shifts in the mix of Med Supp and Med Advantage. And we want our Bankers Agency force to be somewhat agnostic to it, focus more on solutions for the middle market because again what we try to drive out of this is not just product sales, but also growing the number of households we serve so that we can cross sell other products.
So we'll let that shift take place. I think what's causing a little bit of the down graft in Med Supp relative to Med Advantage is a few things.
One is, I think relative pricing actions that have taken place, re-rating actions that have taken place between the two. But also we installed this past year or earlier in the year prescription drug screening which has become more popular installed among most of the Med Supp players here in recent periods.
And our agency force is going through a little bit of shift as they adapt to that new requirement when taking applications and going through the underwriting process. So a little too early to tell whether that will correct correctly itself out, but we’re pleased that what we may be seeing in the way of a reduction in Med Supp, we're seeing a pickup in Med Advantage.
And don't lose sight of the fact that while it doesn't carry the of raw dollars’ worth of margin, it’s a very attractive distribution fee for us, not only because we’ve been seen an increase in the sales of Med Advantage, but also those fees are non-life in nature. And so it’s a good high quality source of earnings for us.
Scott Perry
Hey Humphrey, also just to build on your reference to the Med Supp redundancy, although not directly related. The fact that we offer both product lines means that it puts less pressure on our Med Supp pricing and we're under probably what I would say less competitive pressure.
And that certainly allows us to be stricter and more disciplined in our pricing and underwriting.
Operator
And your next question comes from the line of Randy Binner with FBR.
Randy Binner – FBR Capital Markets
Okay. I’m on.
Can you guys hear me?
Edward Bonach
Yeah. We were concerned for your health when you withdrew questions.
Randy Binner – FBR Capital Markets
I would not wish to recant anything. So I'll move forward quickly here with a question, first on sales.
I couldn't catch in all that back and forth there and Scott, I guess this question is for you, but I’m really focused on the sales growth and I think you affirmed an 8% to 10% goal over time. So if fees get higher on MA, is there any math that you can help us with to figure out what sales we would have gotten otherwise if you had not written more policies in MA?
Or is that even material relative to the 5% sales growth you saw in the quarter?
Scott Perry
Well, I think it’s -- if you think about in terms of policy count, the policy count represented about over 1000 policy increase in the quarter over the last year what we did in Med Advantage. So hard to translate it into the 5% number because we don't reflect it as now, but that's one way of looking at it.
Randy Binner – FBR Capital Markets
What did they run for policy, maybe? Like what is that average MA policy run premium wise?
Edward Bonach
Randy, why don’t you think of it this way? That 1000 policy increase year-over-year in MA is about the same policy change on a decrease in Med Supp sales.
So number of sales were about the same if you look at it on a policy basis year-over-year in the Medicare space.
Scott Perry
Yes. And it's hard to translate the premium because it's apples-to-oranges.
Edward Bonach
And that's why consumers make that choice
Randy Binner – FBR Capital Markets
Understood. I just thought I’d give it a shot.
And then on the 8% to 10% over time, I appreciate that, but is that timeframe including 2014? Is that still on track for 2014, 8% to 10%?
Edward Bonach
Y
So and the other thing that you have going on at the same time is you have other products falling a little bit out of favor. For instance long-term care in the quarter was down 16%.
And so that 5% growth was achieved in spite of that at Bankers. I think that's not an -- long-term care being down is not a particular concern for us.
So all of these things going on, assuming a stable environment, we believe the 8% to 10% is attainable once these initiatives fully ramp up. And I'd say it’s reasonable that we expect and you should expect steady progress towards achieving the goal in a two-year time period.
So thinking '14, rolling into '15.
Randy Binner – FBR Capital Markets
And then one follow-up to the capital conversation and that is that in the slide deck you use a 10% discount rate for the call back you got the valuation allowance for the DTA. Is that really -- I guess the weighted average cost capital has been lowered, Fred, as you said.
Is that what we should think of as the right discount rate for CNO and the right cost of capital in the current environment?
Frederick Crawford
Yeah. It really wasn't dialed in necessarily with that thought.
It was just meant to be a reasonable long-term proxy for cost of capital. Arguably the risk profile of realizing these cash flows is very low, particularly because the benefit is coming on the life side and there has never been a question about our ability to generate enough life earnings to utilize the asset.
It's also a relatively near-term cash flow experience, meaning it's really only discounting out a few years. We would start to realize this benefit three years out or so.
So you could argue in other words from a risk profile perspective that it should carry a lower discount rate. So we just chose something that we thought was reasonable and we'll let you as analysts dial in what you would prefer.
Our cost of capital actually runs a little higher than this level, frankly in part because we don't have the highest, but we're among the higher beta players in the industry. That goes to my comments that when we talk about fortifying the balance sheet and stabilizing the financial strength of the company and creating an environment where our financials are not vulnerable, all of that to me is a beta lowering dynamic.
And we think again we have as much energy in driving shareholder value in that as we do anywhere else. So you weren't asking about that, but I’d say today our cost of capital is actually a bit higher than 10%.
Operator
Your next question comes from the line of Mark Finkelstein with Evercore.
Mark Finkelstein – Evercore Partners
I’ve got a few things. One is, Fred, you mentioned that this represents one of the two tax contingencies that have been settled.
What's the status and the valuation allowance up on the other one in terms of when would you expect it to be settled?
Frederick Crawford
So the other item, again to refresh everybody's memory, it relates to the spin-off of the senior health division, the old long term care blocks where we took a loss on that transaction of about $742 million. For GAAP that loss was treated as a capital loss and we put a valuation allowance up against it, realizing that it would be hard to prove out if you will in a more likely than not basis that we could generate in gains in such a way to actually take care of that size of a capital loss.
The actual valuation allowance tied up in that decision is about $140 million. That's if there was a complete reversal of the issue.
Now on our tax returns we have treated it as an ordinary income item because we believe it to be more business related, but the IRS disagrees. There is no real update in terms of where we are in the process other than we continue to work actively to put forth our best case.
Again, there is disagreement at the IRS. And from the GAAP rules of engagement as you know Mark, the more likely they’re not ruling as we sit here today.
We're keeping the valuation allowance up. So no read beyond that.
Mark Finkelstein – Evercore Partners
Just on the capital deployment for '13, obviously you have markets that are, rates a little bit higher. I guess what are the factors we should be thinking about in terms of whether you’re going to be at the higher or the lower end of the range.
Frederick Crawford
I think it definitely is -- where we see capital conditions going from a threat perspective. And so, while rates have lowered, the recent rise in interest rates and some modest spread benefits have helped to reduce the risk profile of rates as a threat.
I don't think anybody in the industry is ready to declare victory on the rate front. There is still a long way to go.
And so we need to be cautious about that. I think we feel very good about the credit markets and we feel very good about how the general account is positioned.
But at the same time we've all learned over the years that we need to hold a little bit of capital for the inevitable credit cycle returning. And that's little bit implied in what we're doing capital wise.
So I don't see immediate capital threats, but we need to sort of watch that as we go through. I think the pace of retaining capital in our business to support business growth is one that we need to watch carefully, actually from a positive perspective.
If we do see for example some additional energy in the sales annuities that tends to be as you know a product that requires a little more capital to carry, to support it, and we’ve gone through a number of year here where that's not really been a capital drag on our company and on the industry. So we want to watch that.
I think in terms of share price and the trading level of our price, we take a long range view of buying back our stock. And obviously we believe we are executing on plans that will drive growth as we go forward.
At the same time, we’re going to be tactical and realize as the share price rises and trade is closer to book value or intrinsic value, it makes other uses of capital more competitive to consider as opposed to when you’re trading at a deep discount to book and us and the rest of the industry is eager to buy shares back at those levels. So it will depend on a number of different things.
We remain tactical in assessing all the paths, including dividends for a reason because we want to on your behalf, on the shareholders behalf, choose the best path to drive IRIs and ROEs as we go forward.
Mark Finkelstein – Evercore Partners
And then, I guess I just want go back to Chris' question on LTC and the way you answered it Fred was to expect this level of experience to persist, at least through the year. And I guess what I’m trying to understand is, like are we at a new basing level?
Like should we be thinking about that 78%, not just for '13? I’m not asking for guidance going forward.
I’m just saying, is there anything that was in the experience that you've seen in the first couple of quarters that you think is going to persist through the year that represents normal volatility or fluctuations that you think is going to continue versus more of a trend shift?
Frederick Crawford
Yeah. It was really, Mark, as we closed out the second half of last year, heading into our investor conference and dialing in guidance for this year and then as we proceeded the first half of this year, the thing we have been paying most attention to is not necessarily dynamics taking place and actual to expected claims in mortality and these types of dynamics.
It was really more how much had we been enjoying in earlier years, the last few years, how much have we been enjoying in higher than normal lapse rates as a result of the more active rounds of re-rating, roughly 60% of the in-force loss of business over the years. As I've mentioned before, there is really two forms of lapse dynamics when you go through a re-rating process.
There is that shock lapse dynamic, but the more difficult one to assess is what lapse rates remain elevated or linger for a period of time having installed either new benefit structures or new rate schedules with policy holders. So part of what we have been doing this first part of the year is settling into what we think is a more normal benefit ratio, interest adjusted benefit ratio dynamic, watching the rate increases slow.
We’ve got all the actuarial evidence to support very handily and very transparently rate increases. But as you know, it's very challenging to get this done in the various state regulatory environments.
And so we are going to continue to look and work to get rate increases where they are deserved and supported, but it’s certainly getting more tactical and recognizing that's the case. We think it's prudent to expect these benefit ratios to remain in that 77%, 78% range.
Operator
Your next question comes from the line of Sean Dargan with Macquarie.
Sean Dargan – Macquarie
Not to stay on LTC forever, but am I to infer from your comments, Fred, that you expected a certain level of rate increase from the regulators that you're not getting, or am I mishearing things here?
Frederick Crawford
Not exactly. What we do, Sean, each year actually when we're trying to project out the many assumptions that are embedded in our long-term care profit estimates and in the actuarial work, is we try to assess where rate action is possible and what practically speaking is going to be available to us.
That's been more challenging here in recent years because we’ve had to recognize that what we think may be supported in the performance of the policies and our rights under the contract are not always available in various states and every state is different and every dynamic is different. So we’ve had to dial that back from the standpoint of our expectations.
I would say the industry is no doubt experiencing rate increases that are far below what we hoped for and probably modestly below our expectations. In our case, I would say that's the case.
But in other words it's falling a little below our expectations. But don't lose sight of the fact that we’ve been through the many rounds the rate increases as a company.
We’re not necessarily in need of these mass and sizable rate increases having been more diligent about it over the years. So it’s a little less of an impact item for us.
I think though it is safe to say that what we’ve been expecting to be able to achieve and what we have achieved in the current regulatory environment has been less.
Scott Perry
And Sean, this is Scott. On some of the tactical, just to give an example of things that Fred is referring to are often times through negotiations with the state, you'll end up implementing an increase that's approved maybe in two steps.
Or they'll approve a portion and ask you to come back. And so those are some of the tactical things that certainly we're referring to.
But it has been a reflection of the regulatory environment over the last two or three years.
Sean Dargan – Macquarie
And to take it a step further, has there been deviation from your expectations such that perhaps some of the expectation of rate increase baked into your GAAP loss recognition or baked into your GAAP reserves would have to be reversed?
Frederick Crawford
I wouldn't want to call out one particular assumption because what I've learned thus far in my walk through loss recognition testing is that it's an assortment of assumptions, some of which cooperates, some of which do not. And to isolate any one of those, Sean, I think will be dangerous.
I would tell you this, that what we have been very transparent about is that with rates having been lower and lower and earned rate portfolio yields dropping as a result of new money rates, as we mentioned during our LRT disclosures last year, we flag two portfolios as being more vulnerable when it comes to margin on LRT. And that was not surprisingly Bankers long-term care business and then the OCB interest-sensitive life.
In the case of interest-sensitive life and OCB we had actually taken interest rate related charges on that block. In the case of Bankers long-term care, low interest rates have eaten into that margin making them thinner and more susceptible to change.
And so we have to watch it very carefully. We have to actively manage it and look for ways in which we can defend the margins on the business because they’re thin.
Rates are doing better. Too early to declare victory, but to isolate any one assumption as being a problem would probably be a mistake on long-term care.
It’d be a mistake without assessing all of the dynamics of the block.
Sean Dargan – Macquarie
I guess on a related question, in several of last third quarters you’ve taken charges in other stand out businesses or in that business line. Can you just maybe frame where things stand versus last year and what things to think about as we try to maybe plug a number in there?
Frederick Crawford
Yeah. We have tried to make it easy for you in the sense of saying, here is the range, $5 million of EBIT to $20 million of EBIT, realize it’s a relative wide range, but it’s because these types of charges or noise is not uncommon when we are proactively working the block as hard as we can to calm it down and maximize cash flows.
There is a couple of things that are important to recognize in terms of the risk of large charges and that is again we’ve made substantial progress on resolving and bringing to closure the largest of these class actions suits that have resulted in levels of noise and volatility in the past. We actually took the interest rate related -- long-term interest rate related charge last year.
If memory serves, last year third quarter we took $43 million I believe of EBIT hit related to interest rates and $21 million related to a settlement reserve adjustment at that time to give you an idea, so not small numbers. We certainly believe those kinds of days and adjustments are behind us.
But you'll find normal fluctuations in that business. Mortality will move around quarter-to-quarter.
We'll have miscellaneous true-ups in adjustments that run through that business, but similar to this quarter, largely offsetting a nature and not worthy of calling out.
Operator
And your final question comes from the line of Ryan Krueger with Dowling & Partners.
Ryan Krueger – Dowling & Partners
On the IRS settlement in the quarter, could you say how much got reclassified relative to how much you were seeking?
Frederick Crawford
Yeah. It was -- a really easy answer to that question is if you go back into our disclosures, you’ll see that it also was a decision that had about $140 million valuation allowance hanging in the balance if there were to be a complete reversal of the IRS' treatment in favor of our proposed treatment.
The fact that we are estimating a $70 million valuation allowance adjustment gives you the answer. It was more or less a split decision if you will as to the benefit.
Ryan Krueger – Dowling & Partners
And then last one on the Lifetrend litigation, have you already put up any reserve for that? Or is that something we should perhaps be expecting as the case gets settled?
Frederick Crawford
We have in fact established a level of reserve for that case. If you recall back, actually now a couple of quarters ago, we had reached what we felt were principal terms around the economics.
And it’s usually at that point that we crossed the thresholds of GAAP and need to establish some form of estimated reserve. We did that.
It’s not uncommon for there to be miscellaneous true-ups as you continue on working with the other side to get more detail around the settlement and of course move through the courtroom setting where the judge gives preliminary approval and then moves it on to fairness hearings, et cetera. So it’s not uncommon to see little true-ups, but we believe we have established the principal reserves associated with the economic portions of the settlement.
Operator
And there are no more questions at this time.
Edward Bonach
All right, thank you operator and thank you everyone for your interest in CNO.
Operator
And this concludes today's conference call. You may now disconnect.