Our headquarters and the administrative operations of our Washington National segment and certain administrative operations of our subsidiaries are located on a Company-owned corporate campus in Carmel, Indiana, immediately north of Indianapolis. We currently occupy five buildings on the campus with approximately 450,000 square feet of space.
Our Bankers Life segment is primarily administered from downtown Chicago, Illinois. We currently lease approximately 135,000 square feet of office space under an agreement which expires in 2023. We also lease 262 sales offices in various states totaling approximately 892,000 square feet. These leases generally are short-term in length, with remaining lease terms expiring between 2020 and 2027.
In this section, we review the consolidated financial condition of CNO and its consolidated results of operations for the years ended December 31, 2019, 2018 and 2017 and, where appropriate, factors that may affect future financial performance. Please read this discussion in conjunction with the consolidated financial statements and notes included in this Form 10-K.
availability and effectiveness of reinsurance arrangements, as well as the impact of any defaults or failure of reinsurers to perform;
The loss related to reinsurance transaction, net realized investment gains (losses), fair value changes in embedded derivative liabilities (net of related amortization), fair value changes related to the agent deferred compensation plan, loss on extinguishment of debt, and other non-operating items consisting primarily of earnings attributable to VIEs depend on market conditions or represent unusual items that do not necessarily relate to the underlying business of our segments. Net realized investment gains (losses) and fair value changes in embedded derivative liabilities (net of related amortization) may affect future earnings levels since our underlying business is long-term in nature and changes in our investment portfolio may impact our ability to earn the assumed interest rates needed to maintain the profitability of our business.
Colonial Penn, which markets primarily graded benefit and simplified issue life insurance directly to customers in the senior middle-income market through television advertising, direct mail, the internet and telemarketing. The Colonial Penn segment includes primarily the business of Colonial Penn.
In January 2020, we announced a new operating model that realigns the Company from the operating business segments described above into two divisions - Consumer and Worksite. The new structure will create a leaner, more integrated, customer-centric organization that better positions us for long-term success and shareholder value creation. Under the new structure, we will be organized around two business divisions that reflect the customers served by the Company.
The Worksite Division will focus on worksite and group sales for businesses, associations, and other membership groups, interacting with customers at their place of employment. By creating a dedicated Worksite Division, we will bring a sharper focus to this high-growth business while further capitalizing on the strength of our recent WBD acquisition.
We will begin reporting under a different segment structure focused on product types beginning in the first quarter of 2020 based on the way management will make operating decisions and assess performance going forward. Prior period results will be reclassified to conform to the new reporting structure.
The following summarizes our earnings for the three years ending December 31, 2019 (dollars in millions, except per share data):
Management believes that an analysis of net operating income provides a clearer comparison of the operating results of the Company from period to period because it excludes: (i) loss related to reinsurance transaction, including impact of taxes; (ii) net realized investment gains or losses from sales and impairments, net of related amortization and taxes; (iii) net change in market value of investments recognized in earnings, net of taxes; (iv) fair value changes due to fluctuations in the interest rates used to discount embedded derivative liabilities related to our fixed index annuities, net of related amortization and taxes; (v) fair value changes related to the agent deferred compensation plan, net of taxes; (vi) loss on extinguishment of debt; (vii) changes in the valuation allowance for deferred tax assets and other tax items; and (viii) other non-operating items consisting primarily of earnings attributable to VIEs. Adjusted EBIT is presented as net operating income excluding corporate interest expense and income tax expense. The table above reconciles the non-GAAP measure to the corresponding GAAP measure.
Expand and enhance elements of our broker-dealer and registered investment advisor program
Make strategic, measured changes to our business practices to improve our competitive advantage
Continue to invest in technology to support agent productivity and our customer experience
The following summarizes our investments on our consolidated balance sheet carried at fair value by pricing source and fair value hierarchy level as of December 31, 2019 (dollars in millions):
We estimate the amount of the credit loss component of a fixed maturity security impairment as the difference between amortized cost and the present value of the expected cash flows of the security. The present value is determined using the best estimate of future cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating-rate security. The methodology and assumptions for establishing the best estimate of future cash flows vary depending on the type of security.
The remaining noncredit impairment, which is recorded in accumulated other comprehensive income, is the difference between the security's estimated fair value and our best estimate of future cash flows discounted at the effective interest rate prior to impairment. The remaining noncredit impairment typically represents changes in the market interest rates, current market liquidity and risk premiums.
The value assigned to the right to receive future cash flows from contracts existing at the Effective Date is referred to as the present value of future profits. The balance of this account is amortized, evaluated for recovery, and adjusted for the impact of unrealized gains (losses) in the same manner as the deferred acquisition costs described below. We expect to amortize the balance of the present value of future profits as of December 31, 2019 as follows: 11 percent in 2020, 9 percent in 2021, 8 percent in 2022, 7 percent in 2023 and 7 percent in 2024.
When we realize a gain or loss on investments backing our interest-sensitive life or annuity products, we adjust the amortization of insurance acquisition costs to reflect the change in estimated gross profits from the products due to the gain or loss realized and the effect on future investment yields. We increased (decreased) amortization expense for such changes by $.6 million, $(.4) million and $1.0 million during the years ended December 31, 2019, 2018 and 2017, respectively. We also adjust
insurance acquisition costs for the change in amortization that would have been recorded if fixed maturity securities, available for sale, had been sold at their stated aggregate fair value and the proceeds reinvested at current yields. Such adjustments are commonly referred to as "shadow adjustments" and may include adjustments to: (i) deferred acquisition costs; (ii) the present value of future profits; (iii) loss recognition reserves; and (iv) income taxes. We include the impact of this adjustment in accumulated other comprehensive income (loss) within shareholders' equity. The total pre-tax impact of such adjustments on accumulated other comprehensive income was a decrease of $343.3 million at December 31, 2019 (including $135.5 million for premium deficiencies that would exist on certain blocks of business if unrealized gains on the assets backing such products had been realized and the proceeds from our sales of such assets were invested at then current yields). The total pre-tax impact of such adjustments on accumulated other comprehensive income at December 31, 2018 was a decrease of $45.3 million (including $2.5 million for premium deficiencies that would exist on certain blocks of business if unrealized gains on the assets backing such products had been realized and the proceeds from our sales of such assets were invested at then current yields).
The significant assumptions used to calculate the liability for due and unpaid claims, claims in the course of settlement and incurred but not reported claims are based on historical claim payment patterns and include assumptions related to the number of claims and the size and timing of claim payments. These assumptions are updated quarterly to reflect the most current information regarding claim payment patterns. In order to determine the accuracy of our prior estimates, we calculate the total redundancy (deficiency) of our prior claim reserve estimates. The 2018 claim reserve redundancy for long-term care claim reserves in our Bankers Life segment, as measured at December 31, 2019, was approximately $2.0 million.
Estimates of unpaid losses related to long-term care business have a higher degree of uncertainty than estimates for our other products due to the range of ultimate duration of these claims and the resulting variability in their cost (in addition to the variations in the lag time in reporting claims). As an example, an increase in the loss ratio of 5 percentage points for claims incurred in 2019 related to our long-term care business would have resulted in an immediate decrease in our earnings of approximately $13 million. Our financial results depend significantly upon the extent to which our actual claims experience is consistent with the assumptions we used in determining our reserves and pricing our products. If our assumptions with respect to future claims are incorrect, and our reserves are insufficient to cover our actual losses and expenses, we would be required to increase our liabilities, which would negatively affect our operating results.
At December 31, 2019, the total balance of our liabilities for insurance products was $24.4 billion. These liabilities are generally payable over an extended period of time and the profitability of the related products is dependent on the pricing of the products and other factors. Differences between our expectations when we sold these products and our actual experience could result in future losses.
General: CNO is the top tier holding company for a group of insurance companies operating throughout the United States that develop, market and administer health insurance, annuity, individual life insurance and other insurance products. We distribute these products through our Bankers Life segment, which utilizes a career agency force, through our Washington National segment, which utilizes independent producers and through our Colonial Penn segment, which utilizes direct response marketing. We also have a Long-term care in run-off segment that consists of: (i) the long-term care business that was recaptured due to the termination of certain reinsurance agreements effective September 30, 2016 (such business is not actively marketed and was issued or acquired by Washington National and BCLIC); and (ii) certain legacy (prior to 2003) comprehensive and nursing home long-term care policies that were ceded in September 2018 (such business was not actively marketed and was issued by Bankers Life). Beginning in the fourth quarter of 2018, the earnings of this segment only reflect the long-term care business that was recaptured in September 2016 as the legacy long-term care business was ceded under a 100% indemnity coinsurance agreement in September 2018.
Net new client assets includes total inflows of cash and securities into brokerage and managed advisory accounts less outflows. Inflows include interest and dividends and exclude changes due to market fluctuations.
Client assets include cash and securities in brokerage and managed advisory accounts.
Total premium collections were $2,793.0 million in 2019, up 5.5 percent from 2018, and $2,648.2 million in 2018, up 5.2 percent from 2017, primarily driven by sales of fixed index annuities. See "Premium Collections" for further analysis of Bankers Life's premium collections.
In the fourth quarter of 2019, we completed our comprehensive review of actuarial assumptions. Such review resulted in a decrease to reserves of $1.4 million and an increase in amortization of $12.2 million including the impact from changes in earned rate, credited rate, mortality rate and surrender rate assumptions related to fixed index and fixed interest annuities and interest-sensitive life products. In the fourth quarter of 2018, our comprehensive review resulted in a decrease to reserves of $5.2 million and an increase in amortization of $8.3 million including the net impact from changes to spread and persistency assumptions related to fixed index and fixed interest annuities. In the fourth quarter of 2017, our comprehensive review
resulted in a decrease in reserves of $9.0 million and a decrease in amortization of $1.8 million including the net impact of changes to mortality assumptions related to interest-sensitive life products.
The Medicare supplement business consists of both individual and group policies. Government regulations generally require us to attain and maintain a ratio of total benefits incurred to total premiums earned (excluding changes in policy benefit reserves), after three years from the original issuance of the policy and over the lifetime of the policy, of not less than 65 percent on individual products and not less than 75 percent on group products, as determined in accordance with statutory accounting principles. Since the insurance product liabilities we establish for Medicare supplement business are subject to significant estimates, the ultimate claim liability we incur for a particular period is likely to be different than our initial estimate. Our benefit ratios were 73.8 percent, 74.5 percent and 70.8 percent in 2019, 2018 and 2017, respectively. Beginning in 2018, our margins reflect the expansion of the use of the Medicare crossover claims process for all of this segment's Medicare supplement business. The Medicare crossover process is a claims payment platform that provides for straight through processing of provider claims. As expected, this new process increased the reporting of smaller claims, resulting in higher benefit ratios in 2019 and 2018. Annually, we review our loss experience on these products and when appropriate, apply for actuarially justified rate increases. The next effective date for rate increases for the majority of these policies is January 1, 2020. Our insurance policy benefits reflected favorable reserve developments of prior period claim reserves of approximately $1.8 million, $.7 million and $6.0 million in 2019, 2018 and 2017, respectively. Excluding the effects of prior period claim reserve redundancies and deficiencies, our benefit ratios would have been 74.1 percent, 74.5 percent and 71.5 percent in 2019, 2018 and 2017, respectively. The benefit ratio in 2019 on this Medicare supplement business was in line with our previously announced expectations which were in the range of 73 percent to 77 percent for 2019.
Since the insurance product liabilities we establish for the long-term care business are subject to significant estimates, the ultimate claim liability we incur for a particular period is likely to be different than our initial estimate. When policies lapse, active life reserves for such lapsed policies are released, resulting in decreased insurance policy benefits (although such decrease is somewhat offset by additional amortization expense).
Amortization related to net realized investment gains (losses) is the increase or decrease in the amortization of insurance acquisition costs which results from realized investment gains or losses. When we sell securities which back our interest-sensitive life and annuity products at a gain (loss) and reinvest the proceeds at a different yield, we increase (reduce) the amortization of insurance acquisition costs in order to reflect the change in estimated gross profits due to the gains (losses) realized and the resulting effect on estimated future yields. Sales of fixed maturity investments resulted in an increase (decrease) in the amortization of insurance acquisition costs of $.7 million, $(.3) million and $1.0 million in 2019, 2018 and 2017, respectively.
Total premium collections were $711.0 million in 2019, up 2.6 percent from 2018, and $692.8 million in 2018, up 3.2 percent from 2017, driven by sales and persistency of the segment's supplemental health block; partially offset by lower Medicare supplement collected premiums due to the run-off of this block of business. This segment no longer markets Medicare supplement products and no longer actively pursues sales of annuity products. See "Premium Collections" for further analysis of fluctuations in premiums collected by product.
Net investment income on general account invested assets (which excludes income on policyholder portfolios and reinsurer accounts) was $255.5 million in 2019, $261.1 million in 2018 and $257.5 million in 2017. Net investment income on general account invested assets in 2019 reflects lower investment income from alternative investments as well as lower investment yields, as compared to 2018. The lower yields in 2019 are primarily due to lower market yields in general, as well as repositioning a portion of our portfolio into higher rated investments in the first quarter of 2019. Alternative investments are typically reported a quarter in arrears. Alternative investments earned satisfactory returns in 2019 relative to our expectations, but were less than 2018. Investment income from alternative investments was $10.8 million, $12.4 million and $7.3 million in 2019, 2018 and 2017, respectively. Prepayment income (including call premiums) was $4.7 million, $3.8 million and $5.9 million in 2019, 2018 and 2017, respectively.
Insurance margins (insurance policy income less insurance policy benefits) on supplemental health products were $133.2 million, $125.3 million and $98.7 million in 2019, 2018 and 2017, respectively. The increase in margin on this block of business in 2019 reflects the growth in the block and lower claims experience. The increase in margin on this block of business
in 2018, compared to 2017, reflects higher insurance policy income due to higher sales and growth in the block, as well as favorable claims and favorable development of prior period claim reserves. The benefit ratio on these products was 78.8 percent, 79.5 percent and 83.2 percent in 2019, 2018 and 2017, respectively. The interest-adjusted benefit ratio on this supplemental health business was 54.8 percent, 55.4 percent and 59.1 percent in 2019, 2018 and 2017, respectively. The interest-adjusted benefit ratio in 2019 on this supplemental health business was slightly better than our previously announced expectations which were in the range of 55 percent to 58 percent for 2019.
Amounts added to policyholder account liabilities for fixed index products represent a guaranteed minimum rate of return and a higher potential return that is based on a percentage (the "participation rate") of the amount of increase in the value of a particular index, such as the S&P 500 Index, over a specified period. Such amounts include our cost to fund the annual index credits, net of policies that are canceled prior to their anniversary date (classified as cost of options to fund index credits, net of forfeitures). Market value changes in the underlying indices during a specified period of time are classified as market value changes credited to policyholders. Such market value changes are generally offset by the net investment income related to fixed index products discussed above.
Commission expense was $84.1 million, $73.9 million and $69.8 million in 2019, 2018 and 2017, respectively. The increase in commission expense is consistent with the growth in the supplemental health block.
Net realized investment gains (losses) fluctuate each period. During 2019, we recognized net realized investment gains of $24.1 million, which were comprised of: (i) $14.6 million of net gains from the sales of investments; (ii) a $1.6 million favorable change in the fair value of equity securities; (iii) an increase in fair value of certain fixed maturity investments with embedded derivatives of $2.6 million; and (iv) the increase in fair value of embedded derivatives related to a modified coinsurance agreement of $5.3 million. During 2018, we recognized net realized investment losses of $10.0 million, which were comprised of: (i) $1.8 million of net gains from the sales of investments; (ii) a $7.5 million unfavorable change in the fair value of equity securities; (iii) an increase in fair value of certain fixed maturity investments with embedded derivatives of $.9 million; (iv) the decrease in fair value of embedded derivatives related to a modified coinsurance agreement of $5.1 million; and (v) $.1 million of writedowns of investments for other than temporary declines in fair value which were recorded in earnings. During 2017, we recognized net realized investment gains of $11.7 million, which were comprised of: (i) $7.4 million of net gains from the sales of investments; (ii) the increase in fair value of certain fixed maturity investments with embedded derivatives of $2.5 million; (iii) the increase in fair value of embedded derivatives related to a modified coinsurance
Amortization related to net realized investment gains (losses) is the increase or decrease in the amortization of insurance acquisition costs which results from realized investment gains or losses. When we sell securities which back our interest-sensitive life and annuity products at a gain (loss) and reinvest the proceeds at a different yield (or when we have the intent to sell the impaired investments before an anticipated recovery in value occurs), we increase (reduce) the amortization of insurance acquisition costs in order to reflect the change in estimated gross profits due to the gains (losses) realized and the resulting effect on estimated future yields.
This segment's results are significantly impacted by the accounting standard related to deferred acquisition costs. We are not able to defer most of Colonial Penn's direct response advertising costs although such costs generate predictable sales and future inforce profits. We plan to continue to invest in this segment's business, including the development of new products and markets. The amount of our investment in new business during a particular period will have a significant impact on this segment's results. This segment's earnings (before net realized investment gains (losses) and income taxes) in 2019 were in line with our previously announced expectations which were in the range of $12 million to $16 million for 2019.
Total premium collections increased 3.4 percent, to $308.3 million, in 2019 and 2.3 percent, to $298.3 million, in 2018. The increase was driven by recent sales activity and steady persistency. See "Premium Collections" for further analysis of Colonial Penn's premium collections.
Net investment income on general account invested assets decreased in 2019 primarily due to lower investment yields compared to 2018.
Other operating costs and expenses in our Colonial Penn segment fluctuate primarily due to changes in the marketing expenses incurred to generate new business. Marketing expenses were higher in 2019 as compared to 2018. The demand and cost of television advertising appropriate for Colonial Penn's campaigns has fluctuated widely in certain periods. We are disciplined with our marketing expenditures and will increase or decrease our advertising spend depending on prices.
Insurance policy benefits were $32.5 million, $271.3 million and $344.2 million in 2019, 2018 and 2017, respectively. The interest-adjusted benefit ratio on the business in this segment was 35.4 percent, 79.1 percent and 69.1 percent in 2019, 2018 and 2017, respectively. Our 2019 comprehensive actuarial review of this block reflected relatively low margins. Accordingly, this segment's results can be volatile from period to period. This block of business is particularly sensitive to changes in assumptions.
Interest expense on corporate debt was $52.4 million, $48.0 million and $46.5 million in 2019, 2018 and 2017, respectively. Our average corporate debt outstanding was $966.1 million in 2019 and $925.0 million in both 2018 and 2017. The average interest rate on our debt was 5.1 percent, 4.8 percent and 4.8 percent in 2019, 2018 and 2017, respectively. Average corporate debt outstanding and the average interest rate were impacted by the debt refinancing transaction completed in June 2019 (as further discussed in the note to the consolidated financial statements entitled "Notes Payable - Direct Corporate Obligations") along with the mix of interest rates on the related outstanding borrowings.
Net investment income on other special-purpose portfolios includes the income (loss) from: (i) investments related to deferred compensation plans held in a rabbi trust (which is offset by amounts included in other operating costs and expenses as the investment results are allocated to participants' account balances); (ii) trading account activities; and (iii) income (loss) from Company-owned life insurance ("COLI") equal to the difference between the return on these investments (representing the change in value of the underlying investments) and our overall portfolio yield. COLI is utilized as an investment vehicle to fund Bankers Life's agent deferred compensation plan. For segment reporting, the Bankers Life segment is allocated a return on these investments equivalent to the yield on the Company’s overall portfolio, with any difference in the actual COLI return allocated to the Corporate operations segment. We recognized death benefits, net of cash surrender value, of $4.0 million related to the COLI in 2017. At December 31, 2019, our COLI assets had a carrying value of $194.0 million. Since this segment's earnings reflect the changes in values of the underlying investments supporting the insurance contracts (including mutual funds investing in bonds, common stock and real estate) and any death benefits received, such income can be volatile.
Fee revenue and other income includes the fees our wholly-owned investment advisor earns for managing portfolios of commercial bank loans for investment trusts. These trusts are consolidated as VIEs in our consolidated financial statements, but the fees are reflected as revenues and the fee expense is reflected in the earnings attributable to VIEs. This fee revenue fluctuates consistent with the size of the loan portfolios. In addition, other income in 2019 reflected the favorable impact of legal recoveries from settlements with third parties.
Net realized investment losses often fluctuate each period. During 2019, net realized investment losses in this segment were $19.7 million and were comprised of: (i) a $.1 million favorable change in the fair value of equity securities (none of which was recognized by the VIEs); (ii) $11.7 million of net losses from the sales of investments (including $12.4 million of net losses recognized by the VIEs and $.7 million of net gains on other investment sales); (iii) $5.1 million of losses related to the dissolution of a VIE; and (iv) $3.0 million of writedowns of investments held by VIEs due to other-than-temporary declines in value. During 2018, net realized investment losses in this segment were $7.6 million and were comprised of: (i) a $4.3 million unfavorable change in the fair value of equity securities (none of which was recognized by the VIEs); and (ii) $3.3 million of net losses from the sales of investments (including $3.6 million of net losses recognized by the VIEs and $.3 million of net gains on other investment sales). During 2017, net realized investment losses in this segment were $3.0 million and were comprised of: (i) $3.8 million of net gains from the sales of investments (including $1.2 million of net gains recognized by the VIEs and $2.6 million of net gains on other investment sales); (ii) $4.3 million of losses on the dissolution of a VIE; and (iii) $2.5 million of writedowns of investments held by VIEs due to other-than-temporary declines in value.
Net revenue pursuant to transition services agreement represents the difference between the fees we receive from Wilton Re and the overhead costs incurred to provide such services under the agreement in connection with the completion of a long-term care reinsurance transaction in September 2018.
Loss related to reinsurance transaction in 2018 resulted from ceding our legacy (prior to 2003) comprehensive and nursing home long-term care policies in September 2018 through 100% indemnity coinsurance. We recognized a pre-tax loss related to the reinsurance transaction of $704.2 million (net of realized gains on the transfer of assets related to the transaction of $363.4 million) as further described in the note to the consolidated financial statements entitled "Summary of Significant Accounting Policies - Reinsurance".
Agents, insurance brokers and marketing companies who market our products and prospective purchasers of our products use the financial strength ratings of our insurance subsidiaries as an important factor in determining whether to market or purchase. Ratings have the most impact on our sales of supplemental health and life products to consumers at the worksite. The current financial strength ratings of our primary insurance subsidiaries from A.M. Best, S&P, Fitch and Moody's are "A-", "A-", "A-" and "A3", respectively. For a description of these ratings and additional information on our ratings, see "Consolidated Financial Condition - Financial Strength Ratings of our Insurance Subsidiaries."
Premiums collected on Bankers Life's long-term care policies increased .2 percent, to $255.6 million in 2019 and decreased .7 percent, to $255.1 million in 2018.
Collected premiums on Medicare supplement policies in the Washington National segment decreased 12 percent, to $40.9 million, in 2019 and 10 percent, to $46.3 million, in 2018 due to the run-off of this block of business.
Life products in this segment are sold primarily to the senior market. Life premiums collected in this segment increased 3.5 percent, to $307.0 million, in 2019 and 2.4 percent, to $296.6 million, in 2018. Premiums collected reflect both recent sales activity and steady persistency.
Our investment strategy is to: (i) provide largely stable investment income from a diversified high quality fixed income portfolio; (ii) mitigate the effect of changing interest rates through active asset/liability management; (iii) provide liquidity to meet our cash obligations to policyholders and others; and (iv) maximize total return through active strategic asset allocation and investment management. Consistent with this strategy, investments in fixed maturity securities and mortgage loans made up 89 percent of our $25.6 billion investment portfolio at December 31, 2019. The remainder of the invested assets was trading securities, investments held by VIEs, COLI, equity securities, policy loans and other invested assets.
regulations and our business and investment strategy, we generally seek to invest in United States government and government-agency securities and corporate securities rated investment grade by established nationally recognized rating organizations or in securities of comparable investment quality, if not rated.
The following table summarizes the carrying values and gross unrealized losses of our fixed maturity securities, available for sale, by category as of December 31, 2019 (dollars in millions):
The following table summarizes the gross unrealized losses of our fixed maturity securities, available for sale, by category and ratings category as of December 31, 2019 (dollars in millions):
Investment ratings are assigned the second lowest rating by Nationally Recognized Statistical Rating Organizations (Moody's, S&P or Fitch), or if not rated by such firms, the rating assigned by the NAIC. NAIC designations of "1" or "2" include fixed maturities generally rated investment grade (rated "Baa3" or higher by Moody's or rated "BBB-" or higher by S&P and Fitch). NAIC designations of "3" through "6" are referred to as below-investment grade (which generally are rated "Ba1" or lower by Moody's or rated "BB+" or lower by S&P and Fitch). References to investment grade or below-investment grade throughout our consolidated financial statements are determined as described above. The following table sets forth fixed maturity investments at December 31, 2019, classified by ratings (dollars in millions):
We continually evaluate the creditworthiness of each issuer whose securities we hold. We pay special attention to large investments, investments which have significant risk characteristics and to those securities whose fair values have declined materially for reasons other than changes in general market conditions. We evaluate the realizable value of the investment, the specific condition of the issuer and the issuer's ability to comply with the material terms of the security. We review the
During 2019, we sold $971.2 million of fixed maturity investments which resulted in gross investment losses (before income taxes) of $55.5 million. Securities are generally sold at a loss following unforeseen issue-specific events or conditions or shifts in perceived relative values. These reasons include but are not limited to: (i) changes in the investment environment; (ii) expectation that the market value could deteriorate; (iii) our desire to reduce our exposure to an asset class, an issuer or an industry; (iv) prospective or actual changes in credit quality; or (v) changes in expected portfolio cash flows.
The following table shows the distribution of our commercial mortgage loan portfolio by property type as of December 31, 2019 (dollars in millions):
The following table summarizes the distribution of maturities of our commercial mortgage loans as of December 31, 2019 (dollars in millions):
Other invested assets include options backing our fixed index annuity and life insurance products, COLI, FHLB common stock and certain nontraditional investments, including investments in limited partnerships, hedge funds and real estate investments held for sale.
The following table summarizes certain financial ratios as of and for the years ended December 31, 2019 and December 31, 2018:
Includes projected interest payments based on interest rates, as applicable, as of December 31, 2019. Refer to the note to the consolidated financial statements entitled "Notes Payable - Direct Corporate Obligations" for additional information on notes payable.
Includes obligations to third parties for information technology services, software maintenance and license agreements, consulting services and sponsorship agreements.
Three of the Company's insurance subsidiaries (Bankers Life, Washington National and Colonial Penn) are members of the FHLB. As members of the FHLB, our insurance subsidiaries have the ability to borrow on a collateralized basis from the FHLB. We are required to hold certain minimum amounts of FHLB common stock as a condition of membership in the FHLB, and additional amounts based on the amount of the borrowings. At December 31, 2019, the carrying value of the FHLB common stock was $71.0 million. As of December 31, 2019, collateralized borrowings from the FHLB totaled $1.6 billion and the proceeds were used to purchase fixed maturity securities. The borrowings are classified as investment borrowings in the accompanying consolidated balance sheet. The borrowings are collateralized by investments with an estimated fair value of $2.0 billion at December 31, 2019, which are maintained in custodial accounts for the benefit of the FHLB.
During 2019, the financial statements of two of our insurance subsidiaries prepared in accordance with statutory accounting practices prescribed or permitted by regulatory authorities reflected asset adequacy or premium deficiency reserves. Total asset adequacy and premium deficiency reserves for Washington National and BCLIC were $123.0 million and $39.5 million, respectively, at December 31, 2019. Due to differences between statutory and GAAP insurance liabilities, we were not required to recognize a similar asset adequacy or premium deficiency reserve in our consolidated financial statements prepared in accordance with GAAP. The determination of the need for and amount of asset adequacy or premium deficiency reserves is subject to numerous actuarial assumptions, including the Company's ability to change NGEs related to certain products consistent with contract provisions.
On January 29, 2020, A.M. Best affirmed its "A-" financial strength ratings of our primary insurance subsidiaries. The outlook for these ratings remain stable. The "A-" rating is assigned to companies that have an excellent ability, in A.M. Best's opinion, to meet their ongoing obligations to policyholders. A.M. Best ratings for the industry currently range from "A++ (Superior)" to "F (In Liquidation)" and some companies are not rated. An "A++" rating indicates a superior ability to meet ongoing obligations to policyholders. A.M. Best has sixteen possible ratings. There are three ratings above the "A-" rating of our primary insurance subsidiaries and twelve ratings that are below that rating.
On June 14, 2019, Fitch upgraded the financial strength ratings of our primary insurance subsidiaries to "A-" from
Rating agencies have increased the frequency and scope of their credit reviews and requested additional information from the companies that they rate, including us. They may also adjust upward the capital and other requirements employed in
At December 31, 2019, CNO, CDOC and our other non-insurance subsidiaries held unrestricted cash and cash equivalents of $186.7 million. CNO and CDOC are holding companies with no business operations of their own; they depend on their operating subsidiaries for cash to make principal and interest payments on debt, and to pay administrative expenses and income taxes. CNO and CDOC receive cash from insurance subsidiaries, consisting of dividends and distributions, interest payments on surplus debentures and tax-sharing payments, as well as cash from non-insurance subsidiaries consisting of dividends, distributions, loans and advances. The principal non-insurance subsidiaries that provide cash to CNO and CDOC are 40|86 Advisors, which receives fees from the insurance subsidiaries for investment services, and CNO Services which receives fees from the insurance subsidiaries for providing administrative services. The agreements between our insurance subsidiaries and CNO Services and 40|86 Advisors, respectively, were previously approved by the domestic insurance regulator for each insurance company, and any payments thereunder do not require further regulatory approval.
Bankers Life paid dividends of $155.0 million to CLTX in 2019. Bankers Life may pay dividends without regulatory approval or prior notice for any 12-month period if such dividends are less than the greater of: (i) statutory net income for the prior year; or (ii) 10 percent of statutory capital and surplus as of the end of the preceding year. Dividends in excess of these levels require 30 days prior notice.
Free cash flow is a measure of holding company liquidity and is calculated as: (i) dividends, management fees and surplus debenture interest payments received from our subsidiaries; plus (ii) earnings on corporate investments; less (iii) interest expense, corporate expenses and net tax payments. In 2019, we generated $287 million of such free cash flow. The Company is committed to deploying 100 percent of its free cash flow into investment opportunities to accelerate profitable growth, common stock dividends and share repurchases. The amount and timing of the securities we repurchase (if any) will be based on business and market conditions and other factors including, but not limited to, available free cash flow, the current price of our common stock and investment opportunities. In 2019, we repurchased 15.4 million shares of common stock for $252.3 million under our securities repurchase program. The Company had remaining repurchase authority of $532.3 million as of December 31, 2019. Also, in the second quarter of 2019, the Company purchased WBD (as further described in the note to the consolidated financial statements entitled "Business and Basis of Presentation") utilizing $66.7 million of free cash flow.
On June 14, 2019, Fitch upgraded our senior unsecured debt rating to "BBB-" from "BB+" and the outlook for these ratings is stable. In Fitch's view, an obligation rated "BBB" indicates that expectations of default risk are currently low. The capacity for payment of financial commitments is considered adequate but adverse business or economic conditions are more likely to impair this capacity. Pluses and minuses show the relative standing within a category. Fitch has a total of 21 possible ratings ranging from "AAA" to "D". There are nine ratings above CNO's "BBB-" rating and eleven ratings that are below its rating.
Our spread-based insurance business is subject to several inherent risks arising from movements in interest rates, especially if we fail to anticipate or respond to such movements. First, interest rate changes can cause compression of our net spread between interest earned on investments and interest credited on customer deposits, thereby adversely affecting our results. Second, if interest rate changes produce an unanticipated increase in surrenders of our spread-based products, we may be forced to sell invested assets at a loss in order to fund such surrenders. Many of our products include surrender charges, market interest rate adjustments or other features to encourage persistency; however, at December 31, 2019, approximately 20 percent of our total insurance liabilities, or approximately $4.9 billion, could be surrendered by the policyholder without penalty. Finally, changes in interest rates can have significant effects on our investment portfolio. We use asset/liability strategies that are designed to mitigate the effect of interest rate changes on our profitability. However, there can be no assurance that management will be successful in implementing such strategies and sustaining adequate investment spreads.
Our investment strategy is to maximize, over a sustained period and within acceptable parameters of quality and risk, investment income and total investment return through active strategic asset allocation and investment management. Accordingly, we may sell securities at a gain or a loss to enhance the projected total return of the portfolio as market
We have audited the accompanying consolidated balance sheet of CNO Financial Group, Inc. and its subsidiaries (the “Company”) as of December 31, 2019 and 2018, and the related consolidated statements of operations, of comprehensive income, of shareholders' equity and of cash flows for each of the three years in the period ended December 31, 2019, including the related notes and financial statement schedules listed in the index appearing under Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
The principal considerations for our determination that performing procedures relating to the valuation of embedded derivatives associated with fixed index annuity products is a critical audit matter are there was significant judgment by management in estimating the fair value of embedded derivatives, specifically the significant unobservable inputs to the discount rate, which included management’s non-performance risk and risk margins for non-capital market inputs. This in turn led to a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating audit evidence relating to management’s discount rate assumption. Also, the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing procedures and evaluating the audit evidence obtained from these procedures.
The Company manages its business through the following operating segments: Bankers Life, Washington National and Colonial Penn, which are defined on the basis of product distribution; long-term care in run-off; and corporate operations, comprised of holding company activities and certain noninsurance company businesses.
Accounting Standards". Prior to January 1, 2018, changes in the fair value of equity securities were recorded in "Accumulated other comprehensive income".
Cash and cash equivalents include commercial paper, invested cash and other investments purchased with original maturities of less than three months. We carry them at amortized cost, which approximates estimated fair value. It is the Company's policy to offset negative cash balances with positive balances in other accounts with the same counterparty when agreements are in place permitting legal right of offset.
Deferred acquisition costs represent incremental direct costs related to the successful acquisition of new or renewal insurance contracts. For interest-sensitive life or annuity products, we amortize these costs in relation to the estimated gross
When we realize a gain or loss on investments backing our interest-sensitive life or annuity products, we adjust the amortization to reflect the change in estimated gross profits from the products due to the gain or loss realized and the effect on future investment yields. We also adjust deferred acquisition costs for the change in amortization that would have been recorded if our fixed maturity securities, available for sale, had been sold at their stated aggregate fair value and the proceeds reinvested at current yields. We limit the total adjustment related to the impact of unrealized losses to the total of costs capitalized plus interest related to insurance policies issued in a particular year. We include the impact of this adjustment in accumulated other comprehensive income (loss) within shareholders' equity.
We establish liabilities for traditional life, accident and health insurance, and life contingent payment annuity products using mortality tables in general use in the United States, which are modified to reflect the Company's actual experience when
Bankers Life has entered into various distribution and marketing agreements with other insurance companies to use Bankers Life's career agents to distribute prescription drug and Medicare Advantage plans. These agreements allow Bankers Life to offer these products to current and potential future policyholders without investment in management and infrastructure. We receive fee income related to the plans sold through our distribution channels and incur distribution expenses paid to our agents who sell such products.
The recognition of fee revenue and the distribution expenses paid to our agents results from approval of an application by the third-party insurance companies, which we define as our customers. We recognize revenue and distribution fees related to these sales in accordance with the new revenue recognition guidance which was effective January 1, 2018 (see "Recently Issued Accounting Standards - Adopted Accounting Standards" below). This guidance requires us to recognize the net lifetime revenue expected to be earned on these sales, but only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. Prior to the fourth quarter of 2019, our revenue recognition was constrained due to the limited historical data available. In the fourth quarter of 2019, we had accumulated additional historical data with respect to some Medicare Advantage plan sales, and certain assumptions and constraints related to our revenue recognition were updated to reflect this change in estimate. To the extent we make changes to the assumptions we use to calculate revenue on these products, we will recognize the impact of the changes in the period in which the change is made.
The investment portfolios held by the VIEs are primarily comprised of commercial bank loans to corporate obligors which are almost entirely rated below-investment grade. Refer to the note to the consolidated financial statements entitled "Investments in Variable Interest Entities" for additional information about VIEs.
At December 31, 2019, we held investments in various limited partnerships and hedge funds, in which we are not the primary beneficiary, totaling $578.2 million (classified as other invested assets). At December 31, 2019, we had unfunded commitments to these partnerships and hedge funds totaling $102.3 million. Our maximum exposure to loss on these investments is limited to the amount of our investment.
The variable rate borrowings are pre-payable on each interest reset date without penalty. The fixed rate borrowings are pre-payable subject to payment of a yield maintenance fee based on prevailing market interest rates. At December 31, 2019, the aggregate yield maintenance fee to prepay all fixed rate borrowings was $3.6 million.
Interest expense of $46.2 million, $41.9 million and $27.0 million in 2019, 2018 and 2017, respectively, was recognized related to total borrowings from the FHLB.
We purchase certain fixed maturity securities that contain embedded derivatives that are required to be held at fair value on the consolidated balance sheet. We have elected the fair value option to carry the entire security at fair value with changes in fair value reported in net income.
Certain of our annuity products offer sales inducements to contract holders in the form of enhanced crediting rates or bonus payments in the initial period of the contract. Certain of our life insurance products offer persistency bonuses credited to the contract holder's balance after the policy has been outstanding for a specified period of time. These enhanced rates and persistency bonuses are considered sales inducements in accordance with GAAP. Such amounts are deferred and amortized in the same manner as deferred acquisition costs. Sales inducements deferred totaled $24.9 million, $11.6 million and $2.0 million during 2019, 2018 and 2017, respectively. Amounts amortized totaled $7.7 million, $10.6 million and $8.9 million during 2019, 2018 and 2017, respectively. The unamortized balance of deferred sales inducements was $60.7 million and $43.5 million at December 31, 2019 and 2018, respectively.
In June 2016, the Financial Accounting Standards Board (the "FASB") issued authoritative guidance related to the measurement of credit losses on financial instruments. The new guidance replaces the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to form credit loss estimates. The guidance requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset to present the net carrying value at the amount expected to be collected on the financial asset. Credit losses on available for sale debt securities should be measured in a manner similar to current GAAP. However, the guidance requires that credit losses be presented as an allowance rather than as a writedown. The guidance will be effective for the Company on January 1, 2020. The cumulative effect associated with the adoption of this guidance is expected to reduce retained earnings by approximately $18 million on January 1, 2020. This impact is attributable to recognizing the allowance for losses (primarily related to mortgage loans and the commercial bank loans held by VIEs), net of the related increase in deferred tax assets. Refer to note 17, "Investments in Variable Interest Entities," for additional information about the VIEs and the Company's limited financial obligation to these entities.
unavailable. In October 2019, the FASB approved a delay for the effective date of the adoption of this guidance by one year (until January 1, 2022). The Company has not yet determined the expected impact of adoption of this guidance on its consolidated financial position, results of operations or cash flows.
guidance was effective for the Company on January 1, 2019. Based on the Company's current use of derivatives and hedging activities, the adoption of this guidance had no impact on the Company's consolidated financial position, results of operations or cash flows.
In May 2014, the FASB issued authoritative guidance for recognizing revenue from contracts with customers. Certain contracts with customers are specifically excluded from this guidance, including insurance contracts. The core principle of the new guidance is that an entity should recognize revenue when it transfers promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires additional disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The guidance was effective for the Company on January 1, 2018. The adoption of this new guidance impacted the timing of certain revenues and expenses between quarters of a calendar year for various distribution and marketing agreements with other insurance companies pursuant to which Bankers Life's career agents distribute third party products including prescription drug and Medicare Advantage plans. See "Accounting for Certain Marketing Agreements" above, for a description of our accounting under this standard. Furthermore, we recognized distribution expenses in the same period that the associated fee revenue was earned. Periods prior to the January 1, 2018 adoption date were not restated to reflect the new guidance.
Require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements.
In August 2016, the FASB issued authoritative guidance related to how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The guidance addresses eight specific cash flow issues including debt prepayment or debt extinguishment costs, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees, and others. The guidance was effective for the Company on January 1, 2018. The adoption of this guidance resulted in reclassifications to certain cash receipts and payments within our consolidated statement of cash flows, but had no impact on our consolidated financial position, results of operations or cash flows. Periods prior to the January 1, 2018 adoption date were restated to reflect the new guidance.
In November 2016, the FASB issued authoritative guidance to address the diversity in practice that currently exists regarding the classification and presentation of changes in restricted cash on the statement of cash flows. The new guidance requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. Entities are also required to disclose information about the nature of their restricted cash and restricted cash equivalents. Additionally, if cash, cash equivalents, restricted cash and restricted cash equivalents are presented in more than one line item in the statement of financial position, entities will be required to present a reconciliation, either on the face of the statement of cash flows or disclosed in the notes, of the totals in the statement of cash flows to the related line item captions in the statement of financial position. The guidance was effective for the Company on January 1, 2018. The adoption of this guidance impacted the presentation of our consolidated statement of cash flows and related cash flow disclosures, but did not have an impact on our consolidated financial position, results of operations or cash flows. Periods prior to the January 1, 2018 adoption date were restated to reflect the new guidance.
The NAIC evaluates the fixed maturity investments of insurers for regulatory and capital assessment purposes and assigns securities to one of six credit quality categories called NAIC designations, which are used by insurers when preparing
their annual statements based on statutory accounting principles. The NAIC designations are generally similar to the credit quality designations of the NRSROs for marketable fixed maturity securities, except for certain structured securities. However, certain structured securities rated below investment grade by the NRSROs can be assigned NAIC 1 or NAIC 2 designations depending on the cost basis of the holding relative to estimated recoverable amounts as determined by the NAIC. The following summarizes the NAIC designations and NRSRO equivalent ratings:
At December 31, 2018, the amortized cost, gross unrealized gains and losses, estimated fair value and other-than-temporary impairments in accumulated other comprehensive income of fixed maturities, available for sale, and equity securities were as follows (dollars in millions):
The present value of future profits is the value assigned to the right to receive future cash flows from contracts existing at September 10, 2003, the date our Predecessor emerged from bankruptcy.
At December 31, 2019, the amortized cost of the Company's below-investment grade fixed maturity securities was $1,848.1 million, or 9.6 percent of the Company's fixed maturity portfolio. The estimated fair value of the below-investment grade portfolio was $2,024.8 million, or 110 percent of the amortized cost.
The following table sets forth the amortized cost and estimated fair value of fixed maturities, available for sale, at December 31, 2019, by contractual maturity. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties. Structured securities (such as asset-backed securities, collateralized debt obligations, commercial mortgage-backed securities, mortgage pass-through securities and collateralized mortgage obligations, collectively referred to as "structured securities") frequently include provisions for periodic principal payments and permit periodic unscheduled payments.
At December 31, 2019, the carrying value of fixed maturities and mortgage loans that were non-income producing during 2019 totaled $1.0 million and $5.9 million, respectively.
During 2019 and 2017, VIEs that were required to be consolidated were dissolved. We recognized losses of $5.1 million and $4.3 million during 2019 and 2017, respectively, representing the difference between the borrowings of such VIEs and the contractual distributions required following the liquidation of the underlying assets.
million; (v) the decrease in fair value of embedded derivatives related to a modified coinsurance agreement of $5.1 million; and (vi) $2.6 million of writedowns of investments for other than temporary declines in fair value recognized through net income.
At December 31, 2019, there were no fixed maturity investments in default.
The following summarizes the investments sold at a loss during 2019 which had been continuously in an unrealized loss position exceeding 20 percent of the amortized cost basis prior to the sale for the period indicated (dollars in millions):
market liquidity and risk premiums. As of December 31, 2019, other-than-temporary impairments included in accumulated other comprehensive income totaled $.3 million (before taxes and related amortization).
The following table summarizes the amount of credit losses recognized in earnings on fixed maturity securities, available for sale, held at the beginning of the period, for which a portion of the other-than-temporary impairment was also recognized in accumulated other comprehensive income for the years ended December 31, 2019, 2018 and 2017 (dollars in millions):
The following summarizes the investments in our portfolio rated below-investment grade which have been continuously in an unrealized loss position exceeding 20 percent of the cost basis for the period indicated as of December 31, 2019 (dollars in millions):
For structured securities included in fixed maturities, available for sale, that were purchased at a discount or premium, we recognize investment income using an effective yield based on anticipated future prepayments and the estimated final maturity of the securities. Actual prepayment experience is periodically reviewed and effective yields are recalculated when differences arise between the prepayments originally anticipated and the actual prepayments received and currently anticipated. For credit sensitive mortgage-backed and asset-backed securities, and for securities that can be prepaid or settled in a way that we would not recover substantially all of our investment, the effective yield is recalculated on a prospective basis. Under this method, the amortized cost basis in the security is not immediately adjusted and a new yield is applied prospectively. For all other structured and asset-backed securities, the effective yield is recalculated when changes in assumptions are made, and reflected in our income on a retrospective basis. Under this method, the amortized cost basis of the investment in the securities is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the securities. Such adjustments were not significant in 2019.
The amortized cost and estimated fair value of structured securities at December 31, 2019, summarized by type of security, were as follows (dollars in millions):
Pass-throughs, sequentials and equivalent securities have unique prepayment variability characteristics. Pass-through securities typically return principal to the holders based on cash payments from the underlying mortgage obligations. Sequential securities return principal to tranche holders in a detailed hierarchy. Planned amortization classes, targeted amortization classes and accretion-directed bonds adhere to fixed schedules of principal payments as long as the underlying mortgage loans experience prepayments within certain estimated ranges. In most circumstances, changes in prepayment rates are first absorbed by support or companion classes insulating the timing of receipt of cash flows from the consequences of both faster prepayments (average life shortening) and slower prepayments (average life extension).
Life insurance companies are required to maintain certain investments on deposit with state regulatory authorities. Such assets had aggregate carrying values of $39.6 million and $39.0 million at December 31, 2019 and 2018, respectively.
The Company had no fixed maturity investments that were in excess of 10 percent of shareholders' equity at December 31, 2019 and 2018.
are reported as having occurred at the beginning of the period. There were no transfers between Level 1 and Level 2 in both 2019 and 2018.
Debt securities issued by foreign governments are generally priced using the market approach. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets, new issuances, benchmark yields, credit spreads and issuer rating.
As the Company is responsible for the determination of fair value, we have control processes designed to ensure that the fair values received from third-party pricing sources are reasonable and the valuation techniques and assumptions used appear
reasonable and consistent with prevailing market conditions. Additionally, when inputs are provided by third-party pricing sources, we have controls in place to review those inputs for reasonableness. As part of these controls, we perform monthly quantitative and qualitative analysis on the prices received from third parties to determine whether the prices are reasonable estimates of fair value. The Company's analysis includes: (i) a review of the methodology used by third-party pricing services; (ii) where available, a comparison of multiple pricing services' valuations for the same security; (iii) a review of month to month price fluctuations; (iv) a review to ensure valuations are not unreasonably dated; and (v) back testing to compare actual purchase and sale transactions with valuations received from third parties. As a result of such procedures, the Company may conclude a particular price received from a third party is not reflective of current market conditions. In those instances, we may request additional pricing quotes or apply internally developed valuations. However, the number of such instances is insignificant and the aggregate change in value of such investments is not materially different from the original prices received.
Purchases, sales, issuances and settlements, net, represent the activity that occurred during the period that results in a change of the asset or liability but does not represent changes in fair value for the instruments held at the beginning of the period. Such activity primarily consists of purchases and sales of fixed maturity and equity securities and changes to embedded derivative instruments related to insurance products resulting from the issuance of new contracts, or changes to existing contracts. The following summarizes such activity for the year ended December 31, 2019 (dollars in millions):
The following table presents additional information about assets and liabilities measured at fair value on a recurring basis and for which we have utilized significant unobservable (Level 3) inputs to determine fair value for the year ended December 31, 2018 (dollars in millions):
At December 31, 2019, 86 percent of our Level 3 fixed maturities, available for sale, were investment grade and 93 percent of our Level 3 fixed maturities, available for sale, consisted of corporate securities.
On December 22, 2017, the Tax Reform Act was signed into law and enacted a broad range of changes to the Internal Revenue Code (the "Code") including individual and corporate reforms and numerous changes to U.S. international tax provisions. The Tax Reform Act reduced the corporate tax rate to 21 percent from 35 percent effective January 1, 2018, and made significant changes to the taxation of life insurance companies. Among other things, the Tax Reform Act modified the
computation of life insurance reserves, increased the capitalization rate and extended the amortization period for policy acquisition costs, imposed limitations on the deductibility of performance-based compensation to "covered employees" and interest expense, and allowed for the expensing of certain capital expenditures. For NOLs arising after December 31, 2017, the Tax Reform Act limits the ability to utilize NOL carryforwards to 80% of taxable income. In addition, NOLs arising after 2017 can be carried forward indefinitely, but carryback is prohibited. As a result of the reduction in the federal corporate income tax rate, we reduced the value of our net deferred tax assets by $172.5 million (net of the reduction in the valuation allowance for deferred tax assets) which was recorded as additional income tax expense for the year ended December 31, 2017.
Effective January 1, 2017, the Company adopted new authoritative guidance related to several aspects of the accounting for share-based payment transactions, including the income tax consequences. Under the new guidance, any excess tax benefits are recognized as an income tax benefit in the income statement. The new guidance is applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings for all tax benefits that were not previously recognized because the related tax deduction had not reduced taxes payable. The Company had NOL carryforwards of $15.7 million related to deductions for stock options and restricted stock on the date of adoption. However, a corresponding valuation allowance of $15.7 million was recognized as a result of adopting this
guidance. Therefore, there was no impact to our consolidated financial statements related to the initial adoption of this provision of the new guidance.
The 2018 increase to the deferred tax valuation allowance includes: (i) an increase of $104.8 million due to the life NOLs generated by the tax loss on the long-term care reinsurance transaction; and (ii) other changes netting to $(.2) million. The increase in life company NOLs generated by the tax loss on the reinsurance transaction was expected to impact our ability to utilize non-life NOLs in the future.
The 2019 decrease to the deferred tax valuation allowance is related to the tax planning strategy discussed above.
In 2009, the Company's Board of Directors adopted a Section 382 Rights Agreement designed to protect shareholder value by preserving the value of our tax assets primarily associated with tax NOLs under Section 382. The Section 382 Rights Agreement was adopted to reduce the likelihood of an ownership change occurring by deterring the acquisition of stock that would create "5 percent shareholders" as defined in Section 382. The Section 382 Rights Agreement has been amended three times, most recently effective November 13, 2017 (the "Third Amended Section 382 Rights Agreement"). The Third Amended Section 382 Rights Agreement extended the expiration date of the Section 382 Rights Agreement to November 13, 2020, updated the purchase price of the rights described below and provided for a new series of preferred stock relating to the rights that is substantially identical to the prior series of preferred stock. The Third Amended Section 382 Rights Agreement was approved by the Company’s stockholders at the Company’s 2018 annual meeting.
indirect ownership of our common stock by any person or public group (as such term is defined in the regulations under Section 382) from less than 5% to 5% or more of our common stock; (ii) increase the percentage of our common stock owned directly or indirectly by a person or public group owning or deemed to own 5% or more of our common stock; or (iii) create a new public group. The Original Section 382 Charter Amendment was amended and extended in 2013, 2016 and 2019 (the "2019 Section 382 Charter Amendment"). The expiration date for the 2019 Section 382 Charter Amendment is July 31, 2022.
Pursuant to the Tax Reform Act, NOLs generated subsequent to 2017 do not have an expiration date. We have $2.5 billion of federal NOLs as of December 31, 2019, as summarized below (dollars in millions):
The following notes payable were direct corporate obligations of the Company as of December 31, 2019 and 2018 (dollars in millions):
The Company used the net proceeds from the offering of the 2029 Notes to: (i) repay all amounts outstanding under its existing Revolving Credit Agreement (as defined below); (ii) redeem and satisfy and discharge all of its outstanding 4.500% Senior Notes due May 2020 (the "2020 Notes"); and (iii) pay fees and expenses related to the foregoing. The remaining proceeds were used for general corporate purposes.
The 2029 Notes are the Company’s senior unsecured obligations and rank equally with the Company’s other senior unsecured and unsubordinated debt from time to time outstanding. The 2029 Notes are effectively subordinated to all of the Company’s existing and future secured indebtedness to the extent of the value of the assets securing such indebtedness. The 2029 Notes are structurally subordinated to all existing and future indebtedness and other liabilities of the Company’s subsidiaries.
The 2019 Indenture contains covenants that restrict the Company’s ability, with certain exceptions, to:
issue, sell, transfer or otherwise dispose of any shares of capital stock of any Insurance Subsidiary (as defined in the 2019 Indenture); and
Prior to February 28, 2025, the Company may redeem some or all of the 2025 Notes at any time or from time to time at a "make-whole" redemption price plus accrued and unpaid interest to, but not including, the redemption date. On and after February 28, 2025, the Company may redeem some or all of the 2025 Notes at any time or from time to time at a redemption price equal to 100% of the principal amount thereof plus accrued and unpaid interest to, but not including, the redemption date.
Upon the occurrence of a Change of Control Repurchase Event (as defined in the 2015 Indenture), the Company will be required to make an offer to repurchase the 2025 Notes at a price equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to, but not including, the date of repurchase.
issue, sell, transfer or otherwise dispose of any shares of capital stock of any Insurance Subsidiary (as defined in the 2015 Indenture); and
The 2015 Indenture provides for customary events of default (subject in certain cases to customary grace and cure periods), which include nonpayment, breach of covenants in the 2015 Indenture, failure to pay at maturity or acceleration of other indebtedness, a failure to pay certain judgments and certain events of bankruptcy and insolvency. Generally, if an event of default occurs, the Trustee or holders of at least 25% in principal amount of the then outstanding 2025 Notes may declare the principal of and accrued but unpaid interest, including any additional interest, on all of the 2025 Notes to be due and payable.
On May 19, 2015, the Company entered into a $150.0 million four-year unsecured revolving credit agreement with KeyBank National Association, as administrative agent (the "Agent"), and the lenders from time to time party thereto. On May 19, 2015, the Company made an initial drawing of $100.0 million under the Revolving Credit Agreement. On October 13, 2017, the Company entered into an amendment and restatement agreement (the "Amendment Agreement") with respect to its revolving credit agreement (as amended by the Amendment Agreement, the "Revolving Credit Agreement"). The Amendment
The Revolving Credit Agreement provides for customary events of default (subject in certain cases to customary grace and cure periods), which include, without limitation, the following:
actual or asserted invalidity of documentation with respect to the Revolving Credit Agreement;
If an event of default under the Revolving Credit Agreement occurs and is continuing, the Agent may accelerate the amounts and terminate all commitments outstanding under the Revolving Credit Agreement.
The scheduled repayment of our direct corporate obligations was as follows at December 31, 2019 (dollars in millions):
In addition to the inherent difficulty of predicting litigation outcomes, particularly those that will be decided by a jury, some matters purport to seek substantial or an unspecified amount of damages for unsubstantiated conduct spanning several years based on complex legal theories and damages models. The alleged damages typically are indeterminate or not factually supported in the complaint, and, in any event, the Company's experience indicates that monetary demands for damages often bear little relation to the ultimate loss. In some cases, plaintiffs are seeking to certify classes in the litigation and class
certification either has been denied or is pending and we have filed oppositions to class certification or sought to decertify a prior class certification. In addition, for many of these cases: (i) there is uncertainty as to the outcome of pending appeals or motions; (ii) there are significant factual issues to be resolved; and/or (iii) there are novel legal issues presented. Accordingly, the Company cannot reasonably estimate the possible loss or range of loss in excess of amounts accrued, if any, or predict the timing of the eventual resolution of these matters. The Company reviews these matters on an ongoing basis. When assessing reasonably possible and probable outcomes, the Company bases its assessment on the expected ultimate outcome following all appeals.
On September 29, 2016, Washington National and BCLIC commenced an arbitration proceeding seeking compensatory, consequential and punitive damages against Beechwood Re Ltd. ("BRe") based upon BRe’s incurable material breaches of the long-term care reinsurance agreements, conversion, fraud, and breaches of fiduciary duties and the obligation to deal honestly and in good faith. BRe filed a counterclaim against Washington National and BCLIC in the arbitration alleging damages relating to the reinsurance agreements and their termination. In addition, on September 29, 2016, a complaint was filed by BCLIC and Washington National in the United States District Court for the Southern District of New York, Bankers Conseco Life Insurance Company and Washington National Insurance Company v. Moshe M. Feuer, Scott Taylor and David Levy, alleging, among other claims, fraud/fraudulent concealment, and violation of the Racketeer Influenced and Corrupt Organizations Act. These allegations relate to the long-term care reinsurance agreements between BRe and Washington National and BCLIC, respectively, and emanate from the undisclosed relationships between and among the defendants (who were the principal owners and officers of BRe) and Platinum Partners, LP and its affiliates ("Platinum"). On April 27, 2017, an amended complaint was filed adding Beechwood Capital Group, LLC as a defendant. On March 13, 2018, the District Court granted defendants' motion to compel arbitration of Washington National's and BCLIC's claims pending the outcome of the arbitration. In connection with the action brought by the PPCO Receiver, discussed below, BCLIC and Washington National reached agreements in October 2019 to settle all claims between themselves and the parties to the arbitration and litigation, namely BRe, Feuer, Taylor, Levy and Beechwood Capital Group, LLC. These settlements involve BCLIC’s and Washington National’s receipt of financial consideration and have been approved by the Grand Court of the Cayman Islands that is presiding over BRe’s winding up proceedings, as well as by the United States District Court for the Southern District of New York.
By public notice dated July 26, 2017, the Cayman Islands Monetary Authority advised that, effective July 25, 2017, two individuals (the "Controllers") had been appointed pursuant to Section 24(2)(h) of the Cayman Islands Insurance Law to assume control of the affairs of BRe. According to the public notice, effective with their appointment, the Controllers assumed immediate control of the affairs of BRe and have all the powers necessary to administer the affairs of BRe including power to terminate its insurance business. The Controllers are responsible for assessing the financial position of BRe and submitting a report to the Cayman Islands Monetary Authority. On August 10, 2018, the Cayman Islands Monetary Authority filed a public petition in the Grand Court of the Cayman Islands to officially wind up BRe, concluding that BRe was now of doubtful solvency. On November 27, 2018, the Grand Court of the Cayman Islands granted the petition to officially wind up BRe and appointed the current Controllers of BRe to be its Joint Official Liquidators. As noted in the previous paragraph, the Grand Court of the Cayman Islands has approved BRe’s settlements with BCLIC and Washington National.
On March 27, 2019, BCLIC and Washington National brought cross-claims and third-party claims in the PPCO Receiver Action against BRe and a number of its affiliates, as well as many Platinum and BRe insiders, alleging that they secretly funded, controlled and operated the BRe enterprise for the benefit of Platinum. BCLIC and Washington National have also brought third-party claims against Lincoln International LLC, which provided valuation services to the BRe enterprise. In October 2019, in exchange for their receiving financial consideration, BCLIC and Washington National agreed to settle many of their cross-claims and third-party claims against BRe and a number of its affiliates, as well as many Platinum and BRe insiders. BCLIC and Washington National have also resolved their claims against Lincoln International LLC. All of these settlements have been approved by the court.
On June 28, 2019, BCLIC and Washington National commenced an action entitled Bankers Conseco Life Insurance Company and Washington National Insurance Company v. KPMG LLP, in the Supreme Court of the State of New York, County of New York, Commercial Division (the "KPMG Action"). In the KPMG Action, BCLIC and Washington National assert claims against KPMG LLP ("KPMG") for aiding and abetting fraud, constructive fraud and negligent misrepresentation arising from KPMG's alleged role in the Platinum Partners' scheme to defraud BCLIC and Washington National into reinsuring its long-term care business with BRe.
The Company rents office space, equipment and computer software under contractual commitments or noncancellable operating lease agreements. In addition, the Company has entered into certain sponsorship agreements which require future payments. Total expense pursuant to these agreements was $67.0 million, $67.0 million and $61.4 million in 2019, 2018 and 2017, respectively.
Information related to our right of use assets are as follows (dollars in millions):
Maturities of our operating lease liabilities as of December 31, 2019 are as follows (dollars in millions):
The benefits expected to be paid pursuant to our agent deferred compensation plan as of December 31, 2019 were as follows (dollars in millions):
If the counterparties to the call options fail to meet their obligations, we may recognize a loss. We limit our exposure to such a loss by diversifying among several counterparties believed to be strong and creditworthy. At December 31, 2019, all of our counterparties were rated "A" or higher by S&P.
The following table summarizes information related to derivatives with master netting arrangements or collateral as of December 31, 2019 and 2018 (dollars in millions):
In May 2011, the Company announced a securities repurchase program. In 2019, 2018 and 2017, we repurchased 15.4 million, 5.5 million and 7.8 million shares, respectively, for $252.3 million (including $1.8 million of repurchases settled in the first quarter of 2020), $100.9 million and $167.1 million, respectively, under the securities repurchase program. The Company had remaining repurchase authority of $532.3 million as of December 31, 2019.
In 2019, 2018 and 2017, dividends declared on common stock totaled $67.2 million ($0.43 per common share), $65.1 million ($0.39 per common share) and $59.6 million ($0.35 per common share), respectively. In May 2019, the Company increased its quarterly common stock dividend to $0.11 per share from $0.10 per share. In May 2018, the Company increased its quarterly common stock dividend to $0.10 per share from $0.09 per share. In May 2017, the Company increased its quarterly common stock dividend to $0.09 per share from $0.08 per share.
A summary of the Company's stock option activity and related information for 2019 is presented below (shares in thousands; dollars in millions, except per share amounts):
A summary of the Company's stock option activity and related information for 2018 is presented below (shares in thousands; dollars in millions, except per share amounts):
the Company from the exercise of stock options was $6.9 million, $3.9 million and $8.3 million during 2019, 2018 and 2017, respectively.
The exercise price was equal to the market price of our stock on the date of grant for all options granted in 2019, 2018 and 2017.
The following table summarizes information about stock options outstanding at December 31, 2019 (shares in thousands):
During 2019, 2018 and 2017, the Company granted restricted stock of .5 million, .4 million and .3 million, respectively, to certain directors, officers and employees of the Company at a weighted average fair value of $17.07 per share, $22.36 per share and $20.87 per share, respectively. The fair value of such grants totaled $8.1 million, $9.7 million and $6.9 million in 2019, 2018 and 2017, respectively. Such amounts are recognized as compensation expense over the vesting period of the restricted stock. A summary of the Company's non-vested restricted stock activity for 2019 is presented below (shares in thousands):
At December 31, 2019, the unrecognized compensation expense for non-vested restricted stock totaled $7.6 million which is expected to be recognized over a weighted average period of 1.8 years. At December 31, 2018, the unrecognized
compensation expense for non-vested restricted stock totaled $7.7 million. We recognized compensation expense related to restricted stock awards totaling $7.2 million, $7.1 million and $6.1 million in 2019, 2018 and 2017, respectively. The fair value of restricted stock that vested during 2019, 2018 and 2017 was $6.5 million, $4.2 million and $2.7 million, respectively.
Effective January 1, 2017, the Company adopted new authoritative guidance related to several aspects of the accounting for share-based payment transactions, including the accounting policy for forfeiture rate assumptions. Under the new guidance, we elected to account for forfeitures as they occur. The impact of adoption of this provision of the guidance increased additional paid-in capital by $.9 million, decreased retained earnings by $.6 million and increased income tax assets by $.3 million. Prior to 2017, authoritative guidance required us to estimate the amount of unvested stock-based awards that would be forfeited in future periods and reduce the amount of compensation expense recognized over the applicable service period to reflect such estimate.
In 2019, 2018 and 2017, the Company granted performance units totaling 485,830, 319,920 and 452,900, respectively, pursuant to its long-term incentive plan to certain officers of the Company. The criteria for payment for such awards are based on certain company-wide performance levels that must be achieved within a specified performance time (generally three years), each as defined in the award. The performance units granted in 2019, 2018 and 2017 provide for a payout of up to 200 percent of the award if certain performance thresholds are achieved. Unless antidilutive, the diluted weighted average shares outstanding would reflect the number of performance units expected to be issued, using the treasury stock method.
(a) The performance units that vested in 2017, 2018 and 2019 provided for a payout of up to 150 percent, 200 percent and 200 percent, respectively, of the award if certain performance levels were achieved.
The three states with the largest shares of 2019 collected premiums were Florida (11 percent), Pennsylvania (6 percent) and Texas (5 percent). No other state accounted for more than five percent of total collected premiums.
Such non-cash amounts are not included in the consolidated statement of cash flows.
Other non-cash items not reflected in the investing and financing activities sections of the consolidated statement of cash flows (dollars in millions):
At December 31, 2019, the consolidated RBC ratio of our insurance subsidiaries exceeded the minimum RBC requirement included in our Revolving Credit Agreement. See the note to the consolidated financial statements entitled "Notes Payable - Direct Corporate Obligations" for further discussion of various financial ratios and balances we are required to maintain. We calculate the consolidated RBC ratio by assuming all of the assets, liabilities, capital and surplus and other aspects of the business of our insurance subsidiaries are combined together in one insurance subsidiary, with appropriate intercompany eliminations.
We measure segment performance by excluding the loss related to reinsurance transaction, net realized investment gains (losses), fair value changes in embedded derivative liabilities (net of related amortization), fair value changes in the agent deferred compensation plan, loss on extinguishment of debt, income taxes and other non-operating items consisting primarily of earnings attributable to VIEs ("pre-tax operating earnings") because we believe that this performance measure is a better indicator of the ongoing business and trends in our business. Our primary investment focus is on investment income to support our liabilities for insurance products as opposed to the generation of net realized investment gains (losses), and a long-term focus is necessary to maintain profitability over the life of the business.
The loss related to reinsurance transaction, net realized investment gains (losses), fair value changes in embedded derivative liabilities (net of related amortization), fair value changes in the agent deferred compensation plan, loss on extinguishment of debt and other non-operating items consisting primarily of earnings attributable to VIEs depend on market conditions or represent unusual items that do not necessarily relate to the underlying business of our segments. Net realized investment gains (losses) and fair value changes in embedded derivative liabilities (net of related amortization) may affect future earnings levels since our underlying business is long-term in nature and changes in our investment portfolio may impact our ability to earn the assumed interest rates needed to maintain the profitability of our business.
All of the VIEs are collateralized loan trusts that were established to issue securities to finance the purchase of corporate loans and other permitted investments. The assets held by the trusts are legally isolated and not available to the Company. The liabilities of the VIEs are expected to be satisfied from the cash flows generated by the underlying loans held by the trusts, not from the assets of the Company. During 2019 and 2017, VIEs that were required to be consolidated were dissolved. We recognized losses of $5.1 million and $4.3 million in 2019 and 2017, respectively, representing the difference between the borrowings of such VIEs and the contractual distributions required following the liquidation of the underlying assets. The scheduled repayment of the remaining principal balance of the borrowings related to the VIEs are as follows: $2.1 million in 2020; $27.6 million in 2021; $99.7 million in 2022; $340.5 million in 2023; $314.1 million in 2024; $183.3 million in 2025; $120.1 million in 2026; $63.4 million in 2027; $.8 million in 2028; and $7.0 million in 2030. The Company has no financial obligation to the VIEs beyond its investment in each VIE.
During 2019, the VIEs recognized net realized investment losses of $20.5 million which were comprised of: (i) $12.4 million of net losses from the sales of fixed maturities; (ii) $5.1 million of losses on the dissolution of a VIE; and (iii) $3.0 million of writedowns of investments for other than temporary declines in fair value recognized through net income. During 2018, the VIEs recognized net realized investment losses of $3.6 million from the sales of fixed maturities. During 2017, the VIEs recognized net realized investment losses of $5.6 million which were comprised of: (i) $1.2 million of net gains from the sales of fixed maturities; (ii) $4.3 million of losses on the dissolution of VIEs; and (iii) $2.5 million of writedowns of investments for other than temporary declines in fair value recognized through net income.
At December 31, 2019, the VIEs held: (i) investments with a fair value of $153.0 million and gross unrealized losses of $3.1 million that had been in an unrealized loss position for less than twelve months; and (ii) investments with a fair value of $430.1 million and gross unrealized losses of $18.5 million that had been in an unrealized loss position for greater than twelve months.
The Consumer Division will serve individual consumers, engaging with them on the phone, online, face-to-face with agents, or through a combination of sales channels. This structure unifies consumer capabilities into a single division and integrates the strength of our agent sales forces and industry-leading direct-to-consumer business with proven experience in advertising, web/digital and call center support.
We will also centralize certain functional areas previously housed in the three business segments, including marketing, business unit finance, sales training and support, and agent recruiting, among others. We will continue to market our products under our three primary brands: Bankers Life, Washington National and Colonial Penn. All policy, contract, and certificate terms, conditions, and benefits remain unchanged.