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CNO FINANCIAL GROUP, INC. – 10-K – MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
In this section, we review the consolidated financial condition of CNO and its consolidated results of operations for the years endedDecember 31, 2021 , 2020 and 2019 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.
OVERVIEW
We are a holding company for a group of insurance companies operating throughoutthe United States that develop, market and administer health insurance, annuity, individual life insurance and other insurance products. We focus on serving middle-income pre-retiree and retired Americans, which we believe are attractive, underserved, high growth markets. We sell our products through exclusive agents, independent producers (some of whom sell one or more of our product lines exclusively) and direct marketing. We view our operations as three insurance product lines (annuity, health and life) and the investment and fee income segments. Our segments are aligned based on their common characteristics, comparability of profit margins and the way management makes operating decisions and assesses the performance of the business. Our insurance product line segments (annuity, health and life) include marketing, underwriting and administration of the policies our insurance subsidiaries sell. The business written in each of the three product categories through all of our insurance subsidiaries is aggregated allowing management and investors to assess the performance of each product category. When analyzing profitability of these segments, we use insurance product margin as the measure of profitability, which is: (i) insurance policy income; and (ii) net investment income allocated to the insurance product lines; less (i) insurance policy benefits and interest credited to policyholders; and (ii) amortization, non-deferred commissions and advertising expense. Net investment income is allocated to the product lines using the book yield of investments backing the block of business, which is applied to the average insurance liabilities, net of insurance intangibles, for the block in each period. Income from insurance products is the sum of the insurance margins of the annuity, health and life product lines, less expenses allocated to the insurance lines. It excludes the income from our fee income business, investment income not allocated to product lines, net expenses not allocated to product lines (primarily holding company expenses) and income taxes. Management believes insurance product margin and income from insurance products help provide a better understanding of the business and a more meaningful analysis of the results of our insurance product lines.
We market our insurance products through the Consumer and Worksite Divisions
that reflect the customers served by the Company.
The Consumer Division serves individual consumers, engaging with them on the phone, virtually, 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 with one of the largest direct-to-consumer businesses with proven experience in advertising, web/digital and call center support. The Worksite Division focuses on worksite and group sales for businesses, associations, and other membership groups, interacting with customers at their place of employment and virtually. With a separate Worksite Division, we are bringing a sharper focus to this high-growth business while further capitalizing on the strength of our acquisitions of WBD andDirectPath . Sales in the Worksite Division have been particularly adversely impacted by the COVID-19 pandemic given the challenges of interacting with customers at their place of employment. In addition, the Worksite Division is increasing its recruiting efforts to rebuild its agent force which was adversely impacted by the COVID-19 pandemic. The Consumer and Worksite Divisions are primarily focused on marketing insurance products, several types of which are sold in both divisions and underwritten in the same manner. Sales of group underwritten policies are currently not significant, but are expected to increase within the Worksite Division. We have also centralized certain functional areas previously housed in the three business segments, including marketing, business unit finance, sales training and support, and agent recruiting, among others. All policy, contract, and certificate terms, conditions, and benefits remain unchanged. 45 -------------------------------------------------------------------------------- Table of Contents The investment segment involves the management of our capital resources, including investments and the management of corporate debt and liquidity. Our measure of profitability of this segment is the total net investment income not allocated to the insurance products. Investment income not allocated to product lines represents net investment income less: (i) equity returns credited to policyholder account balances; (ii) the investment income allocated to our product lines; (iii) interest expense on notes payable and investment borrowings; (iv) expenses related to the funding agreement-backed note ("FABN") program; and (v) certain expenses related to benefit plans that are offset by special-purpose investment income. Investment income not allocated to product lines includes investment income on investments in excess of average insurance liabilities, investments held by our holding companies, the spread we earn from our FHLB investment borrowing and FABN programs and variable components of investment income (including call and prepayment income, adjustments to returns on structured securities due to cash flow changes, income (loss) from Company-owned life insurance ("COLI") and alternative investment income not allocated to product lines), net of interest expense on corporate debt. Our fee income segment includes the earnings generated from sales of third-party insurance products, services provided by WBD (our on-line benefit administration firm),DirectPath (a national provider of year-round technology-driven employee benefits management services) and the operations of our broker-dealer and registered investment advisor.
Expenses not allocated to product lines include the expenses of our corporate
operations, excluding interest expense on debt.
46 -------------------------------------------------------------------------------- Table of Contents The following summarizes our earnings for the three years endingDecember 31, 2021 (dollars in millions, except per share data): 2021 2020 2019 Insurance product margin Annuity margin$ 270.3 $ 296.7 $ 230.1 Health margin 493.0 459.8 362.9 Life margin 150.4 165.0 196.1 Total insurance product margin 913.7 921.5 789.1 Allocated expenses (566.5) (557.7) (543.0) Income from insurance products 347.2 363.8 246.1 Fee income 19.4 16.7 23.5 Investment income not allocated to product lines 184.5 167.1 152.1 Expenses not allocated to product lines (80.5) (83.8) (53.4) Operating earnings before taxes 470.6 463.8 368.3 Income tax expense on operating income (105.0) (101.5) (78.3) Net operating income (a) 365.6 362.3 290.0
Net realized investment gains (losses) from sales,
impairments and change in allowance for credit losses (net
of related amortization)
34.8 (31.1) 2.1
Net change in market value of investments recognized in
earnings
(17.4) (2.7) 25.5
Fair value changes related to agent deferred compensation
plan
8.9 (16.3) (20.4)
Fair value changes in embedded derivative liabilities (net
of related amortization)
67.2 (79.1) (81.4) Loss on extinguishment of debt - - (7.3) Other 3.6 9.7 (12.6) Net non-operating income (loss) before taxes 97.1 (119.5) (94.1) Income tax expense (benefit): On non-operating income (loss) 21.7 (25.0) (19.8)
Valuation allowance for deferred tax assets and other tax
items
- (34.0) (193.7) Net non-operating income (loss) 75.4 (60.5) 119.4 Net income 441.0 301.8 409.4 Per diluted share: Net operating income$ 2.79 $ 2.53 $ 1.85 Net non-operating income (loss) .57 (.42) .76 Net income$ 3.36 $ 2.11 $ 2.61 47
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(a)Management believes that an analysis of net income applicable to common stock
before: (i) net realized investment gains (losses) from sales, impairments and
change in allowance for credit losses, net of related amortization and taxes;
(ii) net change in market value of investments recognized in earnings, net of
taxes; (iii) 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; (iv) fair value changes
related to the agent deferred compensation plan, net of taxes; (v) loss on
extinguishment of debt; (vi) changes in the valuation allowance for deferred tax
assets and other tax items; and (vii) other non-operating items consisting
primarily of earnings attributable to VIEs ("net operating income", a non-GAAP
financial measure) is important to evaluate the financial performance of the
company, and is a key measure commonly used in the life insurance industry.
Management uses this measure to evaluate performance because the items excluded
from net operating income can be affected by events that are unrelated to the
company's underlying fundamentals. The table above reconciles the non-GAAP
measure to the corresponding GAAP measure.
In addition, management uses these non-GAAP financial measures in its budgeting
process, financial analysis of segment performance and in assessing the
allocation of resources. We believe these non-GAAP financial measures enhance an
investor's understanding of our financial performance and allows them to make
more informed judgments about the Company as a whole. These measures also
highlight operating trends that might not otherwise be apparent. However, net
operating income is not a measurement of financial performance under GAAP and
should not be considered as an alternative to cash flow from operating
activities, as measures of liquidity, or as an alternative to net income as
measures of our operating performance or any other measures of performance
derived in accordance with GAAP. In addition, net operating income should not be
construed as an inference that our future results will be unaffected by unusual
or non-recurring items. Net operating income has limitations as an analytical
tool, and you should not consider such measure either in isolation or as a
substitute for analyzing our results as reported under GAAP. Our definition and
calculation of net operating income are not necessarily comparable to other
similarly titled measures used by other companies due to different methods of
calculation.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of various assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Management has made estimates in the past that we believed to be appropriate but were subsequently revised to reflect actual experience. If our future experience differs materially from these estimates and assumptions, our results of operations and financial condition could be materially affected. We base our estimates on historical experience and other assumptions that we believe are reasonable under the circumstances. We continually evaluate the information used to make these estimates as our business and the economic environment change. The use of estimates is pervasive throughout our financial statements. The accounting policies and estimates we consider most critical are summarized below. Additional information on our accounting policies is included in the note to our consolidated financial statements entitled "Summary of Significant Accounting Policies".
Investment Valuation
Fair value is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at
the measurement date and, therefore, represents an exit price, not an entry
price. We carry certain assets and liabilities at fair value on a recurring
basis, including fixed maturities, equity securities, trading securities,
investments held by VIEs, derivatives, separate account assets and embedded
derivatives related to fixed index annuity products. We carry our COLI, which is
invested in a series of mutual funds, at its cash surrender value which
approximates fair value. In addition, we disclose fair value for certain
financial instruments, including mortgage loans, policy loans, cash and cash
equivalents, insurance liabilities for interest-sensitive products and funding
agreements, investment borrowings, notes payable and borrowings related to VIEs.
The degree of judgment utilized in measuring the fair value of financial
instruments is largely dependent on the level to which pricing is based on
observable inputs. Observable inputs reflect market data obtained from
independent sources, while unobservable inputs reflect our view of market
assumptions in the absence of observable market information. Financial
instruments with readily available active quoted prices would be considered to
have fair values based on the highest level of observable inputs, and little
judgment would be utilized in measuring fair value. Financial instruments that
rarely trade would often have fair value based on a lower level of observable
inputs, and more judgment would be utilized in measuring fair value.
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We categorize our financial instruments carried at fair value into a three-level
hierarchy based on the observability of inputs. The three-level hierarchy for
fair value measurements is described in the note to the consolidated financial
statements entitled "Fair Value Measurements."
The following summarizes investments on our consolidated balance sheet carried
at fair value by pricing source and fair value hierarchy level as of
Quoted prices in
active markets for Significant Significant
identical assets observable inputs unobservable inputs
(Level 1) (Level 2) (Level 3) Total fair value
Priced by third-party pricing services $ 100.8$ 26,121.5 $ -$ 26,222.3 Priced by independent broker quotations - 124.9 130.2 255.1 Priced by matrices - 2.4 - 2.4 Priced by other methods (a) - 70.8 40.2 111.0 Total $ 100.8$ 26,319.6 $ 170.4 $ 26,590.8 Percent of total .4 % 99.0 % .6 % 100.0 % _______________
(a) Represents primarily securities with a fair value based on purchase price.
EffectiveJanuary 1, 2020 , when an available for sale fixed maturity security's fair value is below the amortized cost, the security is considered impaired. If a portion of the decline is due to credit-related factors, we separate the credit loss component of the impairment from the amount related to all other factors. The credit loss component is recorded as an allowance and reported in net investment gains (losses) (limited to the difference between estimated fair value and amortized cost). The impairment related to all other factors (non-credit factors) is reported in accumulated other comprehensive income along with unrealized gains related to fixed maturity investments, available for sale, net of tax and related adjustments. The allowance is adjusted for any additional credit losses and subsequent recoveries. When recognizing an allowance associated with a credit loss, the cost basis is not adjusted. When we determine a security is uncollectable, the remaining amortized cost will be written off. In determining the credit loss component, we discount the estimated cash flows on a security by security basis. We consider the impact of macroeconomic conditions on inputs used to measure the amount of credit loss. For most structured securities, cash flow estimates are based on bond-specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity, prepayment speeds and structural support, including overcollateralization, excess spread, subordination and guarantees. For corporate bonds, cash flow estimates are derived by considering asset type, rating, time to maturity, and applying an expected loss rate. If we intend to sell an impaired fixed maturity security, available for sale, or identify an impaired fixed maturity security, available for sale, for which is it more likely than not we will be required to sell before anticipated recovery, the difference between the fair value and the amortized cost is included in net investment gains (losses) and the fair value becomes the new amortized cost. The new cost basis is not adjusted for any subsequent recoveries in fair value. Prior toJanuary 1, 2020 , we regularly evaluated all of our investments with unrealized losses for possible impairment. Our assessment of whether unrealized losses were "other than temporary" required significant judgment. Factors considered included: (i) the extent to which fair value was less than the cost basis; (ii) the length of time that the fair value had been less than cost; (iii) whether the unrealized loss was event driven, credit-driven or a result of changes in market interest rates or risk premium; (iv) the near-term prospects for specific events, developments or circumstances likely to affect the value of the investment; (v) the investment's rating and whether the investment was investment-grade and/or had been downgraded since its purchase; (vi) whether the issuer was current on all payments in accordance with the contractual terms of the investment and was expected to meet all of its obligations under the terms of the investment; (vii) whether we intend to sell the investment or it was more likely than not that circumstances would require us to sell the investment before recovery occurs; (viii) the underlying current and prospective asset and enterprise values of the issuer and the extent to which the recoverability of the carrying value of our investment would be affected by changes in such values; (ix) projections of, and unfavorable changes in, cash flows on structured securities including mortgage-backed and asset-backed securities; (x) our best estimate of the value of any collateral; and (xi) other objective and subjective factors. 49
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The manner in which impairment losses on fixed maturity securities, available for sale, were recognized in the financial statements was dependent on the facts and circumstances related to the specific security. If we intended to sell a security or it was more likely than not that we would be required to sell a security before the recovery of its amortized cost, the security was other-than-temporarily impaired and the full amount of the impairment was recognized as a loss through earnings. If we did not expect to recover the amortized cost basis, we did not plan to sell the security, and if it was not more likely than not that we would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, the recognition of the other-than-temporary impairment was bifurcated. We recognized the credit loss portion in net income and the noncredit loss portion in accumulated other comprehensive income. We estimated 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 was 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 varied depending on the type of security. For most structured securities, cash flow estimates were based on bond-specific facts and circumstances that included collateral characteristics, expectations of delinquency and default rates, loss severity, prepayment speeds and structural support, including overcollateralization, excess spread, subordination and guarantees. For corporate bonds, cash flow estimates were derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using bond-specific facts and circumstances. The previous amortized cost basis less the impairment recognized in net income became the security's new cost basis. We accreted the new cost basis to the estimated future cash flows over the expected remaining life of the security, except when the security was in default or considered nonperforming. Future events may occur, or additional information may become available, which may necessitate future realized losses in our portfolio. Significant losses could have a material adverse effect on our consolidated financial statements in future periods.
For more information on our investment portfolio and our critical accounting
policies related to investments, see the note to our consolidated financial
statements entitled "Investments".
Present Value of Future Profits and Deferred Acquisition Costs
In conjunction with the implementation of fresh start accounting, we eliminated the historical balances of our Predecessor's deferred acquisition costs and the present value of future profits and replaced them with the present value of future profits as calculated on the Effective Date. 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 ofDecember 31, 2021 as follows: 11 percent in 2022, 10 percent in 2023, 9 percent in 2024, 7 percent in 2025 and 7 percent in 2026. 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 profits using the interest rate credited to the underlying policies. For other products, we generally amortize these costs in relation to future anticipated premium revenue using the projected investment earnings rate. Insurance acquisition costs are amortized to expense over the lives of the underlying policies in relation to future anticipated premiums or gross profits. The insurance acquisition costs for policies other than interest-sensitive life and annuity products are amortized with interest (using the projected investment earnings rate) over the estimated premium-paying period of the policies, in a manner which recognizes amortization expense in proportion to each year's premium income. The insurance acquisition costs for interest-sensitive life and annuity products are amortized with interest (using the interest rate credited to the underlying policy) in proportion to estimated gross profits. The interest, mortality, morbidity and persistency assumptions used to amortize insurance acquisition costs are consistent with those assumptions used to estimate liabilities for insurance products. For interest-sensitive life and annuity products, these assumptions are reviewed on a regular basis. When actual profits or our current best estimates of future profits are different from previous estimates, we adjust cumulative amortization of 50
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insurance acquisition costs to maintain amortization expense as a constant
percentage of gross profits over the entire life of the policies.
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$1.7 million ,$(2.4) million and$.6 million during the years endedDecember 31, 2021 , 2020 and 2019, 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$454.0 million atDecember 31, 2021 (including$165.0 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 atDecember 31, 2020 was a decrease of$665.7 million (including$339.5 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). AtDecember 31, 2021 , the balance of insurance acquisition costs was$1.3 billion . The recoverability of this amount is dependent on the future profitability of the related business. Each year, we evaluate the recoverability of the unamortized balance of insurance acquisition costs. These evaluations are performed to determine whether estimates of the present value of future cash flows, in combination with the related liability for insurance products, will support the unamortized balance. These future cash flows are based on our best estimate of future premium income, less benefits and expenses. The present value of these cash flows, plus the related balance of liabilities for insurance products, is then compared with the unamortized balance of insurance acquisition costs. In the event of a deficiency, such amount would be charged to amortization expense. If the deficiency exceeds the balance of insurance acquisition costs, a premium deficiency reserve is established for the excess. The determination of future cash flows involves significant judgment. Revisions to the assumptions which determine such cash flows could have a significant adverse effect on our results of operations and financial position. The table presented below summarizes our estimates of cumulative adjustments to insurance acquisition costs or premium deficiency reserves (when the deficiency exceeds the balance of insurance acquisition costs) resulting from hypothetical revisions to certain assumptions. Although such hypothetical revisions are not currently required or anticipated, we believe they could occur based on past variances in experience and our expectations of the ranges of future experience that could reasonably occur. We have assumed that revisions to assumptions resulting in the adjustments summarized below would occur equally among policy types, ages and durations within each product classification. Any actual adjustment would be dependent on the specific policies affected and, therefore, may differ from the estimates summarized below. In addition, the impact of actual adjustments would reflect the net effect of all changes in assumptions during the period. 51
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Estimated adjustment to income
before income taxes based on
Change in assumptions
revisions to certain assumptions
(dollars in millions)
Interest-sensitive life products:
5% increase to assumed mortality $(10)
5% decrease to assumed mortality 11
15% increase to assumed expenses (3)
15% decrease to assumed expenses 3
10 basis point decrease to assumed spread (a) (2)
10 basis point increase to assumed spread (a) 2
20% increase to assumed lapses (2)
20% decrease to assumed lapses 2
Fixed index and fixed interest annuity products:
20% increase to assumed surrenders (6)
20% decrease to assumed surrenders 6
15% increase to assumed expenses (1)
15% decrease to assumed expenses 1
10 basis point decrease to assumed spread (a) (11)
10 basis point increase to assumed spread (a) 11
Other than interest-sensitive life and annuity products (b):
Level new money rates for investment earnings rate
(13)
__________________
(a)Spread reduction is calculated by changing earned rates 10 basis points while keeping credited rates unchanged. (b)We have excluded the effect of reasonably likely changes in lapse, surrender and expense assumptions for policies other than interest-sensitive life and annuity products. The following hypothetical scenarios illustrate the sensitivity of changes in interest rates to our products based on our 2021 comprehensive actuarial review (including the impacts of the changes on insurance acquisition costs, premium deficiency reserves and the valuation of the embedded derivatives related to our fixed index products): •The first hypothetical scenario assumes immediate and permanent reductions to current interest rate spreads on interest-sensitive products. We estimate that a pre-tax charge of approximately$25 million would occur if we increased credited rates related to our interest-sensitive life and annuity products immediately and permanently by 10 basis points due to an increase in the rate credited to account values (or an equivalent increase to the amount allocated to the cost of options for our fixed index annuity products) with no change to assumed earned rates. •The second scenario assumes that new money rates decrease to an overall average of 3.00 percent immediately and remain at that level indefinitely on non-interest sensitive products. We estimate that this scenario would not result in a pre-tax charge but would reduce future margins on non-interest sensitive products by approximately$207 million . •The third scenario assumes that new money rates decrease to an overall average of 2.00 percent immediately and remain at that level indefinitely on non-interest sensitive products. We estimate that this scenario would result in a pre-tax charge of approximately$3 million on our life contingent payout annuity block and reduce the future margins on non-interest sensitive products by approximately$439 million . Although the hypothetical revisions described in the scenarios summarized above are not currently required or anticipated, we believe similar changes could occur based on past variances in experience and our expectations of the ranges of future experience that could reasonably occur. We have assumed that revisions to assumptions resulting in such adjustments would occur equally among policy types, ages and durations within each product classification. Any actual adjustment would be dependent on the specific policies affected and, therefore, may differ from such estimates. In addition, the impact of actual adjustments would reflect the net effect of all changes in assumptions during the period. 52
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The following summarizes the persistency of our major blocks of insurance
business summarized by line of business:
Years ended December 31,
2021 2020 2019
Annuity:
Fixed index annuities (1) 84.8 % 85.1 % 82.5 %
Fixed interest annuities (1) 90.9 % 91.5 % 90.5 %
Other annuities (2) 96.8 % 94.1 % 97.0 %
Health:
Supplemental health (3) 88.8 % 88.7 % 88.7 %
Medicare supplement (3) 82.6 % 83.4 % 84.5 %
Long-term care (3) 87.7 % 91.5 % 90.7 %
Life:
Traditional life (3) 84.8 % 85.7 % 85.3 %
Interest-sensitive life (3) 88.7 % 88.7 % 86.2 %
_____________________
(1) Based on the total amount of death benefits, surrenders values and partial
withdrawals divided by the average account value.
(2) Based on total reserves released at death divided by average account value.
(3) Based on number of inforce policies.
Liabilities for Insurance Products - reserves for the future payment of
long-term care policy claims
We calculate and maintain reserves for the future payment of claims to our
policyholders based on actuarial assumptions. For all our insurance products, we
establish an active life reserve, a liability for due and unpaid claims, claims
in the course of settlement and incurred but not reported claims. In addition,
for our health insurance business, we establish a reserve for the present value
of amounts not yet due on claims. Many factors can affect these reserves and
liabilities, such as economic and social conditions, inflation, hospital and
pharmaceutical costs, changes in doctrines of legal liability and
extra-contractual damage awards. Therefore, our reserves and liabilities are
necessarily based on numerous estimates and assumptions as well as historical
experience. Establishing reserves is an uncertain process, and it is possible
that actual claims will materially exceed our reserves and have a material
adverse effect on our results of operations and financial condition. For
example, our long-term care policy claims may be paid over a long period of time
and, therefore, loss estimates have a higher degree of uncertainty.
The following summarizes the components of the reserves related to our long-term
care business:
2021 2020
(Dollars in millions)
Amounts classified as future policy benefits:
Active life reserves $ 3,915.3
Reserves for the present value of amounts not yet due on
claims
1,320.8
1,351.1
Premium deficiency reserves assuming net unrealized gains
had been realized
-
169.5
Amounts classified as liability for policy and contract
claims:
Liability for due and unpaid claims, claims in the course
of settlement and incurred but not reported claims
158.4
219.3
Total 5,394.5
5,675.1
Reinsurance receivables 2,766.7
2,904.5
Long-term care reserves, net of reinsurance receivables
The significant assumptions used to calculate the active life reserves include
morbidity, persistency and investment yields. These assumptions are determined
at the issuance date and generally do not change over the life of the policy
unless a premium deficiency exists.
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The significant assumptions used to calculate the reserves for the present value
of amounts not yet due on claims include future benefit payments, interest rates
and claim continuance patterns. Interest rates are used to determine the present
value of the future benefit payments and are based on the investment yield of
assets supporting the reserves. Claim continuance assumptions are estimates of
the expected period of time that claim payments will continue before termination
due to recovery, death or attainment of policy maximum benefits. These estimates
are based on historical claim experience for similar policy and coverage types.
Our estimates of benefit payments, interest rates and claim continuance are
reviewed regularly and updated to consider current portfolio investment yields
and recent claims experience.
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 2020 claim reserve redundancy for long-term care
claim reserves, as measured at December 31, 2021 , was approximately $78 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). 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.
Income Taxes
Our income tax expense includes deferred income taxes arising from temporary differences between the financial reporting and tax bases of assets and liabilities and NOLs. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which temporary differences are expected to be recovered or paid. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in earnings in the period when the changes are enacted. A reduction of the net carrying amount of deferred tax assets by establishing a valuation allowance is required if, based on the available evidence, it is more likely than not that such assets will not be realized. In assessing the need for a valuation allowance, all available evidence, both positive and negative, shall be considered to determine whether, based on the weight of that evidence, a valuation allowance for deferred tax assets is needed. This assessment requires significant judgment and considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of carryforward periods, our experience with operating loss and tax credit carryforwards expiring unused, and tax planning strategies. We evaluate the need to establish a valuation allowance for our deferred income tax assets on an ongoing basis using a deferred tax valuation model. Our model is adjusted to reflect changes in our projections of future taxable income including changes resulting from the Tax Reform Act, investment strategies, the impact of the sale or reinsurance of business, the recapture of business previously ceded, tax planning strategies and the COVID-19 pandemic. Our estimates of future taxable income are based on evidence we consider to be objectively verifiable. AtDecember 31, 2021 , our projection of future taxable income for purposes of determining the valuation allowance is based on our estimates of such future taxable income through the date our NOLs expire. Such estimates are subject to the risks and uncertainties associated with the COVID-19 pandemic and the extent to which actual impacts differ from the assumptions used in our deferred tax valuation model. Based on our assessment, we have concluded that it is more likely than not that all our deferred tax assets of$112.2 million will be realized through future taxable earnings. Recovery of our deferred tax asset is dependent on achieving the level of future taxable income projected in our deferred tax valuation model and failure to do so could result in an increase in the valuation allowance in a future period. Any future increase in the valuation allowance may result in additional income tax expense and reduce shareholders' equity, and such an increase could have a significant impact upon our earnings in the future. The Code limits the extent to which losses realized by a non-life entity (or entities) may offset income from a life insurance company (or companies) to the lesser of: (i) 35 percent of the income of the life insurance company; or (ii) 35 percent of the total loss of the non-life entities (including NOLs of the non-life entities). There is no similar limitation on the extent to which losses realized by a life insurance entity (or entities) may offset income from a non-life entity (or entities). 54
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We have
below (dollars in millions):
Net operating loss
Year of expiration carryforwards
2023 $ 562.8
2025 85.2
2026 149.9
2027 10.8
2028 80.3
2029 213.2
2030 .3
2031 .2
2032 44.4
2033 .6
2034 .9
2035 .8
Total federal non-life NOLs $ 1,149.4
Our life NOLs were fully utilized in 2020. Our non-life NOLs can be used to
offset 35 percent of life insurance company taxable income and 100 percent of
non-life company taxable income until all non-life NOLs are utilized or expire.
Liabilities for Insurance Products
AtDecember 31, 2021 , the total balance of our liabilities for insurance products was$26.1 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. We calculate and maintain reserves for the future payment of claims to our policyholders based on actuarial assumptions. For our insurance products, we establish an active life reserve, a liability for due and unpaid claims, claims in the course of settlement and incurred but not reported claims. In addition, for our health insurance business, we establish a reserve for the present value of amounts not yet due on claims. Many factors can affect these reserves and liabilities, such as economic and social conditions, inflation, hospital and pharmaceutical costs, changes in doctrines of legal liability and extra-contractual damage awards. We establish liabilities for annuity and interest-sensitive life products and funding agreements equal to the accumulated policy account values, which include an accumulation of deposit payments plus credited interest, less withdrawals and the amounts assessed against the policyholder through the end of the period. In addition, policyholder account values for certain interest-sensitive life products are impacted by our assumptions related to changes of certain NGEs that we are allowed to make under the terms of the policy, such as cost of insurance charges, expense loads, credited interest rates and policyholder bonuses. The options attributed to the policyholder related to our fixed index annuity products are accounted for as embedded derivatives. Therefore, our reserves and liabilities are necessarily based on numerous estimates and assumptions as well as historical experience. Establishing reserves is an uncertain process, and it is possible that actual claims will materially exceed our reserves and have a material adverse effect on our results of operations and financial condition. 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. Liabilities for insurance products are calculated using management's best judgments, based on our past experience and standard actuarial tables, of mortality, morbidity, lapse rates, investment experience and expense levels. 55 -------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS
The following tables and narratives summarize the operating results of our
segments (dollars in millions):
2021 2020 2019 Insurance product margin Annuity: Insurance policy income$ 19.6 $ 18.8 $ 21.1 Net investment income 462.4 465.1 464.4 Insurance policy benefits 14.5 93.7 (12.8) Interest credited (149.1) (170.6) (166.9) Amortization and non-deferred commissions (77.1) (110.3) (75.7) Annuity margin 270.3 296.7 230.1 Health: Insurance policy income 1,661.5 1,699.5 1,701.6 Net investment income 287.7 282.3 279.9 Insurance policy benefits (1,266.3) (1,329.7) (1,424.9) Amortization and non-deferred commissions (189.9) (192.3) (193.7) Health margin 493.0 459.8 362.9 Life: Insurance policy income 842.3 793.0 758.1 Net investment income 144.7 139.6 138.3 Insurance policy benefits (613.5) (570.0) (513.6) Interest credited (44.4) (44.5) (41.9) Amortization and non-deferred commissions (88.9) (87.1) (82.5) Advertising expense (89.8) (66.0) (62.3) Life margin 150.4 165.0 196.1 Total insurance product margin 913.7 921.5 789.1 Allocated expenses: Branch office expenses (62.5) (65.0) (75.8) Other allocated expenses (504.0) (492.7) (467.2) Income from insurance products 347.2 363.8
246.1
Fee income 19.4 16.7
23.5
Investment income not allocated to product lines 184.5 167.1
152.1
Expenses not allocated to product lines (80.5) (83.8) (53.4) Operating earnings before taxes 470.6 463.8
368.3
Income tax expense on operating income (105.0) (101.5) (78.3) Net operating income$ 365.6 $ 362.3 $ 290.0 56
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General: CNO is the top tier holding company for a group of insurance companies operating throughoutthe United States that develop, market and administer health insurance, annuity, individual life insurance and other insurance products. We view our operations by segments, which consist of insurance product lines. These products are distributed by our two divisions. The Consumer Division serves individual consumers, engaging with them on the phone, virtually, online, face-to-face with agents, or through a combination of sales channels. The Worksite Division focuses on worksite and group sales for businesses, associations, and other membership groups, interacting with customers at their place of employment and virtually. Insurance product margin is management's measure of the profitability of its annuity, health and life product lines' performance and consists of insurance policy income plus allocated investment income less insurance policy benefits, interest credited, commissions, advertising expense and amortization of acquisition costs. Income from insurance products is the sum of the insurance margins of the annuity, health and life product lines, less expenses allocated to the insurance lines. It excludes the income from our fee income business, investment income not allocated to product lines, net expenses not allocated to product lines (primarily holding company expenses) and income taxes. Management believes insurance product margin and income from insurance products help provide a better understanding of the business and a more meaningful analysis of the results of our insurance product lines. Investment income is allocated to the product lines using the book yield of investments backing the block of business, which is applied to the average insurance liabilities, net of insurance intangibles, for the block in each period. Investment income not allocated to product lines represents net investment income less: (i) equity returns credited to policyholder account balances; (ii) the investment income allocated to our product lines; (iii) interest expense on notes payable and investment borrowings; (iv) expenses related to the FABN program; and (v) certain expenses related to benefit plans that are offset by special-purpose investment income. Investment income not allocated to product lines includes investment income on investments in excess of average insurance liabilities, investments held by our holding companies, the spread we earn from our FHLB investment borrowing and FABN programs and variable components of investment income (including call and prepayment income, adjustments to returns on structured securities due to cash flow changes, income (loss) from COLI and alternative investment income not allocated to product lines), net of interest expense on corporate debt. Changes in Actuarial Assumptions: We update the assumptions and experience underlying the expected gross margins for policies accounted for as investment contracts annually in the fourth quarter of each year. In addition, we also review and update our assumptions on a more frequent basis to the extent current conditions or circumstances warrant changes that could be significant to our operating results. The impacts of these unlocking exercises have had a significant impact on our earnings. In the fourth quarter of 2021, we performed our annual comprehensive review of actuarial assumptions, including, but not limited to, mortality rates, policyholder behavior assumptions, earned rates, credited rates and expenses. This review resulted in a favorable impact to the fixed indexed annuity and fixed interest annuity margins of$25.1 million and$1.8 million , respectively, and an unfavorable impact to the interest-sensitive life margin by$1.0 million . The primary impact on the fixed indexed annuity margin related to lower earned rates and future option costs. Such future option costs represent the estimated cost we will incur to purchase a series of options that back the index credited to the policyholder. When the earned rates decrease, we are permitted (subject to policy minimums) to decrease this benefit, lowering the option costs. In the second quarter of 2020, our expectation regarding future new money interest rates changed and we performed an actuarial unlocking exercise to reflect our assumption that average new money rates would remain flat at 4 percent for the long-term. This change and the related impacts to persistency assumptions had a$45.6 million unfavorable impact on pre-tax earnings. As part of the actuarial unlocking exercise, we also changed our assumptions related to the future option costs we incur in providing benefits on fixed index annuities which had a favorable impact on pre-tax earnings of$91.5 million . These future option costs represent the estimated cost we will incur to purchase a series of annual forward options over the duration of the policy that back the potential return based on a percentage of the amount of increase in the value of the appropriate index. When interest rates decrease, we are permitted (subject to policy minimums) to decrease this benefit, lowering the option costs. The magnitude of the offsetting impacts of the change in new money rate and the change in future option costs had significantly different impacts on our results in 2020. These results are consistent with the different accounting requirements for insurance intangibles and the embedded derivatives related to the future option budgets for our fixed index annuity products. The actuarial unlocking exercise completed in the second quarter of 2020 did not replace our comprehensive annual review of all assumptions for our insurance products, which we completed in the fourth quarter of 2020. In the fourth quarter of 2020, we updated various assumptions including, but not limited to, earned rates and persistency which favorably impacted our annuity margins by$16.1 million and unfavorably impacted our life margin by$4.3 million . 57 -------------------------------------------------------------------------------- Table of Contents The following tables summarize the impacts of our unlocking exercises in 2021, 2020 and 2019 (dollars in millions): Insurance Amortization policy of insurance Line of business benefits intangibles Total 2021 Fixed index annuities$ 40.7 $ (15.6) $ 25.1 Fixed interest annuities - 1.8 1.8 Interest-sensitive life (.9) (.1) (1.0) Favorable (unfavorable) impact on pre-tax operating income$ 39.8 $ (13.9) $ 25.9 2020 Fixed index annuities: Second quarter unlocking: Impact of change in new money rate assumptions$ (5.0) $ (25.6) $ (30.6) Impact of change in future option costs 104.8 (13.3) 91.5 Total second quarter unlocking impacts 99.8 (38.9) 60.9 Fourth quarter annual unlocking impacts 24.5 (7.7) 16.8 Total unlocking impacts for fixed index annuities 124.3 (46.6) 77.7 Fixed interest annuities: Second quarter unlocking: Impact of change in new money rate assumptions - (9.4) (9.4) Fourth quarter annual unlocking impacts - (.7) (.7) Total unlocking impacts for fixed interest annuities - (10.1) (10.1) Interest-sensitive life: Second quarter unlocking: Impact of change in new money rate assumptions (7.4) 1.8 (5.6) Fourth quarter annual unlocking impacts (1.8) (2.5) (4.3) Total unlocking impacts for interest-sensitive life (9.2) (.7) (9.9) Favorable (unfavorable) impact on pre-tax operating income$ 115.1 $ (57.4) $ 57.7 2019 Fixed index annuities$ 11.4 $ (5.5)$ 5.9 Fixed interest annuities - (6.2) (6.2) Interest-sensitive life (11.4) 1.7 (9.7) Favorable (unfavorable) impact on pre-tax operating income $ -$ (10.0) $ (10.0) 58
-------------------------------------------------------------------------------- Table of Contents Impact of COVID-19 on Insurance Product Margin: Insurance product margin has been significantly impacted by the COVID-19 pandemic. Our life margin reflected adverse mortality related to increased deaths caused by COVID-19 of approximately$53 million and$38 million in 2021 and 2020, respectively. Our health margin reflected favorable COVID-19 impacts driven by the deferral of health care of approximately$130 million and$97 million in 2021 and 2020, respectively. Our annuity margin reflected a favorable (unfavorable) net COVID-19 impact of approximately$5 million and$(4) million in 2021 and 2020, respectively, primarily due to persistency impacts indirectly related to the pandemic.
Summary of Operating Results: Net operating income was
compared to
Insurance product margin in 2021 and 2020 was significantly impacted by: (i) changes in our actuarial assumptions as further described above under the caption "Changes in Actuarial Assumptions"; and (ii) pandemic-related impacts including lower health claims reflecting the deferral of health care, net of higher mortality claims, as further described above under the caption "Impact of COVID-19 on Insurance Product Margin".
The fee income segment is summarized below (dollars in millions):
2021 2020 2019 Fee revenue$ 147.6 $ 106.0 $ 88.7 Operating costs and expenses (128.2) (89.3) (65.2) Net fee income$ 19.4 $ 16.7 $ 23.5 The higher fee revenue and expenses in 2021, relative to 2020, is primarily due to the activity associated withDirectPath which was acquired in the first quarter of 2021, higher revenues on the sales of third-party products and growth in our broker-dealer business. The higher fee revenue in 2020, relative to 2019, primarily reflects changes in assumptions used to estimate revenues on the sales of third-party products. Net fee income in 2021 also reflects additional expenses due to the activity ofDirectPath and additional expenses related to selling third-party Medicare Advantage policies. Operating costs and expenses in 2020 included$13.1 million related to our initiative to sell third-party Medicare Advantage policies through direct-to-consumer channels. Investment income not allocated to product lines generally fluctuates from period to period based on the level of prepayment income (including call premiums) and trading account income; the performance of our alternative investments (which are typically reported a quarter in arrears); the earnings related to the investments underlying our COLI; and the spread we earn from our FHLB investment borrowing and FABN programs. Allocated expenses in 2021 includes higher variable expenses related to sales production. Certain costs in 2020 and 2019 were allocated to a transition services agreement with a third party that was completed in the third quarter of 2020, favorably impacting allocated expenses in both 2020 and 2019. Both allocated and unallocated expenses include higher incentive compensation expense related to business outperformance in 2021 and 2020. Expenses not allocated to product lines in 2021 include$12.8 million of significant items related to legal and regulatory matters and$2.5 million of transaction expenses related to the acquisition ofDirectPath . In 2020,$23.5 million of legal and regulatory matters related to an increase to our liability for claims and interest pursuant to the Global Resolution Agreement. See the note to the consolidated financial statements entitled "Litigation and Other Legal Proceedings - Regulatory Examinations and Fines" for further information about the Global Resolution Agreement. In addition, expenses not allocated to product lines in 2020 included a$3.7 million charge related to asset impairments. Expenses not allocated to product lines in 2019 included a$20 million expense reduction related to the net favorable impact from legal and regulatory matters.
The following summarizes total unallocated expenses adjusted for the significant
items summarized above (dollars in millions):
2021 2020 2019
Expenses not allocated to product lines $ 80.5 $ 83.8 $ 53.4
Net expenses related to significant legal and
regulatory matters (12.8) (23.5) 20.0
Charge related to asset impairments - (3.7) -
Transaction expenses related to acquisition of
DirectPath (2.5) - -
Adjusted total $ 65.2 $ 56.6 $ 73.4
59
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Margin from Annuity Products (dollars in millions):
2021 2020 2019
Annuity margin:
Fixed index annuities
Insurance policy income $ 12.8 $ 11.3 $ 11.6
Net investment income 343.9 332.1 310.6
Insurance policy benefits 33.7 108.8 14.2
Interest credited (95.7) (110.1) (99.8)
Amortization and non-deferred commissions (71.3) (91.3)
(57.2)
Margin from fixed index annuities$ 223.4 $ 250.8 $ 179.4 Average net insurance liabilities$ 7,771.8 $ 7,123.4 $ 6,480.3 Margin/average net insurance liabilities 2.87 % 3.52 % 2.77 % Fixed interest annuities Insurance policy income$ .8 $ .9 $ 1.5 Net investment income 93.6 105.6 123.2 Insurance policy benefits (1.1) (.6) (.4) Interest credited (50.9) (57.4) (63.3)
Amortization and non-deferred commissions (5.4) (18.7)
(18.4)
Margin from fixed interest annuities
$ 42.6 Average net insurance liabilities$ 1,880.1 $ 2,069.1 $ 2,305.7 Margin/average net insurance liabilities 1.97 % 1.44 % 1.85 % Other annuities Insurance policy income$ 6.0 $ 6.6 $ 8.0 Net investment income 24.9 27.4 30.6 Insurance policy benefits (18.1) (14.5) (26.6) Interest credited (2.5) (3.1) (3.8) Amortization and non-deferred commissions (.4) (.3)
(.1)
Margin from other annuities$ 9.9 $ 16.1 $ 8.1 Average net insurance liabilities$ 504.1 $ 531.7 $ 571.2 Margin/average net insurance liabilities 1.96 % 3.03 % 1.42 % Total annuity margin$ 270.3 $ 296.7 $ 230.1 Average net insurance liabilities$ 10,156.0 $ 9,724.2 $ 9,357.2 Margin/average net insurance liabilities 2.66 % 3.05 %
2.46 %
Margin from fixed index annuities was$223.4 million in 2021, compared to$250.8 million in 2020 and$179.4 million in 2019. The margin in 2021, 2020 and 2019 reflects the favorable impact of the actuarial assumption changes previously discussed totaling$25.1 million ,$77.7 million and$5.9 million , respectively. Excluding such favorable impacts, the margin from fixed index annuities was$198.3 million ,$173.1 million and$173.5 million in 2021, 2020 and 2019, respectively. The increase in the margin in 2021 is primarily due to growth in the block. Average net insurance liabilities (total insurance liabilities less: (i) amounts related to reinsured business; (ii) deferred acquisition costs; (iii) present value of future profits; and (iv) the value of unexpired options credited to insurance liabilities) were$7,771.8 million ,$7,123.4 million and$6,480.3 million in 2021, 2020 and 2019, respectively, driven by deposits and reinvested returns in excess of withdrawals. The increase in net insurance liabilities results in higher net investment income allocated, however, the earned yield was 4.42 percent in 2021, down from 4.66 percent in 2020 and 4.79 percent in 2019, reflecting lower market yields. We believe the margin on annuities (primarily fixed index annuities) was favorably (unfavorably) impacted by approximately$5 million and$(4) million in 2021 and 2020, respectively, primarily due to persistency impacts indirectly related to the pandemic. 60 -------------------------------------------------------------------------------- Table of Contents Net investment income and interest credited exclude the change in market values of the underlying options supporting the fixed index annuity products and corresponding offsetting amount credited to policyholder account balances. Such amounts were$195.5 million ,$32.3 million and$135.1 million in 2021, 2020 and 2019, respectively. Margin from fixed interest annuities was$37.0 million in 2021, compared to$29.8 million in 2020 and$42.6 million in 2019. The margin in 2021, 2020 and 2019 reflects the favorable (unfavorable) impact of the actuarial assumption changes previously discussed totaling$1.8 million ,$(10.1) million and$(6.2) million , respectively. Excluding such favorable (unfavorable) impacts, the margin from fixed interest annuities was$35.2 million ,$39.9 million and$48.8 million in 2021, 2020 and 2019, respectively. The decrease in margins primarily relates to the reduction in the size of the block and lower yields on investments. Average net insurance liabilities were$1,880.1 million ,$2,069.1 million and$2,305.7 million in 2021, 2020 and 2019, respectively, driven by withdrawals in excess of deposits and reinvested returns. The decrease in net insurance liabilities results in lower net investment income allocated. The earned yield was 4.98 percent in 2021, down from 5.10 percent in 2020 and 5.34 in 2019, reflecting lower market yields.
Margin from other annuities in 2021 and 2020 reflects favorable mortality
compared to the prior years. The margin on this relatively small block of
business is sensitive to annuitant mortality related to contracts with life
contingencies. An increase in mortality in this block will result in a decrease
in insurance liabilities and insurance policy benefits. Such mortality was
higher in 2021 and 2020, compared to 2019. Unusually high mortality in 2020
(unrelated to COVID-19) resulted in higher earnings.
Margin from
2021 2020 2019
Health margin:
Supplemental health
Insurance policy income $ 683.8 $ 679.4 $ 660.4
Net investment income 146.6 140.9 138.7
Insurance policy benefits (509.7) (520.9) (507.1)
Amortization and non-deferred commissions (117.9) (112.7) (111.3)
Margin from supplemental health
$ 202.8 $ 186.7 $
180.7
Margin/insurance policy income 30 % 27 % 27 % Medicare supplement Insurance policy income$ 714.1 $ 754.7 $ 773.0 Net investment income 5.1 4.9 4.4 Insurance policy benefits (493.5) (505.0) (576.0)
Amortization and non-deferred commissions (61.7) (66.3) (68.9)
Margin from Medicare supplement
$ 164.0 $ 188.3 $
132.5
Margin/insurance policy income 23 % 25 % 17 % Long-term care Insurance policy income$ 263.6 $ 265.4 $ 268.2 Net investment income 136.0 136.5 136.8 Insurance policy benefits (263.1) (303.8) (341.8)
Amortization and non-deferred commissions (10.3) (13.3) (13.5)
Margin from long-term care
$ 126.2 $ 84.8 $
49.7
Margin/insurance policy income 48 % 32 % 19 % Total health margin$ 493.0 $ 459.8 $
362.9
Margin/insurance policy income 30 % 27 %
21 %
Margin from supplemental health business was$202.8 million in 2021, compared to$186.7 million in 2020 and$180.7 million in 2019. The margin as a percentage of insurance policy income was 30% in 2021, compared to 27% in both 2020 and 2019. Insurance policy benefits in 2021 and 2020 reflected better claims experience than expected which is attributable to policyholders deferring health care during the pandemic which is expected to normalize in future periods. We estimate that the supplemental health margin in 2021 and 2020 was favorably impacted by approximately$26 million and$11 million , respectively, relative to our expectations and previous experience prior to COVID-19. The favorable claims experience in 2020 was partially offset by higher persistency resulting in a lower release of reserves. Such higher persistency primarily resulted from regulatory mandates and the Company's policy which delayed the lapsation of policies due to the non-payment of premiums during the early months of the pandemic. 61
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Our supplemental health products (including specified disease, accident and hospital indemnity products) generally provide fixed or limited benefits. For example, payments under cancer insurance policies are generally made directly to, or at the direction of, the policyholder following diagnosis of, or treatment for, a covered type of cancer. Approximately three-fourths of our supplemental health policies inforce (based on policy count) are sold with return of premium or cash value riders. The return of premium rider generally provides that after a policy has been inforce for a specified number of years or upon the policyholder reaching a specified age, we will pay to the policyholder, or a beneficiary under the policy, the aggregate amount of all premiums paid under the policy, without interest, less the aggregate amount of all claims incurred under the policy. The cash value rider is similar to the return of premium rider, but also provides for payment of a graded portion of the return of premium benefit if the policy terminates before the return of premium benefit is earned. Accordingly, the net cash flows from these products generally result in the accumulation of amounts in the early years of a policy (reflected in our earnings as reserve increases which is a component of insurance policy benefits) which will be paid out as benefits in later policy years (reflected in our earnings as reserve decreases which offset the recording of benefit payments). As the policies age, insurance policy benefits will typically increase, but the increase in benefits will be partially offset by investment income earned on the accumulated assets. Margin from Medicare supplement business was$164.0 million in 2021, compared to$188.3 million in 2020 and$132.5 million in 2019. The margins on the Medicare supplement business in 2021 and 2020 reflect favorable claim experience. Such favorable claim experience is attributable to policyholders deferring health care during the pandemic. We expect claim experience to normalize over time and the deferral of care may lead to higher claim costs in future periods. Based on actual claims incurred and persistency relative to our expectations and previous experience prior to COVID-19, we estimate that the Medicare supplement margin was favorably impacted by approximately$32 million and$50 million in 2021 and 2020, respectively. Insurance policy income was$714.1 million in 2021, compared to$754.7 million in 2020 and$773.0 million in 2019, reflecting lower sales in recent periods partially offset by premium rate increases. We have experienced a shift in the sale of Medicare supplement policies to the sale of Medicare Advantage policies. We receive fee income when Medicare Advantage policies of other providers are sold, which is recorded in our Fee income segment. We continue to invest in both our Medicare supplement products and Medicare Advantage distribution to meet our customers' needs and preferences. Medicare supplement business consists of both individual and group policies. Government regulations generally require we attain and maintain a ratio of total benefits incurred to total premiums earned (excluding changes in policy benefits reserves which is a component of Insurance policy benefits) of not less than 65 percent on individual products and not less than 75 percent on group products. The ratio is determined after three years from the original issuance of the policy and over the lifetime of the policy and measured 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. Changes to our estimates are reflected in Insurance policy benefits in the period the change is determined. Margin from Long-term care products was$126.2 million in 2021, compared to$84.8 million in 2020 and$49.7 million in 2019. The margin as a percentage of insurance policy income increased to 48% in 2021, compared to 32% in 2020 and 19% in 2019. The margins in both 2021 and 2020 benefited from lower claims incurred attributable to policyholders deferring health care during the pandemic which is expected to normalize in future periods. In addition, an increase in policyholder deaths attributable to the pandemic resulted in higher than expected reserve releases. Based on actual claims incurred and persistency relative to our expectations and previous experience prior to COVID-19, we estimate that the long-term care margin was favorably impacted by approximately$72 million and$36 million in 2021 and 2020, respectively. 62 -------------------------------------------------------------------------------- Table of Contents Margin from Life Products (dollars in millions): 2021 2020 2019 Life margin: Interest-sensitive life Insurance policy income$ 167.1 $ 158.8 $ 148.6 Net investment income 50.2 47.4 46.7 Insurance policy benefits (82.6) (76.1) (67.6) Interest credited (43.7) (43.8) (41.1) Amortization and non-deferred commissions (25.3) (28.2) (25.8) Margin from interest-sensitive life$ 65.7 $ 58.1 $ 60.8 Average net insurance liabilities$ 976.4 $ 920.0 $ 866.3 Interest margin$ 6.5 $ 3.6 $ 5.6 Interest margin/average net insurance liabilities .67 % .39 % .65 % Underwriting margin$ 59.2 $ 54.5 $ 55.2 Underwriting margin/insurance policy income 35 % 34 % 37 % Traditional life Insurance policy income$ 675.2 $ 634.2 $ 609.5 Net investment income 94.5 92.2 91.6 Insurance policy benefits (530.9) (493.9) (446.0) Interest credited (.7) (.7) (.8) Amortization and non-deferred commissions (63.6) (58.9) (56.7) Advertising expense (89.8) (66.0) (62.3) Margin from traditional life$ 84.7 $ 106.9 $ 135.3 Margin/insurance policy income 13 % 17 % 22 % Margin excluding advertising expense/insurance policy income 26 % 27 % 32 % Total life margin$ 150.4 $ 165.0 $ 196.1 Margin from interest-sensitive life business was$65.7 million in 2021, compared to$58.1 million in 2020 and$60.8 million in 2019. The margin in 2021, 2020 and 2019 reflects the unfavorable impact of the actuarial assumption changes previously discussed totaling$1.0 million ,$9.9 million and$9.7 million , respectively. Excluding such unfavorable impacts, the margin from interest-sensitive life business was$66.7 million ,$68.0 million and$70.5 million , respectively. The decrease in margins reflects unfavorable mortality related to COVID-19; partially offset by growth in the block due to sales in recent periods. We estimate that the unfavorable impact from death claims related to COVID-19 on the margin of this block of business was approximately$16 million and$9 million in 2021 and 2020, respectively. The interest margin was$6.5 million in 2021, compared to$3.6 million in 2020 and$5.6 million in 2019. Net investment income was higher in 2021 compared to 2020 and 2019. The increase in average net insurance liabilities results in higher net investment income allocated, which is partially offset by lower earned yields. The earned yield was 5.14 percent in 2021, down from 5.15 percent in 2020 and 5.39 percent 2019. Interest credited to policyholders may be changed annually but are subject to minimum guaranteed rates and, as a result, any reduction in our earned rate may not fully reflected in the rate credited to policyholders. Net investment income and interest credited excludes the change in market values of the underlying options supporting the fixed index life products and corresponding offsetting amount credited to policyholder account balances. Such amounts were$24.3 million ,$5.5 million and$18.6 million in 2021, 2020 and 2019, respectively. Margin from traditional life business was$84.7 million in 2021, compared to$106.9 million in 2020 and$135.3 million in 2019. Insurance policy income was$675.2 million in 2021, compared to$634.2 million in 2020 and$609.5 million in 2019, reflecting new sales and persistency in the block. Insurance policy benefits were$530.9 million in 2021, compared to$493.9 million in 2020 and$446.0 million in 2019. We estimate that the impact from death claims related to COVID-19 increased insurance policy benefits by approximately$37 million and$29 million in 2021 and 2020, respectively. 63 -------------------------------------------------------------------------------- Table of Contents Allocated net investment income was slightly higher in 2021 as the growth in the block was partially offset by lower average investment yields. Advertising expense was$89.8 million in 2021, compared to$66.0 million in 2020 and$62.3 million in 2019. The demand and cost of television advertising can fluctuate from period to period. We are disciplined with our marketing expenditures and will increase or decrease our marketing spend depending on prices or other factors.
Investment Income Not Allocated to Product Lines (dollars in millions):
2021 2020 2019
Net investment income $ 1,420.7 $ 1,222.5 $ 1,362.9
Allocated to product lines:
Annuity (462.4) (465.1) (464.4)
Health (287.7) (282.3) (279.9)
Life (144.7) (139.6) (138.3)
Equity returns credited to policyholder account balances (219.8)
(37.8) (153.7)
Amounts allocated to product lines and credited to
policyholder account balances
(1,114.6)
(924.8) (1,036.3)
Amount related to variable interest entities and other
non-operating items
(30.5) (39.2) (61.6) Interest expense on debt (62.4) (55.2) (52.4) Interest expense on investment borrowings (9.8) (21.2) (46.2) Expenses related to FABN program (a) (2.3) - -
Less amounts credited to deferred compensation plans
(offsetting investment income)
(16.6) (15.0) (14.3) Total adjustments (121.6) (130.6) (174.5) Investment income not allocated to product lines$ 184.5
_____________________
(a) Comprised of interest credited and amortization of deferred acquisition
costs.
The above table reconciles net investment income to investment income not allocated to product lines. Such amount will generally fluctuate from period to period based on the level of prepayment income (including call premiums) and trading account income; the performance of our alternative investments (which are typically reported a quarter in arrears); the earnings related to the investments underlying our COLI; and the spread we earn from our FHLB investment borrowing and FABN programs.
Net Non-Operating Income (Loss):
The following summarizes our net non-operating income (loss) for the three years
ended
2021 2020 2019
Net realized investment gains (losses) from sales,
impairments and change in allowance for credit losses (net
of related amortization)
$ 34.8
Net change in market value of investments recognized in
earnings
(17.4) (2.7) 25.5
Fair value changes related to agent deferred compensation
plan
8.9 (16.3) (20.4)
Fair value changes in embedded derivative liabilities (net
of related amortization)
67.2 (79.1) (81.4) Loss on extinguishment of debt - - (7.3) Other 3.6 9.7 (12.6) Net non-operating income (loss) before taxes$ 97.1
Net realized investment gains, net of related amortization, were
in 2021, including the favorable change in the allowance for credit losses
of
losses, net of related
64 -------------------------------------------------------------------------------- Table of Contents amortization, were$31.1 million in 2020, including an increase in the allowance for credit losses and other-than-temporary impairment losses of$18.5 million . Net realized investment gains, net of related amortization, were$2.1 million in 2019, net of other-than-temporary impairment losses of$12.4 million . During 2021, 2020 and 2019, we recognized an increase (decrease) in earnings of$(17.4) million ,$(2.7) million and$25.5 million , respectively, due to the net change in market value of investments recognized in earnings. During 2021, 2020 and 2019, we recognized an increase (decrease) in earnings of$8.9 million ,$(16.3) million and$(20.4) million , respectively, for the mark-to-market change in the agent deferred compensation plan liability which was impacted by changes in the underlying actuarial assumptions used to value the liability. We recognize the mark-to-market change in the estimated value of this liability through earnings as assumptions change. During 2021, 2020 and 2019, we recognized an increase (decrease) in earnings of$67.2 million ,$(79.1) million and$(81.4) million , respectively, resulting from changes in the estimated fair value of embedded derivative liabilities related to our fixed index annuities, net of related amortization. Such amounts include the impacts of changes in market interest rates used to determine the derivative's estimated fair value. The discount rate is based on risk-free rates (U.S. Treasury rates for similar durations) adjusted for non-performance risk and risk margins for non-capital market inputs. The increase inU.S. Treasury rates in 2021 was the primary factor in the change in estimated fair value of the embedded derivative liabilities while suchU.S. Treasury rates decreased in 2020 and 2019.
Loss on extinguishment of debt in 2019 of
premium of
2020
unamortized issuance costs due to the redemption of the 2020 Notes.
Other non-operating items include earnings attributable to VIEs that we are required to consolidate, net of affiliated amounts. Such earnings are not indicative of, and are unrelated to, the Company's underlying fundamentals. Also, other non-operating items include the net revenue earned pursuant to a transition services agreement representing 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 inSeptember 2018 . In addition, such non-operating items in 2019 include$15.9 million of one-time expenses associated with: (i) the new operating model announced in earlyJanuary 2020 to create a more customer-centric structure and improve operating performance; and (ii) a new strategic technology partnership with two leading, global technology solutions providers for our application development, maintenance and testing functions as well as IT infrastructure and cybersecurity services. 65 -------------------------------------------------------------------------------- Table of Contents PREMIUM COLLECTIONS In accordance with GAAP, insurance policy income in our consolidated statement of operations consists of premiums earned for traditional insurance policies that have life contingencies or morbidity features. For annuity and interest-sensitive life contracts, premiums collected are not reported as revenues, but as deposits to insurance liabilities. We recognize revenues for these products over time in the form of investment income and surrender or other charges. Agents, insurance brokers and marketing organizations 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 AM Best, Fitch, Moody's and S&P are "A", "A-", "A3" and "A-", respectively. For a description of these ratings and additional information on our ratings, see "Consolidated Financial Condition - Financial Strength Ratings of our Insurance Subsidiaries." We set premium rates on our health insurance policies based on facts and circumstances known at the time we issue the policies using assumptions about numerous variables, including but not limited to, the actuarial probability of a policyholder incurring a claim, the probable size of the claim, and the interest rate earned on our investment of premiums. We also consider historical claims information, industry statistics, the rates of our competitors and other factors. If our actual claims experience is less favorable than we anticipated and we are unable to raise our premium rates, our financial results may be adversely affected. We generally cannot raise our health insurance premiums in any state until we obtain the approval of the state insurance regulator. We review the adequacy of our premium rates regularly and file for rate increases on our products when we believe such rates are too low. It is likely that we will not be able to obtain approval for all requested premium rate increases. If such requests are denied in one or more states, our net income may decrease. If such requests are approved, increased premium rates may reduce the volume of our new sales and may cause existing policyholders to lapse their policies. If the healthier policyholders allow their policies to lapse, this would reduce our premium income and profitability in the future. 66 -------------------------------------------------------------------------------- Table of Contents Total premium collections were as follows (dollars in millions): 2021 2020
2019
Premiums collected by product: Annuities: Fixed index (first-year)$ 1,347.8 $ 1,121.7 $ 1,241.2 Fixed index (renewal) .3 .4 .8 Subtotal - fixed index annuities 1,348.1 1,122.1 1,242.0 Fixed interest (first-year) 40.4 33.5 51.6 Fixed interest (renewal) 5.0 3.8 5.3 Subtotal - fixed interest annuities 45.4 37.3 56.9 Other annuities (first-year) 6.9 5.6 7.5 Total annuities 1,400.4 1,165.0 1,306.4 Health: Supplemental health (first-year) 67.9 72.7 73.5 Supplemental health (renewal) 620.1 604.5 589.6 Subtotal - supplemental health 688.0 677.2 663.1 Medicare supplement (first-year) 40.3 54.2 60.2 Medicare supplement (renewal) 667.2 696.3 715.8 Subtotal - Medicare supplement 707.5 750.5 776.0 Long-term care (first-year) 20.7 18.3 18.9 Long-term care (renewal) 243.3 245.6 250.2 Subtotal - long-term care 264.0 263.9 269.1 Total health 1,659.5 1,691.6 1,708.2 Life insurance: Interest-sensitive (first-year) 41.5 44.3 52.8 Interest-sensitive (renewal) 177.9 162.2 148.5 Subtotal - interest-sensitive 219.4 206.5 201.3 Traditional (first-year) 163.9 136.9 120.7 Traditional (renewal) 512.5 496.2 489.2 Subtotal - traditional 676.4 633.1 609.9 Total life insurance 895.8 839.6 811.2 Collections on annuity, health and life products: Total first-year premium collections 1,729.4 1,487.2 1,626.4 Total renewal premium collections 2,226.3 2,209.0 2,199.4 Total collections on insurance products$ 3,955.7 $
3,696.2
Annuities include fixed index, fixed interest and other annuities sold to the senior market. Annuity collections were$1,400.4 million in 2021, compared to$1,165.0 million in 2020 and$1,306.4 million in 2019. The increase in premium collections from our fixed index products in 2021, as compared to 2020, was primarily due to the general stock market performance which made these products attractive to certain customers. We have proactively managed the participation rates on our fixed index products in order to balance sales growth and profitability in the current low interest rate environment. The decrease in premium collections from our fixed index products in 2020, as compared to 2019, primarily reflected our pricing discipline and market conditions existing after the pandemic began. Premium collections from our fixed interest products reflect consumer preference for fixed index products in the current low interest rate environment. Health products include supplemental health, Medicare supplement and long-term care products. Our profits on health policies depend on the overall level of sales, the length of time the business remains inforce, investment yields, claims experience and expense management. 67
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Premiums collected on supplemental health products (including specified disease, accident and hospital indemnity insurance products) were$688.0 million in 2021, compared to$677.2 million in 2020 and$663.1 million in 2019. Such increases are primarily due to new sales and steady persistency. Collected premiums on Medicare supplement policies were$707.5 million ,$750.5 million and$776.0 million in 2021, 2020 and 2019, respectively. The decreases reflect lower sales in recent periods partially offset by premium rate increases. We have experienced a shift in the sale of Medicare supplement policies to the sale of Medicare Advantage policies. We receive fee income when Medicare Advantage policies of other providers are sold, which is recorded in our Fee income segment. We continue to invest in both our Medicare supplement products and Medicare Advantage distribution to ensure we are well-positioned to meet our customers' needs and preferences. Life products include interest-sensitive and traditional life products. Life premiums were$895.8 million ,$839.6 million and$811.2 million in 2021, 2020 and 2019, respectively. Premiums collected reflect both recent sales activity and steady persistency. INVESTMENTS 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 90 percent of our$28.9 billion investment portfolio atDecember 31, 2021 . The remainder of the invested assets was trading securities, investments held by VIEs, COLI, equity securities, policy loans and other invested assets.
The following table summarizes the composition of our investment portfolio as of
Carrying value Percent of total investments
Fixed maturities, available for sale $ 24,805.4 86 %
Equity securities 131.1 -
Mortgage loans 1,218.6 4
Policy loans 120.2 -
Trading securities 227.2 1
Investments held by variable interest
entities 1,199.6 4
Company-owned life insurance 207.0 1
Other invested assets 1,017.0 4
Total investments $ 28,926.1 100 %
68
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The following table summarizes investment yields earned over the past three
years on the investments allocated to our product lines. General account
investments exclude the value of options.
2021 2020 2019
(dollars in millions)
Weighted average investments at amortized cost
allocated to product lines $ 18,877.0 $ 18,093.0 $ 17,382.6
Allocated investment income 894.8 887.0 882.6
Average yield on allocated investments 4.74 % 4.90 % 5.08 %
Insurance statutes regulate the types of investments that our insurance
subsidiaries are permitted to make and limit the amount of funds that may be
used for any one type of investment. In addition, we have internal management
compliance limits on various exposures and activities which are typically more
restrictive than insurance statutes. In light of these statutes and 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.
Fixed Maturities, Available for Sale
The following table summarizes the carrying values and gross unrealized losses
of our fixed maturity securities, available for sale, by category as of
Percent of
Percent of gross
fixed Gross unrealized unrealized
Carrying value maturities losses losses
States and political
subdivisions $ 3,004.2 12.1 % $ 1.5 3.6 %
Commercial mortgage-backed
securities 2,216.9 8.9 9.2 22.5
Non-agency residential
mortgage-backed securities 2,023.8 8.2 3.1 7.5
Insurance 1,754.1 7.1 3.1 7.5
Banks 1,627.0 6.6 1.3 3.1
Healthcare/pharmaceuticals 1,606.0 6.5 3.0 7.3
Utilities 1,555.5 6.3 1.9 4.5
Asset-backed securities 1,162.9 4.7 3.1 7.5
Food/beverage 1,053.0 4.2 .9 2.3
Brokerage 1,041.6 4.2 1.2 3.0
Technology 1,000.6 4.0 4.2 10.2
Energy 810.9 3.3 .7 1.8
Collateralized loan
obligations 588.3 2.4 1.3 3.2
Cable/media 564.6 2.3 1.4 3.3
Transportation 517.4 2.1 - -
Telecom 514.8 2.1 - -
Real estate/REITs 456.9 1.8 .2 .6
Capital goods 433.4 1.7 - -
Chemicals 408.7 1.6 .2 .5
Aerospace/defense 277.2 1.1 .1 .2
Retail 258.0 1.0 1.9 4.7
Other 1,929.6 7.8 2.8 6.7
Total fixed maturities,
available for sale $ 24,805.4 100.0 % $ 41.1 100.0 %
69
-------------------------------------------------------------------------------- Table of Contents The following table summarizes the gross unrealized losses of our fixed maturity securities, available for sale, by category and ratings category as ofDecember 31, 2021 (dollars in millions): Investment grade Below-investment grade Total gross B+ and unrealized AAA/AA/A BBB BB below losses Commercial mortgage-backed securities$ 6.8 $ 1.9 $ .5 $ -$ 9.2 Technology .9 3.3 - - 4.2 Insurance 2.0 .9 .2 - 3.1 Asset-backed securities 1.0 .9 .6 .6 3.1 Non-agency residential mortgage-backed securities 1.4 1.5 - .2 3.1 Healthcare/pharmaceuticals 2.5 .4 .1 - 3.0 Retail 1.5 .2 .2 - 1.9 Utilities .2 1.5 .2 - 1.9 States and political subdivisions 1.5 - - - 1.5 Cable/media - 1.2 .1 .1 1.4 Collateralized loan obligations .8 .4 .1 - 1.3 Banks .7 .6 - - 1.3 Brokerage .5 .7 - - 1.2 Other 1.6 2.7 .5 .1 4.9 Total fixed maturities, available for sale$ 21.4 $ 16.2 $ 2.5 $ 1.0 $ 41.1 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 atDecember 31, 2021 , classified by ratings (dollars in millions): Estimated fair value Percent of fixed Investment rating Amortized cost Amount maturities AAA$ 1,165.2 $ 1,214.1 5 % AA 2,878.5 3,264.4 13 A 7,400.8 8,441.8 34 BBB+ 2,520.1 3,001.9 12 BBB 3,468.1 4,080.7 17 BBB- 2,639.9 2,827.6 11 Investment grade 20,072.6 22,830.5 92 BB+ 326.2 362.2 1 BB 176.1 182.7 1 BB- 318.6 327.8 1 B+ and below 974.1 1,102.2 5 Below-investment grade 1,795.0 1,974.9 8 Total fixed maturity securities$ 21,867.6 $ 24,805.4 100 % 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 70 -------------------------------------------------------------------------------- Table of Contents 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 historical and recent operational results and financial position of the issuer, information about its industry, information about factors affecting the issuer's performance and other information. 40|86 Advisors employs experienced securities analysts in a broad variety of specialty areas who compile and review such data. During 2021, we recognized net investment gains of$19.1 million , which were comprised of: (i)$24.2 million of net gains from the sales of investments; (ii)$10.2 million of losses related to equity securities, including the change in fair value; (iii) the decrease in fair value of certain fixed maturity investments with embedded derivatives of$4.0 million ; (iv) the decrease in fair value of embedded derivatives related to a modified coinsurance agreement of$3.1 million ; and (v) a decrease in the allowance for credit losses of$12.2 million . During 2021, we sold$493.5 million of fixed maturity investments which resulted in gross realized investment losses (before income taxes) of$20.4 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. Our investment portfolio is subject to the risk of declines in realizable value. However, we attempt to mitigate this risk through the diversification and active management of our portfolio. The Company reports accrued investment income separately from fixed maturities, available for sale, and has elected not to measure an allowance for credit losses for accrued investment income. Accrued investment income is written off through net investment income at the time the issuer of the bond defaults or is expected to default on payments. As ofDecember 31, 2021 , we had fixed maturity securities with an amortized cost and fair value of$1.0 million and nil, respectively, that were in substantive default (i.e., in default due to nonpayment of interest or principal). There were no other investments about which we had serious doubts as to the recoverability of the carrying value of the investment.
Other Investments
AtDecember 31, 2021 , we held commercial mortgage loan investments with an amortized cost of$1,177.3 million (or 4.1 percent of total invested assets) and a fair value of$1,250.2 million . Our commercial mortgage loan portfolio is primarily comprised of large commercial mortgage loans. Approximately 17 percent, 8 percent, 7 percent and 6 percent of the commercial mortgage loan balance were on properties located inCalifornia, Maryland ,Georgia andWisconsin , respectively. No other state comprised greater than six percent of the mortgage loan balance. AtDecember 31, 2021 , there were no commercial mortgage loans in process of foreclosure or that were noncurrent. AtDecember 31, 2021 , we held residential mortgage loan investments with an amortized cost of$46.9 million and a fair value of$47.3 million . AtDecember 31, 2021 , there were 14 residential mortgage loans that were noncurrent with a carrying value of$4.5 million (of which, 8 such loans with a carrying value of$3.3 million were in forbearance and 1 loan with a carrying value of$.1 million was in foreclosure). The allowance for credit losses related to mortgage loans was$5.6 million atDecember 31, 2021 , and decreased$6.2 million in 2021. The allowance for credit losses related to mortgage loans increased$5.1 million in 2020. During 2019, there were no impairments on commercial mortgage loans. The following table shows the distribution of our commercial mortgage loan portfolio by property type as ofDecember 31, 2021 (dollars in millions): Number of loans Amortized cost Multi-family 21 $ 326.6 Retail 58 252.2 Industrial 35 249.8 Office building 26 237.1 Other 14 111.6 Total commercial mortgage loans 154$ 1,177.3 71 -------------------------------------------------------------------------------- Table of Contents The following table shows our commercial mortgage loan portfolio by loan size as ofDecember 31, 2021 (dollars in millions): Number of loans Amortized
cost
Under$5 million 66 $
176.0
$5 million but less than$10 million 44
306.2
$10 million but less than$20 million 36
510.6
Over$20 million 8
184.5
Total commercial mortgage loans 154 $
1,177.3
The following table summarizes the distribution of maturities of our commercial
mortgage loans as of
Number of loans Amortized cost
2022 8 $ 38.8
2023 4 47.0
2024 11 102.8
2025 14 77.3
2026 8 56.1
after 2026 109 855.3
Total commercial mortgage loans 154 $ 1,177.3
The following table provides the amortized cost by year of origination and
estimated fair value of our outstanding commercial mortgage loans and the
underlying collateral as of
Estimated fair
value
Total
Loan-to-value ratio (a) 2021 2020 2019 2018 2017 Prior amortized cost Mortgage loans Collateral
Less than 60% $ 138.6 $ 28.1 $ 98.7 $ 101.4 $ 74.9 $ 550.4 $ 992.1 $ 1,062.1 $ 3,691.2
60% to less than 70% 22.2 - - - - 88.7 110.9 114.4 169.9
70% to less than 80% - 18.3 - 8.4 - 12.3 39.0 38.9 51.6
80% to less than 90% - - - - - 35.3 35.3 34.8 43.0
Total $ 160.8 $ 46.4 $ 98.7 $ 109.8 $ 74.9 $ 686.7 $ 1,177.3 $ 1,250.2 $ 3,955.7
________________
(a)Loan-to-value ratios are calculated as the ratio of: (i) the amortized cost
of the commercial mortgage loans; to (ii) the estimated fair value of the
underlying collateral.
AtDecember 31, 2021 , we held$227.2 million of trading securities. We carry trading securities at estimated fair value; changes in fair value are reflected in the statement of operations. Our trading securities include: (i) investments purchased with the intent of selling in the near term to generate income; and (ii) certain fixed maturity securities containing embedded derivatives for which we have elected the fair value option. Investment income from trading securities backing certain insurance liabilities is substantially offset by the change in insurance policy benefits related to certain products and agreements. 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. AtDecember 31, 2021 , we held investments with an amortized cost of$1,206.8 million and an estimated fair value of$1,199.6 million related to VIEs that we are required to consolidate. The investment portfolio held by the VIEs is primarily comprised of commercial bank loans, the borrowers for 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 on these investments. 72
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LIQUIDITY AND CAPITAL RESOURCES
Potential Future Impacts of COVID-19 Pandemic and Outlook
We expect the potential impact of the pandemic on our future results will be largely driven by three things which are already impacting our business, but the duration and severity of which are currently unknown:
•the impact of the COVID-19 environment on the sales of some of our insurance
products;
•changes in mortality, morbidity, and persistency (or lapse rates) impacting
insurance product margin; and
•general economic impacts, driving: (i) potential impacts on net investment income due to changes in interest rates; (ii) the potential for credit deterioration and its impact on invested assets and capital; and (iii) potential impacts to reserves and deferred acquisition costs resulting from changes in interest rates, equity valuations, and market volatility. While uncertainty continues related to how the COVID-19 pandemic will impact our results and the continued economic impact it will have, based on annual stress testing, including a stress test scenario that simulates adverse pandemic-like conditions, we believe it is very unlikely that any currently plausible future COVID-19 pandemic scenario would cause the capital of our insurance subsidiaries or our holding company liquidity to fall below our target levels. Accordingly, in our quarterly re-forecast, consistent with our practice following the second quarter of 2021, we are modeling a single base case scenario or forecast and are no longer modeling a formal adverse case scenario, as we had done in previous periods. Both our annual stress testing and our quarterly re-forecast models are dynamic as higher or lower risk assumptions may be applied from time to time. We most recently updated our quarterly re-forecast inJanuary 2022 . Our modeling incorporates many assumptions and actual conditions in future periods may differ materially from the assumptions used in our model. The COVID-19 pandemic has impacted our consolidated sales volumes. In 2021, our sales of health and life insurance products (measured by new annualized premiums) across both our Consumer and Worksite Divisions increased by 9 percent and 2 percent compared to 2020 and 2019, respectively. The lower sales in 2020 will adversely impact our earnings in future periods. In 2021, our Consumer Division life sales (new annualized premiums) increased 11 percent and 32 percent compared to 2020 and 2019, respectively. Sales of health products also increased by 6 percent in 2021 compared to 2020, but decreased 11 percent from 2019. Collected premiums from our annuity products in 2021 increased 20 percent and 7 percent compared to 2020 and 2019, respectively. As the economy has partially reopened and our customers and agents have become more accustomed to virtual transactions, overall sales in the Consumer Division have improved and are approaching or exceeding pre-pandemic levels. Similar to other insurance companies selling insurance products at the workplace, sales during the pandemic within our Worksite Division have been significantly below pre-pandemic levels. In 2021, our Worksite Division life and health sales (new annualized premiums) increased 13 percent compared to 2020, but such sales decreased 35 percent compared to 2019. With respect to 2022, we expect continued positive sales momentum with respect to new annualized premiums, collected premiums and fee revenue, despite ongoing agent recruiting challenges in the tight labor market. With respect to changes in mortality and morbidity, we currently expect continued net favorable COVID-19 impacts on total insurance product margin during 2022 tapering off over the course of the year. This assumes that no additional surge in COVID-19 infections and deaths emerge in the wake of the surge from the omicron variant. In 2021, our margin on life insurance products reflected an estimated$53 million of adverse mortality impact related to COVID-19. While higher mortality claims unfavorably impacted our life product margins, our health product margins have generally benefited due to lower claims experience. We estimate the COVID-19 environment favorably impacted our health margins by approximately$130 million in 2021 primarily due to consumers deferring medical care treatments. We expect mortality and morbidity trends to revert to pre-pandemic levels over time, although such deferral of care and possible long-term health complications from COVID-19 may lead to higher life and health claim costs in future periods. Regarding our investment portfolio, net investment income was higher in 2021 and 2020 compared to 2019, driven by outperformance of variable investment income, including income from alternative investments; whereas the pandemic scenario of our annual stress testing assumes the adverse impacts from a pandemic, including adverse impacts on capital from credit 73 -------------------------------------------------------------------------------- Table of Contents migration, rising default levels and adverse impacts on net investment income due to underperformance from variable net investment income. We believe our 2022 earnings will be impacted by the continuation of the low interest rate environment. We expect investment income allocated to product lines to be relatively flat in 2022, compared to 2021, as growth in invested assets is offset by lower yields which reflects both the lower interest rate environment and our up-in-quality shift in asset allocation. We expect net investment income not allocated to product lines to trend lower in 2022, as compared to the elevated levels in 2021. We also expect earnings from our fee income segment to be higher in 2022 compared to 2021. Total expenses allocated and not allocated to product lines in 2022 are expected to trend modestly higher than 2021 (excluding certain significant items related to legal and regulatory matters and transaction expenses related to the acquisition ofDirectPath ) as we capture operating efficiencies, while also investing in growth. Refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations - Changes in Actuarial Assumptions" for further information related to changes in certain actuarial assumptions and their impact on our operating results in 2021.
While uncertainty related to COVID-19 continues, we do not expect that any
potential scenario would jeopardize our ability to:
•maintain our target RBC level, debt to capital ratios and minimum holding
company liquidity; and
•maintain our quarterly dividend to shareholders.
We expect free cash flow to be less than the$380 million generated in 2021, reflecting less favorable insurance product margin impacts from COVID-19, lower alternative investment returns, capital strain from new business and future issuances under the FABN program (including the$900.0 million issued inJanuary 2022 ). There are many modeling scenarios which could result in materially different projected outcomes from those used in our modeling and, accordingly, our modeling does not constitute the only outcome resulting from the COVID-19 pandemic which could affect our business, results of operations, financial condition and liquidity. Similarly, given the unprecedented nature of the COVID-19 pandemic, the assumptions used in our modeling are based on assumed facts which are inherently unpredictable, are subject to change, and have been difficult to predict accurately in prior periods. The outcome generated by the application of updated assumptions may be materially different from those described above. If the impact of the COVID-19 pandemic is ultimately worse than contemplated by our modeling, the impact to our business, results of operations, financial condition and liquidity could be significantly different than described above.
Changes in the Consolidated Balance Sheet
Changes in our consolidated balance sheet between
in the fair value of our fixed maturity securities, available for sale; and
(iii) payments to repurchase common stock of
Our capital structure as of
follows (dollars in millions):
December 31,
2021 December 31, 2020
Total capital:
Corporate notes payable $ 1,137.3 $ 1,136.2
Shareholders' equity:
Common stock 1.2 1.3
Additional paid-in capital 2,184.2
2,544.5
Accumulated other comprehensive income 1,947.1
2,186.1
Retained earnings 1,127.2
752.3
Total shareholders' equity 5,259.7
5,484.2
Total capital $ 6,397.0 $ 6,620.4
74
-------------------------------------------------------------------------------- Table of Contents The following table summarizes certain financial ratios as of and for the years endedDecember 31, 2021 andDecember 31, 2020 :
2021 December 31, 2020
Book value per common share $
43.69 $ 40.54
Book value per common share, excluding accumulated other
comprehensive income (a)
27.52 24.38 Debt to total capital ratios: Corporate debt to total capital 17.8 % 17.2 %
Corporate debt to total capital, excluding accumulated other
comprehensive income (a)
25.6 % 25.6 %
_____________________
(a)This non-GAAP measure differs from the corresponding GAAP measure presented immediately above, because accumulated other comprehensive income has been excluded from the value of capital used to determine this measure. Management believes this non-GAAP measure is useful because it removes the volatility that arises from changes in accumulated other comprehensive income. Such volatility is often caused by changes in the estimated fair value of our investment portfolio resulting from changes in general market interest rates rather than the business decisions made by management. However, this measure does not replace the corresponding GAAP measure.
Contractual Obligations
The Company's significant contractual obligations as of
as follows (dollars in millions):
Payment due in
Total 2022 2023-2024 2025-2026 Thereafter
Insurance liabilities (a) $ 52,898.3 $ 3,393.4 $ 6,720.6 $ 6,710.3 $ 36,074.0
Notes payable (b) 1,741.6 60.8 121.6 582.1 977.1
Investment borrowings (c) 1,799.7 305.4 734.4 759.9 -
Borrowings related to variable
interest
entities (d) 1,236.6 106.6 507.7 374.0 248.3
Postretirement plans (e) 271.7 7.9 16.7 17.7 229.4
Operating leases 53.5 22.6 25.0 5.8 .1
Commitments to purchase/fund
investments 241.6 241.6 - - -
Other contractual commitments (f) 410.6 108.9 165.6 136.1 -
Total $ 58,653.6 $ 4,247.2 $ 8,291.6 $ 8,585.9 $ 37,528.9
________________
(a) These cash flows represent our estimates of the payments we expect to make to our policyholders, without consideration of future premiums or reinsurance recoveries. These estimates are based on numerous assumptions (depending on the product type) related to mortality, morbidity, lapses, withdrawals, future premiums, future deposits, interest rates on investments, credited rates, expenses and other factors which affect our future payments. The cash flows presented are undiscounted for interest. As a result, total outflows for all years exceed the corresponding liabilities of$26.1 billion included in our consolidated balance sheet as ofDecember 31, 2021 . As such payments are based on numerous assumptions, the actual payments may vary significantly from the amounts shown.
In estimating the payments we expect to make to our policyholders, we considered
the following:
•For products such as immediate annuities and structured settlement annuities
without life contingencies, the payment obligation is fixed and determinable
based on the terms of the policy.
•For products such as universal life, ordinary life, long-term care,
supplemental health and fixed rate annuities, the future payments are not due
until the occurrence of an insurable event (such as death or disability) or a
triggering event (such as a surrender or partial withdrawal). We estimated these
payments using actuarial models based on historical experience and our
expectation of the future payment patterns which is consistent with the
assumptions used in our loss recognition testing for these blocks of business.
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•For short-term insurance products such as Medicare supplement insurance, the
future payments relate only to amounts necessary to settle all outstanding
claims, including those that have been incurred but not reported as of the
balance sheet date. We estimated these payments based on our historical
experience and our expectation of future payment patterns which is consistent
with the assumptions used in our loss recognition testing for these blocks of
business.
•The average interest rate we assumed would be credited to our total insurance
liabilities (excluding interest rate bonuses for the first policy year only and
excluding the effect of credited rates attributable to variable or fixed index
products) over the term of the contracts was 4.5 percent.
(b) Includes projected interest payments based on interest rates, as
applicable, as of
financial statements entitled "Notes Payable - Direct Corporate Obligations" for
additional information on notes payable.
(c) These borrowings represent collateralized borrowings from the FHLB.
(d) These borrowings represent the securities issued by VIEs and include
projected interest payments based on interest rates, as applicable, as of
(e) Includes benefits expected to be paid pursuant to our deferred compensation
plan and postretirement plans based on numerous actuarial assumptions and
interest credited at 2.75 percent.
(f) Includes obligations to third parties for information technology services,
software maintenance and license agreements and consulting services.
It is possible that the ultimate outcomes of various uncertainties could affect our liquidity in future periods. For example, the following events could have a material adverse effect on our cash flows:
•An adverse decision in pending or future litigation.
•An inability to obtain rate increases on certain of our insurance products.
•Worse than anticipated claims experience.
•Lower than expected dividends and/or surplus debenture interest payments from our insurance subsidiaries (resulting from inadequate earnings or capital or regulatory requirements).
•An inability to meet and/or maintain the covenants in our Revolving Credit
Agreement.
•A significant increase in policy surrender levels.
•A significant increase in investment defaults.
•An inability of our reinsurers to meet their financial obligations.
While we actively manage the relationship between the duration and cash flows of our invested assets and the estimated duration and cash flows of benefit payments arising from contract liabilities, there could be significant variations in the timing of such cash flows. Although we believe our current estimates properly project future claim experience, if these estimates prove to be wrong, and our experience worsens (as it did in some prior periods), our future liquidity could be adversely affected.
Liquidity for Insurance Operations
Our insurance companies generally receive adequate cash flows from premium
collections and investment income to meet their obligations. Life insurance,
long-term care and supplemental health insurance and annuity liabilities are
generally long-term in nature. Life and annuity policyholders may, however,
withdraw funds or surrender their policies, subject to any applicable penalty
provisions; there are generally no withdrawal or surrender benefits for
long-term care insurance. We actively manage the relationship between the
duration of our invested assets and the estimated duration of benefit payments
arising from contract liabilities.
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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. AtDecember 31, 2021 , the carrying value of the FHLB common stock was$75.4 million . As ofDecember 31, 2021 , collateralized borrowings from the FHLB totaled$1.7 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$2.1 billion atDecember 31, 2021 , which are maintained in custodial accounts for the benefit of the FHLB. In the third quarter of 2021, Bankers Life established a FABN program pursuant to which Bankers Life may issue funding agreements to aDelaware statutory trust organized in series (the "Trust") to generate spread-based earnings. The maximum aggregate principal amount of funding agreements permitted to be outstanding at any one time under the FABN program is$3 billion . InOctober 2021 , Bankers Life issued a funding agreement to a series of the Trust in an aggregate principal amount of$500 million . InJanuary 2022 , Bankers Life issued additional funding agreements totaling$900 million . Under current market conditions, we expect the FABN program to provide approximately 100 basis points of annualized pre-tax spread income on the notional amount of the funding agreements outstanding, net of the expense associated with the program. The activity related to the funding agreements is reported in investment income not allocated to product lines. State laws generally give state insurance regulatory agencies broad authority to protect policyholders in their jurisdictions. Regulators have used this authority in the past to restrict the ability of our insurance subsidiaries to pay any dividends or other amounts without prior approval. We cannot be assured that the regulators will not seek to assert greater supervision and control over our insurance subsidiaries' businesses and financial affairs. Our estimated consolidated statutory RBC ratio was 386 percent atDecember 31, 2021 , compared to 411 percent atDecember 31, 2020 . In 2021, our estimated consolidated statutory operating earnings were$289 million and insurance company dividends of$328.3 million were paid to the holding company. InJune 2021 , among other things, the NAIC adopted new bond factors to be used in the RBC ratio calculation effectiveDecember 31, 2021 . The estimated impact of these changes was a reduction in the RBC ratio of approximately 16 percentage points (which is equivalent to approximately$80 million of capital). We have refined our target consolidated statutory RBC ratio to a point estimate of approximately 375 percent which was the low end of our previous targeted range of between 375 percent and 400 percent and reflects the stable operating results and balanced risk profile of our insurance subsidiaries. In the context of a stress scenario, we may fall below 375 percent temporarily but would expect to return to that level over a short period of time. We believe that the 375 percent RBC target continues to adequately support our financial strength and credit ratings and is aligned with our risk appetite. During 2021, the financial statements of three 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 Bankers Life,Washington National andBankers Conseco Life Insurance Company were$30.0 million ,$125.5 million and$39.5 million , respectively, atDecember 31, 2021 . 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 and state requirements. Our insurance subsidiaries transfer exposure to certain risk to others through reinsurance arrangements. When we obtain reinsurance, we are still liable for those transferred risks in the event the reinsurer defaults on its obligations. The failure, insolvency, inability or unwillingness of one or more of the Company's reinsurers to perform in accordance with the terms of its reinsurance agreement could negatively impact our earnings or financial position and our consolidated statutory RBC ratio.
Financial Strength Ratings of our Insurance Subsidiaries
Financial strength ratings provided by AM Best, Fitch, Moody's and S&P are the rating agency's opinions of the ability of our insurance subsidiaries to pay policyholder claims and obligations when due. OnJanuary 26, 2022 , AM Best upgraded the financial strength ratings of our primary insurance subsidiaries to "A" from "A-" and the outlook for these ratings is stable. The "A" rating is assigned to companies that have an excellent ability, in AM Best's opinion, to meet their ongoing obligations to policyholders. AM 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 77 -------------------------------------------------------------------------------- Table of Contents ongoing obligations to policyholders. AM Best has sixteen possible ratings. There are two ratings above the "A" rating of our primary insurance subsidiaries and thirteen ratings that are below that rating. OnDecember 2, 2021 , Fitch affirmed its "A-" financial strength ratings of our primary insurance subsidiaries. The outlook for these ratings remain stable. An insurer rated "A", in Fitch's opinion, indicates a low expectation of ceased or interrupted payments and indicates strong capacity to meet policyholder and contract obligations. This capacity may, nonetheless, be more vulnerable to changes in circumstances or in economic conditions than is the case for higher ratings. Fitch ratings for the industry range from "AAA Exceptionally Strong " to "C Distressed" and some companies are not rated. Pluses and minuses show the relative standing within a category. Fitch has nineteen possible ratings. There are six ratings above the "A-" rating of our primary insurance subsidiaries and twelve ratings that are below that rating. OnSeptember 28, 2021 , Moody's affirmed its "A3" financial strength ratings of our primary insurance subsidiaries. The outlook for these ratings remains stable. Moody's financial strength ratings range from "Aaa" to "C". These ratings may be supplemented with numbers "1", "2", or "3" to show relative standing within a category. In Moody's view, an insurer rated "A" offers good financial security, however, certain elements may be present which suggests a susceptibility to impairment sometime in the future. Moody's has twenty-one possible ratings. There are six ratings above the "A3" rating of our primary insurance subsidiaries and fourteen ratings that are below that rating. OnJune 21, 2019 , S&P upgraded the financial strength ratings of our primary insurance subsidiaries to "A-" from "BBB+" and the outlook for these ratings is stable. S&P financial strength ratings range from "AAA" to "R" and some companies are not rated. An insurer rated "A", in S&P's opinion, has strong financial security characteristics, but is somewhat more likely to be affected by adverse business conditions than are insurers with higher ratings. Pluses and minuses show the relative standing within a category. S&P has twenty-one possible ratings. There are six ratings above the "A-" rating of our primary insurance subsidiaries and fourteen ratings that are below that rating. 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 the rating agency models for maintenance of certain ratings levels. We cannot predict what actions rating agencies may take, or what actions we may take in response. Accordingly, downgrades and outlook revisions related to us or the life insurance industry may occur in the future at any time and without notice by any rating agency. These could increase policy surrenders and withdrawals, adversely affect relationships with our distribution channels, reduce new sales, reduce our ability to borrow and increase our future borrowing costs.
Liquidity of the Holding Companies
Availability and Sources and Uses of Holding Company Liquidity; Limitations on
Ability of Insurance Subsidiaries to Make Dividend and Surplus Debenture
Interest Payments to the Holding Companies; Limitations on Holding Company
Activities
CNO andCDOC 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 andCDOC 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 andCDOC are 40|86 Advisors, which receives fees from the insurance subsidiaries for investment services, andCNO Services, LLC ("CNO Services") which receives fees from the insurance subsidiaries for providing administrative services. The agreements between our insurance subsidiaries andCNO 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. AtDecember 31, 2021 , CNO,CDOC and our other non-insurance subsidiaries held: (i) unrestricted cash and cash equivalents of$198.7 million ; and (ii) exchange-traded funds that invest in fixed income securities of$49.9 million . In 2022, we expect to manage our liquidity level closer to our minimum target level of$150 million . 78
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The following table sets forth the aggregate amount of dividends (net of capital
contributions) and other distributions that our insurance subsidiaries paid to
our non-insurance subsidiaries in each of the last three fiscal years (dollars
in millions):
Years ended December 31,
2021 2020 2019
Net dividends (contributions) from/to insurance
subsidiaries $ 328.3 $ 294.1 $ 186.3
Surplus debenture interest 55.4 57.4 59.9
Fees for services provided pursuant to service
agreements 117.8 111.7 115.5
Total dividends and other distributions paid by
insurance subsidiaries $ 501.5 $ 463.2 $ 361.7
The ability of our insurance subsidiaries to pay dividends is subject to state
insurance department regulations and is based on the financial statements of our
insurance subsidiaries prepared in accordance with statutory accounting
practices prescribed or permitted by regulatory authorities, which differ from
GAAP. These regulations generally permit dividends to be paid from statutory
earned surplus of the insurance company without regulatory approval for any
12-month period in amounts equal to the greater of (or in some states, the
lesser of): (i) statutory net gain from operations or net income for the prior
year; or (ii) 10 percent of statutory capital and surplus as of the end of the
preceding year. However, as each of the immediate insurance subsidiaries of CDOC
has significant negative earned surplus, any dividend payments from the
insurance subsidiaries require the prior approval of the director or
commissioner of the applicable state insurance department. In 2021, our
insurance subsidiaries paid dividends to CDOC totaling $328.3 million . We expect
to receive regulatory approval for future dividends from our subsidiaries, but
there can be no assurance that such payments will be approved or that the
financial condition of our insurance subsidiaries will not change, making future
approvals less likely.
CDOC holds surplus debentures from CLTX with an aggregate principal amount of
$749.6 million . Interest payments on those surplus debentures do not require
additional approval provided the RBC ratio of CLTX exceeds 100 percent (but do
require prior written notice to the Texas state insurance department). The
estimated RBC ratio of CLTX was 329 percent at December 31, 2021 . CDOC also
holds a surplus debenture from Colonial Penn with a principal balance of $160.0
million . Interest payments on that surplus debenture require prior approval by
the Pennsylvania state insurance department. Dividends and other payments from
our non-insurance subsidiaries, including 40|86 Advisors and CNO Services , to
CNO or CDOC do not require approval by any regulatory authority or other third
party. However, insurance regulators may prohibit payments by our insurance
subsidiaries to parent companies if they determine that such payments could be
adverse to our policyholders or contractholders.
The insurance subsidiaries of CDOC receive funds to pay dividends primarily
from: (i) the earnings of their direct businesses; (ii) tax sharing payments
received from subsidiaries (if applicable); and (iii) with respect to CLTX,
dividends received from subsidiaries. At December 31, 2021 , the subsidiaries of
CLTX had earned surplus (deficit) as summarized below (dollars in millions):
Subsidiary of CLTX Earned surplus (deficit) Additional information
Bankers Life $ 262.6 (a)
Colonial Penn (413.3) (b)
____________________
(a)Bankers Life paid dividends of $225.0 million to CLTX in 2021. 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.
(b)The deficit is primarily due to transactions which occurred several years
ago, including a tax planning transaction and the fee paid to recapture a block
of business previously ceded to an unaffiliated insurer.
A significant deterioration in the financial condition, earnings or cash flow of
the material subsidiaries of CNO or CDOC for any reason could hinder such
subsidiaries' ability to pay cash dividends or other disbursements to CNO and/or
CDOC , which, in turn, could limit CNO's ability to meet debt service
requirements and satisfy other financial obligations. In addition, we may choose
to retain capital in our insurance subsidiaries or to contribute additional
capital to our insurance subsidiaries to maintain or strengthen their surplus or
fund reinsurance transactions, and these decisions could limit the amount
available at our top tier insurance subsidiaries to pay dividends to the holding
companies.
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On July 16, 2021 , the Company entered into a second amendment and restatement
agreement (the "Second Amendment Agreement") with respect to its Revolving
Credit Agreement. The Second Amendment Agreement, among other things, (i)
revised the debt to total capitalization ratio to exclude hybrid securities from
the calculation, except to the extent that the aggregate amount outstanding of
all such hybrid securities exceeds an amount equal to 15% of total
capitalization, (ii) reduced the net equity proceeds prong of the minimum
consolidated net worth covenant from 50% to 25%, (iii) removed the aggregate RBC
ratio covenant and (iv) extended the maturity date of the revolving credit
facility to July 16, 2026 . The Second Amendment Agreement continues to contain
certain other restrictive covenants with which the Company must comply. The
interest rate applicable to loans under the Second Amendment Agreement continues
to be calculated as the eurodollar rate or the base rate, at the Company's
option, plus a margin based on the Company's unsecured debt rating. The margins
under the Second Amendment Agreement continue to range from 1.375% to 2.125%, in
the case of loans at the eurodollar rate, and 0.375% to 1.125%, in the case of
loans at the base rate. The commitment fee under the Second Amendment Agreement
continues to be based on the Company's unsecured debt rating and the Second
Amendment Agreement includes updated LIBOR fallback provisions. There were no
amounts outstanding under the Revolving Credit Agreement at December 31, 2021 .
The scheduled principal and interest payments on our direct corporate
obligations are as follows (dollars in millions):
Principal Interest (a) 2022 $ -$ 60.8 2023 - 60.8 2024 - 60.8 2025 500.0 (b) 47.8 2026 - (c) 34.3 2027 and thereafter 650.0 (d) 327.1$ 1,150.0 $ 591.6
_________________________
(a)Based on interest rates as of
(b)Such amount represents our 5.250% Notes due 2025.
(c)The maturity date of the Revolving Credit Agreement is
(d)Such amount includes
Debentures due 2060.
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 2021, we generated$380 million of such free cash flow. The Company is committed to deploying 100 percent of its free cash flow into investments to accelerate profitable growth, common stock dividends and share repurchases. The amount and timing of future share repurchases (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 2021, we repurchased 16.6 million shares of common stock for$402.4 million under our securities repurchase program. InMay 2021 , the Company's Board of Directors approved an additional$500.0 million to repurchase the Company's outstanding shares of common stock. The Company had remaining repurchase authority of$366.9 million as ofDecember 31, 2021 . In the first quarter of 2021, the Company purchasedDirectPath (as further described in the note to the consolidated financial statements entitled "Business and Basis of Presentation") utilizing$51 million of holding company liquidity. In 2021, 2020 and 2019, dividends declared on common stock totaled$66.1 million ($0.51 per common share),$67.4 million ($0.47 per common share) and$67.2 million ($0.43 per common share), respectively. InMay 2021 , the Company increased its quarterly common stock dividend to$0.13 per share from$0.12 per share. OnJanuary 26, 2022 , AM Best upgraded our issuer credit and senior unsecured debt ratings to "bbb" from "bbb-" and the outlook for these ratings is stable. In AM Best's view, a company rated "bbb" has an adequate ability to meet the terms of its obligations; however, the issuer is more susceptible to changes in economic or other conditions. Pluses and minuses show the relative standing within a category. AM Best has a total of 22 possible ratings ranging from "aaa (Exceptional)" to "d (In default)". There are eight ratings above CNO's "bbb" rating and thirteen ratings that are below its rating. OnDecember 2, 2021 , Fitch affirmed its "BBB-" rating on our senior unsecured debt. The outlook for these ratings remain 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 80 -------------------------------------------------------------------------------- Table of Contents 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. OnSeptember 28, 2021 , Moody's affirmed its "Baa3" rating on our senior unsecured debt. The outlook for these ratings remains stable. In Moody's view, obligations rated "Baa" are subject to moderate credit risk and may possess certain speculative characteristics. A rating is supplemented with numerical modifiers "1", "2" or "3" to show the relative standing within a category. Moody's has a total of 21 possible ratings ranging from "Aaa" to "C". There are nine ratings above CNO's "Baa3" rating and eleven ratings that are below its rating. OnJune 21, 2019 , S&P upgraded our senior unsecured debt rating to "BBB-" from "BB+" and the outlook for these ratings is stable. In S&P's view, an obligation rated "BBB" exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation. Pluses and minuses show the relative standing within a category. S&P has a total of 22 possible ratings ranging from "AAA (Extremely Strong)" to "D (Payment Default)". There are nine ratings above CNO's "BBB-" rating and twelve ratings that are below its rating. Outlook We believe that the existing cash available to the holding company, the cash flows to be generated from operations and other transactions will be sufficient to allow us to meet our debt service obligations, pay corporate expenses and satisfy other financial obligations. However, our cash flow is affected by a variety of factors, many of which are outside of our control, including insurance regulatory issues, competition, financial markets and other general business conditions. We cannot provide assurance that we will possess sufficient income and liquidity to meet all of our debt service requirements and other holding company obligations. For additional discussion regarding the liquidity and other risks that we face, see "Risk Factors".
MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
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, atDecember 31, 2021 , approximately$4.4 billion of our total insurance liabilities 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 management 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. We seek to invest our assets allocated to our insurance products in a manner that will fund future obligations to policyholders and meet profitability objectives, subject to appropriate risk considerations. We seek to meet this objective through investments that: (i) have similar cash flow characteristics with the liabilities they support; (ii) are diversified (including by types of obligors); and (iii) are predominantly investment-grade in quality. 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 opportunities change, to reflect changing perceptions of risk, or to better match certain characteristics of our investment portfolio with the corresponding characteristics of our insurance liabilities. The profitability of many of our products depends on the spread between the interest earned on investments and the rates credited on our insurance liabilities. In addition, changes in competition and other factors, including the level of surrenders and withdrawals, may limit our ability to adjust or to maintain crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions. As ofDecember 31, 2021 , approximately 15 percent of our insurance liabilities had interest rates that may be reset annually; 48 percent had a fixed explicit interest rate for the duration of the contract; 34 percent are fixed index products where the income earned is subject to a participation rate that typically may be changed annually; and the remainder had no explicit interest rates. 81 -------------------------------------------------------------------------------- Table of Contents The following table summarizes the distribution of annuity and universal life account values, net of amounts ceded, by guaranteed interest crediting rates as ofDecember 31, 2021 (dollars in millions): Guaranteed Fixed index Fixed interest Universal rate annuities annuities life Total > 5.0% to 6.0% $ - $ .2$ 7.8 $ 8.0 > 4.0% to 5.0% - 24.9 248.4 273.3 > 3.0% to 4.0% 13.9 583.5 37.2 634.6 > 2.0% to 3.0% 541.4 653.9 261.7 1,457.0 > 1.0% to 2.0% 1,469.2 150.6 32.2 1,652.0 1.0% and under 6,658.5 399.3 559.5 7,617.3$ 8,683.0 $ 1,812.4 $ 1,146.8 $ 11,642.2 Weighted average 1.16 % 2.71 % 2.38 % 1.52 % AtDecember 31, 2021 ,$2.4 billion and$0.3 billion of our annuity and universal life account values, respectively, net of amounts ceded, were at minimum guaranteed crediting rates. The weighted average crediting rates atDecember 31, 2021 , related to such annuity and universal life account values, that were at the minimum guaranteed crediting rate were 2.43 percent and 4.48 percent, respectively. AtDecember 31, 2021 , the weighted average yield, computed on the cost basis of investments allocated to our product lines, was approximately 4.7 percent, and the average interest rate credited or accruing to our total insurance liabilities (excluding interest rate bonuses for the first policy year only and excluding the effect of credited rates attributable to variable or fixed index products) was 4.5 percent. Such 4.5 percent rate includes interest credited to annuity and universal life products as well as the rates assumed in our calculations of reserves for health and traditional life products which are set based on investment yields at policy issuance and are locked-in in accordance with current accounting requirements. Refer to "Part 1 - Item 1A. Risk Factors - Potential continuation of a low interest rate environment for an extended period of time may negatively impact our results of operations, financial position and cash flows" for additional information on interest rate risks. We simulate the cash flows expected from our existing insurance business under various interest rate scenarios. These simulations help us to measure the potential gain or loss in fair value of our interest rate-sensitive investments and to manage the relationship between the interest sensitivity of our assets and liabilities. When the estimated durations of assets and liabilities are similar, absent other factors, a change in the value of assets related to changes in interest rates should be largely offset by a change in the value of liabilities. AtDecember 31, 2021 , the estimated duration of our fixed income securities (as modified to reflect estimated prepayments and call premiums) and the estimated duration of our insurance liabilities were approximately 10.2 years and 9.5 years, respectively. We estimate that our fixed maturity securities and short-term investments (net of corresponding changes in insurance acquisition costs or loss recognition reserves) would decline in fair value by approximately$330 million if interest rates were to increase by 10 percent from their levels atDecember 31, 2021 . Our simulations incorporate numerous assumptions, require significant estimates and assume an immediate change in interest rates without any management of the investment portfolio in reaction to such change. Consequently, potential changes in value of our financial instruments indicated by the simulations will likely be different from the actual changes experienced under given interest rate scenarios, and the differences may be material. Because we actively manage our investments and liabilities, our net exposure to interest rates can vary over time. We are subject to the risk that our investments will decline in value. This has occurred in the past and may occur again, particularly if interest rates rise from their current low levels. The Company is subject to risk resulting from fluctuations in market prices of our equity securities. In general, these investments have more year-to-year price variability than our fixed maturity investments. However, returns over longer time frames have been consistently higher. We manage this risk by limiting our equity securities to a relatively small portion of our total investments.
Our investment in options backing our equity-linked products is closely matched
with our obligation to fixed index annuity holders. Fair value changes
associated with that investment are substantially offset by an increase or
decrease in the amounts added to policyholder account liabilities for fixed
index products.
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Table of Contents Inflation Inflation rates may impact the financial statements and operating results in several areas. Inflation influences interest rates, which in turn impact the fair value of the investment portfolio and yields on new investments. Inflation also impacts a portion of our insurance policy benefits affected by increased medical coverage costs. Operating expenses, including payrolls, are impacted to a certain degree by the inflation rate.
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