SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Investments

We classify our fixed maturity securities into one of two categories: (i) "available for sale" (which we carry at estimated fair value with any unrealized gain or loss, net of tax and related adjustments, recorded as a component of shareholders' equity); or (ii) "trading" (which we carry at estimated fair value with changes in such value recognized as net investment income (classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios)).

Equity securities include investments in common stock and non-redeemable preferred stock. We carry these investments at estimated fair value. We record any unrealized gain or loss, net of tax and related adjustments, as a component of shareholders' equity.

Mortgage loans held in our investment portfolio are carried at amortized unpaid balances, net of provisions for estimated losses. Interest income is accrued on the principal amount of the loan based on the loan's contractual interest rate. Payment terms specified for mortgage loans may include a prepayment penalty for unscheduled payoff of the investment. Prepayment penalties are recognized as investment income when received.

Policy loans are stated at current unpaid principal balances.

Our trading securities include: (i) investments purchased with the intent of selling in the near term to generate income on price changes; (ii) investments supporting certain insurance liabilities (including investments backing the market strategies of our multibucket annuity products) and certain reinsurance agreements; and (iii) certain fixed maturity securities containing embedded derivatives for which we have elected the fair value option. The change in fair value of these securities is recognized in income from policyholder and reinsurer accounts and other special-purpose portfolios (a component of net investment income). Investment income from trading securities backing certain insurance liabilities and certain reinsurance agreements is substantially offset by the change in insurance policy benefits related to certain products and agreements. Prior to June 30, 2011, certain of our trading securities were held to offset the income statement volatility caused by the effect of interest rate fluctuations on the value of embedded derivatives related to our fixed index annuity products. During the second quarter of 2011, we sold this trading portfolio. See the section of this note entitled "Accounting for Derivatives" for further discussion regarding these embedded derivatives. The change in value of these securities is recognized in realized investment gains (losses). Our trading securities totaled $266.2 million and $91.6 million at December 31, 2012 and 2011, respectively.

Other invested assets include: (i) call options purchased in an effort to offset or hedge the effects of certain policyholder benefits related to our fixed index annuity and life insurance products; (ii) Company-owned life insurance ("COLI"); and (iii) certain non-traditional investments. We carry the call options at estimated fair value as further described in the section of this note entitled "Accounting for Derivatives". We carry COLI at its cash surrender value which approximates its net realizable value. Non-traditional investments include investments in certain limited partnerships, which are accounted for using the equity method; promissory notes, which are accounted for using the cost method; and investments in certain hedge funds that are carried at estimated fair value.

We defer any fees received or costs incurred when we originate investments. We amortize fees, costs, discounts and premiums as yield adjustments over the contractual lives of the investments without anticipation of prepayments. We consider anticipated prepayments on mortgage-backed securities in determining estimated future yields on such securities.

When we sell a security (other than trading securities), we report the difference between the sale proceeds and amortized cost (determined based on specific identification) as a realized investment gain or loss.

We regularly evaluate our investments for possible impairment as further described in the note to the consolidated financial statements entitled "Investments".

When a security defaults (including mortgage loans) or securities (other than structured securities) are other-than-temporarily impaired, our policy is to discontinue the accrual of interest and eliminate all previous interest accruals, if we determine that such amounts will not be ultimately realized in full.

Cash and Cash Equivalents

Cash and cash equivalents include commercial paper, invested cash and other investments purchased with original maturities of less than three months. We carry them at amortized cost, which approximates estimated fair value.

Deferred Acquisition Costs

Deferred acquisition costs represent incremental direct costs related to the successful acquisition of new or renewal insurance contracts. For universal life or investment 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 amortize these costs in relation to future anticipated premium revenue using the projected investment earnings rate.

When we realize a gain or loss on investments backing our universal life or investment-type products, we adjust the amortization to reflect the change in estimated gross profits from the products due to the gain or loss realized and the effect on future investment yields. We also adjust deferred acquisition costs for the change in amortization that would have been recorded if our fixed maturity securities, available for sale, had been sold at their stated aggregate fair value and the proceeds reinvested at current yields. We limit the total adjustment related to the impact of unrealized losses to the total of costs capitalized plus interest related to insurance policies issued in a particular year. We include the impact of this adjustment in accumulated other comprehensive income (loss) within shareholders' equity.

We regularly evaluate the recoverability of the unamortized balance of the deferred acquisition costs. We consider estimated future gross profits or future premiums, expected mortality or morbidity, interest earned and credited rates, persistency and expenses in determining whether the balance is recoverable. If we determine a portion of the unamortized balance is not recoverable, it is charged to amortization expense. In certain cases, the unamortized balance of the deferred acquisition costs may not be deficient in the aggregate, but our estimates of future earnings indicate that profits would be recognized in early periods and losses in later periods. In this case, we increase the amortization of the deferred acquisition costs over the period of profits, by an amount necessary to offset losses that are expected to be recognized in the later years.

Refer to the caption "Recently Issued Accounting Standards - Accounting Standard Adopted on a Retrospective Basis" for further information regarding the impact of adoption.

Present Value of Future Profits

The value assigned to the right to receive future cash flows from policyholder insurance contracts existing at the Effective Date is referred to as the present value of future profits. The discount rate we used to determine the present value of future profits was 12 percent. The balance of this account is amortized and evaluated for recovery in the same manner as described above for deferred acquisition costs. We also adjust the present value of future profits for the change in amortization that would have been recorded if the fixed maturity securities, available for sale, had been sold at their stated aggregate fair value and the proceeds reinvested at current yields, similar to the manner described above for deferred acquisition costs. We limit the total adjustment related to the impact of unrealized losses to the total present value of future profits plus interest.

Assets Held in Separate Accounts

Separate accounts are funds on which investment income and gains or losses accrue directly to certain policyholders. The assets of these accounts are legally segregated. They are not subject to the claims that may arise out of any other business of CNO. We report separate account assets at fair value; the underlying investment risks are assumed by the contractholders. We record the related liabilities at amounts equal to the separate account assets. We record the fees earned for administrative and contractholder services performed for the separate accounts in insurance policy income.

Recognition of Insurance Policy Income and Related Benefits and Expenses on Insurance Contracts

For universal life and investment contracts that do not involve significant mortality or morbidity risk, the amounts collected from policyholders are considered deposits and are not included in revenue. Revenues for these contracts consist of charges for policy administration, cost of insurance charges and surrender charges assessed against policyholders' account balances. Such revenues are recognized when the service or coverage is provided, or when the policy is surrendered.

We establish liabilities for investment and universal life products 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. Sales inducements provided to the policyholders of these products are recognized as liabilities over the period that the contract must remain in force to qualify for the inducement. The options attributed to the policyholder related to our fixed index annuity products are accounted for as embedded derivatives as described in the section of this note entitled "Accounting for Derivatives".

Premiums from individual life products (other than interest-sensitive life contracts), and health products are recognized when due. When premiums are due over a significantly shorter period than the period over which benefits are provided, any gross premium in excess of the net premium (i.e., the portion of the gross premium required to provide for all expected future benefits and expenses) is deferred and recognized into revenue in a constant relationship to insurance in force. Benefits are recorded as an expense when they are incurred.

We establish liabilities for traditional life, accident and health insurance, and life contingent payment annuity products using mortality tables in general use in the United States, which are modified to reflect the Company's actual experience when appropriate. We establish liabilities for accident and health insurance products using morbidity tables based on the Company's actual or expected experience. These reserves are computed at amounts that, with additions from estimated future premiums received and with interest on such reserves at estimated future rates, are expected to be sufficient to meet our obligations under the terms of the policy. Liabilities for future policy benefits are computed on a net-level premium method based upon assumptions as to future claim costs, investment yields, mortality, morbidity, withdrawals, policy dividends and maintenance expenses determined when the policies were issued (or with respect to policies inforce at August 31, 2003, the Company's best estimate of such assumptions on the Effective Date). We make an additional provision to allow for potential adverse deviation for some of our assumptions. Once established, assumptions on these products are generally not changed unless a premium deficiency exists. In that case, a premium deficiency reserve is recognized and the future pattern of reserve changes is modified to reflect the relationship of premiums to benefits based on the current best estimate of future claim costs, investment yields, mortality, morbidity, withdrawals, policy dividends and maintenance expenses, determined without an additional provision for potential adverse deviation.

We establish claim reserves based on our estimate of the loss to be incurred on reported claims plus estimates of incurred but unreported claims based on our past experience.

Accounting for Long-term Care Premium Rate Increases

Many of our long-term care policies have been subject to premium rate increases. In some cases, these premium rate increases were materially consistent with the assumptions we used to value the particular block of business at the Effective Date. With respect to certain premium rate increases, some of our policyholders were provided an option to cease paying their premiums and receive a non-forfeiture option in the form of a paid-up policy with limited benefits. In addition, our policyholders could choose to reduce their coverage amounts and premiums in the same proportion, when permitted by our contracts or as required by regulators. The following describes how we account for these policyholder options:

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Premium rate increases - If premium rate increases reflect a change in our previous rate increase assumptions, the new assumptions are not reflected prospectively in our reserves. Instead, the additional premium revenue resulting from the rate increase is recognized as earned and original assumptions continue to be used to determine changes to liabilities for insurance products unless a premium deficiency exists.


•	Benefit reductions - A policyholder may choose reduced coverage with a proportionate reduction in premium, when permitted by our contracts. This option does not require additional underwriting. Benefit reductions are treated as a partial lapse of coverage, and the balance of our reserves and deferred insurance acquisition costs is reduced in proportion to the reduced coverage.

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Non-forfeiture benefits offered in conjunction with a rate increase - In some cases, non-forfeiture benefits are offered to policyholders who wish to lapse their policies at the time of a significant rate increase. In these cases, exercise of this option is treated as an extinguishment of the original contract and issuance of a new contract. The balance of our reserves and deferred insurance acquisition costs are released, and a reserve for the new contract is established.


•	Florida Order - In 2004, the Florida Office of Insurance Regulation issued an order regarding home health care business in Florida in our Other CNO Business segment. The order required a choice of three alternatives to be offered to holders of home health care policies in Florida subject to premium rate increases as follows:


•	retention of their current policy with a rate increase of 50 percent in the first year and actuarially justified increases in subsequent years;


•	receipt of a replacement policy with reduced benefits and a rate increase in the first year of 25 percent and no more than 15 percent in subsequent years; or


•	receipt of a paid-up policy, allowing the holder to file future claims up to 100 percent of the amount of premiums paid since the inception of the policy.

Reserves for all three groups of policies under the order were prospectively adjusted using a prospective revision methodology, as these alternatives were required by the Florida Office of Insurance Regulation. These policies had no insurance acquisition costs established at the Effective Date.

Some of our policyholders may receive a non-forfeiture benefit if they cease paying their premiums pursuant to their original contract (or pursuant to changes made to their original contract as a result of a litigation settlement made prior to the Effective Date or an order issued by the Florida Office of Insurance Regulation). In these cases, exercise of this option is treated as the exercise of a policy benefit, and the reserve for premium paying benefits is reduced, and the reserve for the non-forfeiture benefit is adjusted to reflect the election of this benefit.

Accounting for Marketing and Reinsurance Agreements with Coventry

The Medicare Prescription Drug, Improvement and Modernization Act of 2003 provided for the introduction of a prescription drug benefit. In order to offer this product to our current and potential future policyholders without investing in management and infrastructure, we entered into a national distribution agreement with Coventry to use our career and independent agents to distribute Coventry's prescription drug plan, Advantra Rx. We receive a fee based on the premiums collected on plans sold through our distribution channels. In addition, CNO has a quota-share reinsurance agreement with Coventry for CNO enrollees that provides CNO with 50 percent of net premiums and related policy benefits subject to a risk corridor.

The following describes how we account for and report our PDP business:

Our accounting for the national distribution agreement


•	We recognize distribution income based on a fixed fee per PDP contract. This fee income is recognized over the calendar year term as premiums are collected.


•	We also pay commissions to our agents who sell the plans on behalf of Coventry. These payments are deferred and amortized over the remaining term of the initial enrollment period (the one-year life of the initial policy).

Our accounting for the quota-share agreement


•	We recognize premium revenue evenly over the period of the underlying Medicare Part D contracts.


•	We recognize policyholder benefits and ceding commission expense as incurred.


•	We recognize risk-share premium adjustments consistent with Coventry's risk-share agreement with the Centers for Medicare and Medicaid Services.

Reinsurance

In the normal course of business, we seek to limit our loss exposure on any single insured or to certain groups of policies by ceding reinsurance to other insurance enterprises. We currently retain no more than $.8 million of mortality risk on any one policy. We diversify the risk of reinsurance loss by using a number of reinsurers that have strong claims-paying ratings. In each case, the ceding CNO subsidiary is directly liable for claims reinsured in the event the assuming company is unable to pay.

The cost of reinsurance on life and health coverages is recognized over the life of the reinsured policies using assumptions consistent with those used to account for the underlying policy. The cost of reinsurance ceded totaled $220.0 million, $238.1 million and $258.6 million in 2012, 2011 and 2010, respectively. We deduct this cost from insurance policy income. Reinsurance recoveries netted against insurance policy benefits totaled $210.2 million, $204.9 million and $471.6 million in 2012, 2011 and 2010, respectively.

From time-to-time, we assume insurance from other companies. Any costs associated with the assumption of insurance are amortized consistent with the method used to amortize deferred acquisition costs described above. Reinsurance premiums assumed totaled $69.4 million, $80.4 million and $92.6 million in 2012, 2011 and 2010, respectively. Reinsurance premiums included amounts assumed pursuant to marketing and quota-share agreements with Coventry of $49.9 million, $58.1 million and $67.2 million in 2012, 2011 and 2010, respectively.

See the section of this note entitled "Accounting for Derivatives" for a discussion of the derivative embedded in the payable related to certain modified coinsurance agreements.

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, capital loss carryforwards and net operating loss carryforwards ("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 tax assets on an ongoing basis. The realization of our deferred tax assets depends upon generating sufficient future taxable income during the periods in which our temporary differences become deductible and before our capital loss carryforwards and NOLs expire.

At December 31, 2012, our valuation allowance for our net deferred tax assets was $766.9 million, as we have determined that it is more likely than not that a portion of our deferred tax assets will not be realized. This determination was made by evaluating each component of the deferred tax assets and assessing the effects of limitations and/or interpretations on the value of such component to be fully recognized in the future.

Investments in Variable Interest Entities

We have concluded that we are the primary beneficiary with respect to certain variable interest entities ("VIEs"), which are consolidated in our financial statements. The following is a description of our significant investments in VIEs:

All of the VIEs are collateralized loan trusts that were established to issue securities and use the proceeds to principally invest in corporate loans and other permitted investments (including a new VIE which was consolidated in the first quarter of 2012). The assets held by the trusts are legally isolated and not available to the Company. The liabilities of the VIEs are expected to be satisfied from the cash flows generated by the underlying investments held by the trusts, not from the assets of the Company. The Company has no further commitments to the VIEs.

The investment portfolios held by the VIEs are primarily comprised of corporate fixed maturity securities which are almost entirely rated as below-investment grade securities. Refer to the note to the consolidated financial statements entitled "Investments in Variable Interest Entities" for additional information about VIEs.

Investment Borrowings

Three of the Company's insurance subsidiaries (Conseco Life, Washington National and Bankers Life) are members of the Federal Home Loan Bank ("FHLB"). As members of the FHLB, Conseco Life, Washington National and Bankers Life have the ability to borrow on a collateralized basis from the FHLB. Conseco Life, Washington National and Bankers Life are required to hold certain minimum amounts of FHLB common stock as a condition of membership in the FHLB, and additional amounts based on the amount of the borrowings. At December 31, 2012, the carrying value of the FHLB common stock was $82.5 million. As of December 31, 2012, 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 $2.0 billion at December 31, 2012, which are maintained in custodial accounts for the benefit of the FHLB. Such investments are classified as fixed maturities, available for sale, in our consolidated balance sheet. Interest expense of $28.0 million, $25.7 million and $20.8 million in 2012, 2011 and 2010, respectively, was recognized related to the borrowings.

The following summarizes the terms of the borrowings (dollars in millions):



Amount		Maturity	Interest rate at
borrowed		date	December 31, 2012
$	67.0	February 2014	Fixed rate – 1.830%
50.0		August 2014	Variable rate – 0.440%
100.0		August 2014	Variable rate – 0.470%
50.0		September 2015	Variable rate – 0.613%
150.0		October 2015	Variable rate – 0.559%
100.0		November 2015	Variable rate – 0.390%
146.0		November 2015	Fixed rate – 5.300%
100.0		December 2015	Fixed rate – 4.710%
100.0		June 2016	Variable rate – 0.650%
75.0		June 2016	Variable rate – 0.471%
100.0		October 2016	Variable rate – 0.535%
50.0		November 2016	Variable rate – 0.581%
50.0		November 2016	Variable rate – 0.680%
100.0		June 2017	Variable rate – 0.735%
100.0		July 2017	Fixed rate – 3.900%
50.0		August 2017	Variable rate – 0.510%
75.0		August 2017	Variable rate – 0.462%
100.0		October 2017	Variable rate – 0.770%
37.0		November 2017	Fixed rate – 3.750%
50.0		July 2018	Variable rate – 0.783%
$	1,650.0

The variable rate borrowings are pre-payable on each interest reset date without penalty. The fixed rate borrowings are pre-payable subject to payment of a yield maintenance fee based on current market interest rates. At December 31, 2012, the aggregate fee to prepay all fixed rate borrowings was $51.2 million.

As part of our investment strategy, we may enter into investment borrowings, including repurchase agreements, to increase our investment return. With respect to repurchase agreements, we account for these transactions as collateralized borrowings, where the amount borrowed is equal to the sales price of the underlying securities. Repurchase agreements involve a sale of securities and an agreement to repurchase the same securities at a later date at an agreed-upon price. We had no such borrowings outstanding at December 31, 2012. The primary risks associated with short-term collateralized borrowings are: (i) a substantial decline in the market value of the margined security; and (ii) that a counterparty may be unable to perform under the terms of the contract or be unwilling to extend such financing in future periods especially if the liquidity or value of the margined security has declined. Exposure is limited to any depreciation in value of the related securities.

At December 31, 2012, investment borrowings consisted of: (i) collateralized borrowings from the FHLB of $1.7 billion; and (ii) other borrowings of $.8 million.

At December 31, 2011, investment borrowings consisted of: (i) collateralized borrowings from the FHLB of $1.7 billion; (ii) repurchase agreements of $24.8 million; and (ii) other borrowings of $1.7 million.

Accounting for Derivatives

Our fixed index annuity products provide a guaranteed minimum rate of return and a higher potential return that is based on a percentage (the "participation rate") of the amount of increase in the value of a particular index, such as the Standard & Poor's 500 Index, over a specified period. Typically, on each policy anniversary date, a new index period begins. We are generally able to change the participation rate at the beginning of each index period during a policy year, subject to contractual minimums. We typically buy call options (including call spreads) referenced to the applicable indices in an effort to offset or hedge potential increases to policyholder benefits resulting from increases in the particular index to which the policy's return is linked. We reflect changes in the estimated fair value of these options in net investment income (classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios). Net investment gains (losses) related to fixed index products were $25.5 million, $(21.2) million and $28.2 million in 2012, 2011 and 2010, respectively. These amounts were substantially offset by a corresponding change to insurance policy benefits. The estimated fair value of these options was $54.4 million and $37.9 million at December 31, 2012 and 2011, respectively. We classify these instruments as other invested assets.

The Company accounts for the options attributed to the policyholder for the estimated life of the annuity contract as embedded derivatives. The Company purchases options to hedge liabilities for the next policy year on each policy anniversary date and must estimate the fair value of the forward embedded options related to the policies. These accounting requirements often create volatility in the earnings from these products. We record the changes in the fair values of the embedded derivatives in earnings as a component of insurance policy benefits. The fair value of these derivatives, which are classified as "liabilities for interest-sensitive products", was $734.0 million and $666.3 million at December 31, 2012 and 2011, respectively. Prior to June 30, 2011, we maintained a specific block of investments in our trading securities account (which we carried at estimated fair value with changes in such value recognized as investment income from policyholder and reinsurer accounts and other special-purpose portfolios) to offset the income statement volatility caused by the effect of interest rate fluctuations on the value of embedded derivatives related to our fixed index annuity products. During the second quarter of 2011, we sold this trading portfolio. Because we no longer seek to offset changes from the effect of interest rates on derivative embedded in our fixed index annuity products, we recognized $2.8 million and $20.4 million of decreased earnings in 2012 and 2011, respectively, since the volatility caused by the accounting requirements to record embedded options at fair value was no longer being offset.

If the counterparties for the call options we hold fail to meet their obligations, we may have to recognize a loss. We limit our exposure to such a loss by diversifying among several counterparties believed to be strong and creditworthy. At December 31, 2012, substantially all of our counterparties were rated "BBB+" or higher by Standard & Poor's Corporation ("S&P").

Certain of our reinsurance payable balances contain embedded derivatives. Such derivatives had an estimated fair value of $5.5 million and $3.5 million at December 31, 2012 and 2011, respectively. We record the change in the fair value of these derivatives as a component of investment income (classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios). We maintain the investments related to these agreements in our trading securities account, which we carry at estimated fair value with changes in such value recognized as investment income (also classified as investment income from policyholder and reinsurer accounts and other special-purpose portfolios). The change in value of these trading securities offsets the change in value of the embedded derivatives.

We purchase certain fixed maturity securities that contain embedded derivatives that are required to be bifurcated from the instrument and held at fair value on the consolidated balance sheet. For certain of these securities, we have elected the fair value option to carry the entire security at fair value with changes in fair value reported in net income for operational ease.

Multibucket Annuity Product

The Company's multibucket annuity is an annuity product that credits interest based on the experience of a particular market strategy. Policyholders allocate their annuity premium payments to several different market strategies based on different asset classes within the Company's investment portfolio. Interest is credited to this product based on the market return of the given strategy, less management fees, and funds may be moved between different strategies. The Company guarantees a minimum return of premium plus approximately 3 percent per annum over the life of the contract. The investments backing the market strategies of these products are designated by the Company as trading securities. The change in the fair value of these securities is recognized as investment income (classified as income from policyholder and reinsurer accounts and other special-purpose portfolios), which is substantially offset by the change in insurance policy benefits for these products. We hold insurance liabilities of $47.8 million and $52.6 million related to multibucket annuity products as of December 31, 2012 and 2011, respectively.

Fair Value Measurements

Definition of Fair Value

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, cash and cash equivalents, separate account assets and embedded derivatives. We carry our company-owned life insurance policy, which is backed by a series of mutual funds, at its cash surrender value and our hedge fund investments at their net asset values; in both cases, we believe these values approximate their fair values. In addition, we disclose fair value for certain financial instruments, including mortgage loans and policy loans, insurance liabilities for interest-sensitive products, 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.

Valuation Hierarchy

There is a three-level hierarchy for valuing assets or liabilities at fair value based on whether inputs are observable or unobservable.


•	Level 1 – includes assets and liabilities valued using inputs that are unadjusted quoted prices in active markets for identical assets or liabilities. Our Level 1 assets primarily include cash and exchange traded securities.

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Level 2 – includes assets and liabilities valued using inputs that are quoted prices for similar assets in an active market, quoted prices for identical or similar assets in a market that is not active, observable inputs, or observable inputs that can be corroborated by market data. Level 2 assets and liabilities include those financial instruments that are valued by independent pricing services using models or other valuation methodologies. These models are primarily industry-standard models that consider various inputs such as interest rate, credit or issuer spreads, reported trades and other inputs that are observable or derived from observable information in the marketplace or are supported by observable levels at which transactions are executed in the marketplace. Financial assets in this category primarily include: certain public and privately placed corporate fixed maturity securities; certain government or agency securities; certain mortgage and asset-backed securities; certain equity securities; most investments held by our consolidated VIEs; certain mutual fund and hedge fund investments; and most short-term investments; and non-exchange-traded derivatives such as call options to hedge liabilities related to our fixed index annuity products. Financial liabilities in this category include investment borrowings, notes payable and borrowings related to VIEs.

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Level 3 – includes assets and liabilities valued using unobservable inputs that are used in model-based valuations that contain management assumptions. Level 3 assets and liabilities include those financial instruments whose fair value is estimated based on broker/dealer quotes, pricing services or internally developed models or methodologies utilizing significant inputs not based on, or corroborated by, readily available market information. Financial assets in this category include certain corporate securities (primarily certain below-investment grade privately placed securities), certain structured securities, mortgage loans, and other less liquid securities. Financial liabilities in this category include our insurance liabilities for interest-sensitive products, which includes embedded derivatives (including embedded derivatives related to our fixed index annuity products and to a modified coinsurance arrangement) since their values include significant unobservable inputs including actuarial assumptions.

At each reporting date, we classify assets and liabilities into the three input levels based on the lowest level of input that is significant to the measurement of fair value for each asset and liability reported at fair value. This classification is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established, the characteristics specific to the transaction and overall market conditions. Our assessment of the significance of a particular input to the fair value measurement and the ultimate classification of each asset and liability requires judgment and is subject to change from period to period based on the observability of the valuation inputs. Any transfers between levels are reported as having occurred at the beginning of the period. There were no transfers between Level 1 and Level 2 in 2012.

The vast majority of our fixed maturity and equity securities, including those held in trading portfolios and those held by consolidated VIEs, short-term and separate account assets use Level 2 inputs for the determination of fair value. These fair values are obtained primarily from independent pricing services, which use Level 2 inputs for the determination of fair value. Substantially all of our Level 2 fixed maturity securities and separate account assets were valued from independent pricing services. Third party pricing services normally derive the security prices through recently reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information. If there are no recently reported trades, the third party pricing services may use matrix or model processes to develop a security price where future cash flow expectations are developed and discounted at an estimated risk-adjusted market rate. The number of prices obtained for a given security is dependent on the Company's analysis of such prices as further described below.

For securities that are not priced by pricing services and may not be reliably priced using pricing models, we obtain broker quotes. These broker quotes are non-binding and represent an exit price, but assumptions used to establish the fair value may not be observable and therefore represent Level 3 inputs. Approximately 20 percent of our Level 3 fixed maturity securities were valued using unadjusted broker quotes or broker-provided valuation inputs. The remaining Level 3 fixed maturity investments do not have readily determinable market prices and/or observable inputs. For these securities, we use internally developed valuations. Key assumptions used to determine fair value for these securities may include risk-free rates, risk premiums, performance of underlying collateral and other factors involving significant assumptions which may not be reflective of an active market. For certain investments, we use a matrix or model process to develop a security price where future cash flow expectations are developed and discounted at an estimated market rate. The pricing matrix utilizes a spread level to determine the market price for a security. The credit spread generally incorporates the issuer's credit rating and other factors relating to the issuer's industry and the security's maturity. In some instances issuer-specific spread adjustments, which can be positive or negative, are made based upon internal analysis of security specifics such as liquidity, deal size, and time to maturity.

As the Company is responsible for the determination of fair value, we have control processes designed to ensure that the fair values received from third-party pricing sources are reasonable and the valuation techniques and assumptions used appear reasonable and consistent with prevailing market conditions. Additionally, when inputs are provided by third-party pricing sources, we have controls in place to review those inputs for reasonableness. As part of these controls, we perform monthly quantitative and qualitative analysis on the prices received from third parties to determine whether the prices are reasonable estimates of fair value. The Company's analysis includes: (i) a review of the methodology used by third party pricing services; (ii) where available, a comparison of multiple pricing services' valuations for the same security; (iii) a review of month to month price fluctuations; (iv) a review to ensure valuations are not unreasonably stale; and (v) back testing to compare actual purchase and sale transactions with valuations received from third parties. As a result of such procedures, the Company may conclude the prices received from third parties are not reflective of current market conditions. In those instances, we may request additional pricing quotes or apply internally developed valuations. However, the number of instances is insignificant and the aggregate change in value of such investments is not materially different from the original prices received.

The categorization of the fair value measurements of our investments priced by independent pricing services was based upon the Company's judgment of the inputs or methodologies used by the independent pricing services to value different asset classes. Such inputs include: benchmark yields, reported trades, broker dealer quotes, issuer spreads, benchmark securities, bids, offers and reference data. The Company categorizes such fair value measurements based upon asset classes and the underlying observable or unobservable inputs used to value such investments.

The fair value measurements for derivative instruments, including embedded derivatives requiring bifurcation, are determined based on the consideration of several inputs including closing exchange or over-the-counter market price quotations; time value and volatility factors underlying options; market interest rates; and non-performance risk. For certain embedded derivatives, we may use actuarial assumptions in the determination of fair value.

The categorization of fair value measurements, by input level, for our financial instruments carried at fair value on a recurring basis at December 31, 2012 is as follows (dollars in millions):



	Quoted prices in active markets for identical assets or liabilities (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)		Total
Assets:
Fixed maturities, available for sale:
Corporate securities	$	—	$	16,498.6	$	355.5	$	16,854.1
United States Treasury securities and obligations of United States government corporations and agencies	—		99.5		—		99.5
States and political subdivisions	—		2,115.0		13.1		2,128.1
Debt securities issued by foreign governments	—		.8		—		.8
Asset-backed securities	—		1,416.9		44.0		1,460.9
Collateralized debt obligations	—		—		324.0		324.0
Commercial mortgage-backed securities	—		1,471.2		6.2		1,477.4
Mortgage pass-through securities	—		19.9		1.9		21.8
Collateralized mortgage obligations	—		2,230.6		16.9		2,247.5
Total fixed maturities, available for sale	—		23,852.5		761.6		24,614.1
Equity securities:
Corporate securities	49.7		118.8		.1		168.6
Venture capital investments	—		—		2.8		2.8
Total equity securities	49.7		118.8		2.9		171.4
Trading securities:
Corporate securities	—		46.6		—		46.6
United States Treasury securities and obligations of United States government corporations and agencies	—		4.8		—		4.8
States and political subdivisions	—		14.0		.6		14.6
Asset-backed securities	—		50.1		—		50.1
Collateralized debt obligations	—		—		7.3		7.3
Commercial mortgage-backed securities	—		93.3		—		93.3
Mortgage pass-through securities	—		.1		—		.1
Collateralized mortgage obligations	—		41.2		5.8		47.0
Equity securities	.9		1.5		—		2.4
Total trading securities	.9		251.6		13.7		266.2
Investments held by variable interest entities - corporate securities	—		814.3		—		814.3
Other invested assets - derivatives	—		54.4		—		54.4
Assets held in separate accounts	—		14.9		—		14.9
Total assets carried at fair value by category	$	50.6	$	25,106.5	$	778.2	$	25,935.3

Liabilities:
Liabilities for insurance products:
Interest-sensitive products - embedded derivatives associated with fixed index annuity products	—		—		734.0		734.0
Interest-sensitive products - embedded derivatives associated with modified coinsurance agreement	—		—		5.5		5.5
Total liabilities for insurance products	—		—		739.5		739.5
Total liabilities carried at fair value by category	$	—	$	—	$	739.5	$	739.5

For those financial instruments disclosed at fair value, we use the following methods and assumptions to determine the estimated fair values:

Mortgage loans and policy loans. We discount future expected cash flows for loans included in our investment portfolio based on interest rates currently being offered for similar loans to borrowers with similar credit ratings. We aggregate loans with similar characteristics in our calculations. The fair value of policy loans approximates their carrying value.

Company-owned life insurance is backed by a series of mutual funds and is carried at cash surrender value which approximates estimated fair value.

Hedge fund investments are carried at their net asset values which approximates estimated fair value.

Insurance liabilities for interest-sensitive products. We discount future expected cash flows based on interest rates currently being offered for similar contracts with similar maturities.

Investment borrowings, notes payable and borrowings related to variable interest entities. For publicly traded debt, we use current fair values. For other notes, we use discounted cash flow analyses based on our current incremental borrowing rates for similar types of borrowing arrangements.

The fair value measurements for our financial instruments disclosed at fair value on a recurring basis are as follows (dollars in millions):



	December 31, 2012										December 31, 2011
	Quoted prices in active markets for identical assets or liabilities (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)		Total estimated fair value		Total carrying amount		Total estimated fair value		Total carrying amount
Assets:
Mortgage loans	$	—	$	—	$	1,682.1	$	1,682.1	$	1,573.2	$	1,735.4	$	1,602.8
Policy loans	—		—		272.0		272.0		272.0		279.7		279.7
Other invested assets:
Company-owned life insurance	—		123.0		—		123.0		123.0		103.9		103.9
Hedge funds	—		16.1		—		16.1		16.1		18.2		18.2
Cash and cash equivalents:
Unrestricted	432.3		150.2		—		582.5		582.5		436.0		436.0
Held by variable interest entities	54.2		—		—		54.2		54.2		74.4		74.4
Liabilities:
Insurance liabilities for interest-sensitive products excluding embedded derivatives (a)	—		—		12,153.7		12,153.7		12,153.7		13,165.5		13,165.5
Investment borrowings	—		1,702.0		—		1,702.0		1,650.8		1,735.7		1,676.5
Borrowings related to variable interest entities	—		752.2		—		752.2		767.0		485.1		519.9
Notes payable – direct corporate obligations	—		1,100.3		—		1,100.3		1,004.2		978.3		857.9

____________________


(a)	The estimated fair value of insurance liabilities for interest-sensitive products was approximately equal to its carrying value at December 31, 2012. This was because interest rates credited on the vast majority of account balances approximate current rates paid on similar products and because these rates are not generally guaranteed beyond one year.

The categorization of fair value measurements, by input level, for our fixed maturity securities, equity securities, trading securities, certain other invested assets, assets held in separate accounts and embedded derivative instruments included in liabilities for insurance products at December 31, 2011 is as follows (dollars in millions):



	Quoted prices in active markets for identical assets or liabilities (Level 1)		Significant other observable inputs (Level 2) (a)		Significant unobservable inputs (Level 3) (a)			Total
Assets:
Fixed maturities, available for sale:
Corporate securities	$	—	$	15,594.4	$	278.1		$	15,872.5
United States Treasury securities and obligations of United States government corporations and agencies	—		303.8		1.6			305.4
States and political subdivisions	—		1,952.3		2.1			1,954.4
Debt securities issued by foreign governments	—		1.4		—			1.4
Asset-backed securities	—		1,334.3		79.7			1,414.0
Collateralized debt obligations	—		—		327.3			327.3
Commercial mortgage-backed securities	—		1,415.7		17.3			1,433.0
Mortgage pass-through securities	—		29.8		2.2			32.0
Collateralized mortgage obligations	—		2,051.2		124.8			2,176.0
Total fixed maturities, available for sale	—		22,682.9		833.1			23,516.0
Equity securities	17.9		87.3		69.9			175.1
Trading securities:
Corporate securities	—		67.6		—			67.6
United States Treasury securities and obligations of United States government corporations and agencies	—		4.9		—			4.9
States and political subdivisions	—		15.6		—			15.6
Asset-backed securities	—		.1		—			.1
Commercial mortgage-backed securities	—		—		.4			.4
Mortgage pass-through securities	—		.2		—			.2
Collateralized mortgage obligations	—		.7		—			.7
Equity securities	.7		1.4		—			2.1
Total trading securities	.7		90.5		.4			91.6
Investments held by variable interest entities	—		496.3		—			496.3
Other invested assets - derivatives	—		37.8		—			37.8
Assets held in separate accounts	—		15.0		—			15.0
Liabilities:
Liabilities for insurance products:
Interest-sensitive products	—		—		669.8		(b)	669.8

_____________


(a)	We revised the hierarchy classification of certain fixed maturities, equity securities, trading securities and other invested assets as we believe the observability of the inputs more closely represent Level 2 valuations.


(b)	Includes $666.3 million of embedded derivatives associated with our fixed index annuity products and $3.5 million of embedded derivatives associated with a modified coinsurance agreement.

The following table presents additional information about assets and liabilities measured at fair value on a recurring basis and for which we have utilized significant unobservable (Level 3) inputs to determine fair value for the year ended December 31, 2012 (dollars in millions):



	December 31, 2012
	Beginning balance as of December 31, 2011 (a)			Purchases, sales, issuances and settlements, net (c)			Total realized and unrealized gains (losses) included in net income			Total realized and unrealized gains (losses) included in accumulated other comprehensive income (loss)			Transfers into Level 3		Transfers out of Level 3 (b)			Ending balance as of December 31, 2012			Amount of total gains (losses) for the year ended December 31, 2012 included in our net income relating to assets and liabilities still held as of the reporting date
Assets:
Fixed maturities, available for sale:
Corporate securities	$	278.1		$	88.1		$	(.2	)	$	9.9		$	68.6	$	(89.0	)	$	355.5		$	—
United States Treasury securities and obligations of United States government corporations and agencies	1.6			(1.6		)	—			—			—		—			—			—
States and political subdivisions	2.1			(1.8		)	—			.9			11.9		—			13.1			—
Asset-backed securities	79.7			15.2			(.3		)	6.3			.5		(57.4		)	44.0			—
Collateralized debt obligations	327.3			(24.8		)	—			21.5			—		—			324.0			—
Commercial mortgage-backed securities	17.3			(2.5		)	—			.8			5.7		(15.1		)	6.2			—
Mortgage pass-through securities	2.2			(.3		)	—			—			—		—			1.9			—
Collateralized mortgage obligations	124.8			.2			—			(.1		)	5.0		(113.0		)	16.9			—
Total fixed maturities, available for sale	833.1			72.5			(.5		)	39.3			91.7		(274.5		)	761.6			—
Equity securities:
Corporate securities	6.4			(3.2		)	(3.8		)	.7			—		—			.1			(3.8		)
Venture capital investments	63.5			(34.3		)	(26.0		)	(.4		)	—		—			2.8			—
Total equity securities	69.9			(37.5		)	(29.8		)	.3			—		—			2.9			(3.8		)
Trading securities:
States and political subdivisions	—			—			.1			—			.5		—			.6			.1
Collateralized debt obligations	—			6.9			.4			—			—		—			7.3			.4
Commercial mortgage-backed securities	.4			—			—			—			—		(.4		)	—			—
Collateralized mortgage obligations	—			4.5			1.3			—			—		—			5.8			1.3
Total trading securities	.4			11.4			1.8			—			.5		(.4		)	13.7			1.8
Liabilities:
Liabilities for insurance products:
Interest-sensitive products	(669.8		)	(54.5		)	(15.2		)	—			—		—			(739.5		)	(15.2		)

____________


(a)	We revised the hierarchy classification of certain fixed maturities, equity securities, trading securities and other invested assets as we believe the observability of the inputs more closely represent Level 2 valuations.


(b)	For our fixed maturity securities, the majority of our transfers out of Level 3 are the result of obtaining a valuation from an independent pricing service at the end of the period, whereas a broker quote was used as of the beginning of the period.

(c)

Purchases, sales, issuances and settlements, net, represent the activity that occurred during the period that results in a change of the asset or liability but does not represent changes in fair value for the instruments held at the beginning of the period. Such activity primarily consists of purchases and sales of fixed maturity and equity securities and changes to embedded derivative instruments related to insurance products resulting from the issuance of new contracts, or changes to existing contracts. The following summarizes such activity for the year ended December 31, 2012 (dollars in millions):



	Purchases			Sales			Issuances			Settlements		Purchases, sales, issuances and settlements, net
Assets:
Fixed maturities, available for sale:
Corporate securities	$	110.3		$	(22.2	)	$	—		$	—	$	88.1
United States Treasury securities and obligations of United States government corporations and agencies	—			(1.6		)	—			—		(1.6		)
States and political subdivisions	—			(1.8		)	—			—		(1.8		)
Asset-backed securities	19.0			(3.8		)	—			—		15.2
Collateralized debt obligations	35.4			(60.2		)	—			—		(24.8		)
Commercial mortgage-backed securities	—			(2.5		)	—			—		(2.5		)
Mortgage pass-through securities	—			(.3		)	—			—		(.3		)
Collateralized mortgage obligations	11.2			(11.0		)	—			—		.2
Total fixed maturities, available for sale	175.9			(103.4		)	—			—		72.5
Equity securities:
Corporate securities	—			(3.2		)	—			—		(3.2		)
Venture capital investments	—			(34.3		)	—			—		(34.3		)
Total equity securities	—			(37.5		)	—			—		(37.5		)
Trading securities:
Collateralized debt obligations	6.9			—			—			—		6.9
Collateralized mortgage obligations	4.5			—			—			—		4.5
Total trading securities	11.4			—			—			—		11.4
Liabilities:
Liabilities for insurance products:
Interest-sensitive products	(103.3		)	60.4			(50.9		)	39.3		(54.5		)



	December 31, 2011
	Beginning balance as of December 31, 2010 (a)			Purchases, sales, issuances and settlements, net (c)			Total realized and unrealized gains (losses) included in net income			Total realized and unrealized gains (losses) included in accumulated other comprehensive income (loss)			Transfers into Level 3		Transfers out of Level 3 (b)			Ending balance as of December 31, 2011			Amount of total gains (losses) for the year ended December 31, 2011 included in our net income relating to assets and liabilities still held as of the reporting date
Assets:
Fixed maturities, available for sale:
Corporate securities	$	1,907.8		$	(292.3	)	$	(17.0	)	$	15.2		$	43.3	$	(1,378.9	)	$	278.1		$	(11.5	)
United States Treasury securities and obligations of United States government corporations and agencies	2.0			(.1		)	—			(.3		)	—		—			1.6			—
States and political subdivisions	2.5			—			—			.1			2.0		(2.5		)	2.1			—
Asset-backed securities	182.3			(4.1		)	—			4.8			39.4		(142.7		)	79.7			—
Collateralized debt obligations	256.5			69.4			1.5			(.1		)	—		—			327.3			—
Commercial mortgage-backed securities	—			—			—			.2			17.1		—			17.3			—
Mortgage pass-through securities	3.5			(1.3		)	—			—			—		—			2.2			—
Collateralized mortgage obligations	197.1			28.4			(2.1		)	3.7			3.9		(106.2		)	124.8			—
Total fixed maturities, available for sale	2,551.7			(200.0		)	(17.6		)	23.6			105.7		(1,630.3		)	833.1			(11.5		)
Equity securities	6.9			67.0			(3.8		)	(.2		)	—		—			69.9			—
Trading securities:
Commercial mortgage-backed securities	.4			—			—			—			—		—			.4			—
Collateralized mortgage obligations	.4			(.4		)	—			—			—		—			—			—
Total trading securities	.8			(.4		)	—			—			—		—			.4			—
Liabilities:
Liabilities for insurance products:
Interest-sensitive products	(553.2		)	(62.5		)	(54.1		)	—			—		—			(669.8		)	(54.1		)

_________


(a)	We revised the hierarchy classification of certain fixed maturities, equity securities, trading securities and other invested assets as we believe the observability of the inputs more closely represent Level 2 valuations.


(b)	For our fixed maturity securities, the majority of our transfers out of Level 3 are the result of obtaining a valuation from an independent pricing service at the end of the period, whereas a broker quote was used as of the beginning of the period.

(c)



	Purchases			Sales			Issuances			Settlements		Purchases, sales, issuances and settlements, net
Assets:
Fixed maturities, available for sale:
Corporate securities	$	5.8		$	(298.1	)	$	—		$	—	$	(292.3	)
United States Treasury securities and obligations of United States government corporations and agencies	—			(.1		)	—			—		(.1		)
Asset-backed securities	.2			(4.3		)	—			—		(4.1		)
Collateralized debt obligations	182.2			(112.8		)	—			—		69.4
Mortgage pass-through securities	—			(1.3		)	—			—		(1.3		)
Collateralized mortgage obligations	63.6			(35.2		)	—			—		28.4
Total fixed maturities, available for sale	251.8			(451.8		)	—			—		(200.0		)
Equity securities - venture capital investments	67.0			—			—			—		67.0
Trading securities - collateralized mortgage obligations	—			(.4		)	—			—		(.4		)
Liabilities:
Liabilities for insurance products:
Interest-sensitive products	(119.8		)	54.5			(34.6		)	37.4		(62.5		)

At December 31, 2012, 91 percent of our Level 3 fixed maturities, available for sale, were investment grade and 43 percent and 47 percent of our Level 3 fixed maturities, available for sale, consisted of collateralized debt securities and corporate securities, respectively.

Realized and unrealized investment gains and losses presented in the preceding tables represent gains and losses during the time the applicable financial instruments were classified as Level 3.

Realized and unrealized gains (losses) on Level 3 assets are primarily reported in either net investment income for policyholder and reinsurer accounts and other special-purpose portfolios, net realized investment gains (losses) or insurance policy benefits within the consolidated statement of operations or accumulated other comprehensive income within shareholders' equity based on the appropriate accounting treatment for the instrument.

The amount presented for gains (losses) included in our net loss for assets and liabilities still held as of the reporting date primarily represents impairments for fixed maturities, available for sale, changes in fair value of trading securities and certain derivatives and changes in fair value of embedded derivative instruments included in liabilities for insurance products that exist as of the reporting date.

The following table provides additional information about the significant unobservable (Level 3) inputs developed internally by the Company to determine fair value for certain assets and liabilities carried at fair value at December 31, 2012 (dollars in millions):



	Fair value at December 31, 2012		Valuation technique(s)	Unobservable inputs	Range (weighted average)
Assets:
Corporate securities (a)	$	248.3	Discounted cash flow analysis	Discount margins	1.90% - 3.25% (2.78%)
Asset-backed securities (b)	33.3		Discounted cash flow analysis	Discount margins	2.78% - 3.14% (2.99%)
Collateralized debt obligations (c)	331.4		Discounted cash flow analysis	Recoveries	65% - 66%
				Constant prepayment rate	20%
				Discount margins	.95% - 8.75% (2.02%)
				Annual default rate	.95% - 5.54% (3.01%)
				Portfolio CCC %	1.18% - 21.56% (11.99%)
Venture capital investments (d)	2.8		Market multiples	EBITDA multiple	6.8
				Revenue multiple	1.5
Other assets categorized as Level 3 (e)	162.4		Unadjusted third-party price source	Not applicable	Not applicable
Total	778.2
Liabilities:
Interest sensitive products (f)	739.5		Discounted projected embedded derivatives	Projected portfolio yields	5.35% - 5.61% (5.55%)
				Discount rates	0.0 - 3.6% (1.4%)
				Surrender rates	4% - 43% (19%)

________________________________


(a)	Corporate securities - The significant unobservable input used in the fair value measurement of our corporate securities is discount margin added to a riskless market yield. Significant increases (decreases) in discount margin in isolation would result in a significantly lower (higher) fair value measurement.


(b)	Asset-backed securities - The significant unobservable input used in the fair value measurement of our asset-backed securities is discount margin added to a riskless market yield. Significant increases (decreases) in discount margin in isolation would result in a significantly lower (higher) fair value measurement.

(c)

Collateralized debt obligations - The significant unobservable inputs used in the fair value measurement of our collateralized debt obligations relate to collateral performance, including default rate, recoveries and constant prepayment rate, as well as discount margins of the underlying collateral. Significant increases (decreases) in default rate in isolation would result in a significantly lower (higher) fair value measurement. Generally, a significant increase (decrease) in the constant prepayment rate and recoveries in isolation would result in a significantly higher (lower) fair value measurement. Generally a significant increase (decrease) in discount margin in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the annual default rate is accompanied by a directionally similar change in the assumption used for discount margins and portfolio CCC % and a directionally opposite change in the assumption used for constant prepayment rate and recoveries. A tranche's payment priority and investment cost basis could alter generalized fair value outcomes.


(d)	Venture capital investments - The significant unobservable inputs used in the fair value measurement of our venture capital investments are the EBITDA multiple and revenue multiple. Generally, a significant increase (decrease) in the EBITDA or revenue multiples in isolation would result in a significantly higher (lower) fair value measurement.


(e)	Other assets categorized as Level 3 - For these assets, there were no adjustments to quoted market prices obtained from third-party pricing sources.

(f)

Interest sensitive products - The significant unobservable inputs used in the fair value measurement of our interest sensitive products are projected portfolio yields, discount rates and surrender rates. Increases (decreases) in projected portfolio yields in isolation would lead to a higher (lower) fair value measurement. The discount rate is based on the Treasury rate adjusted by a margin. Increases (decreases) in the discount rates would lead to a lower (higher) fair value measurement. Assumed surrender rates are used to project how long the contracts remain in force. Generally, the longer the contracts are assumed to be in force the higher the fair value of the embedded derivative.

Sales Inducements

Certain of our annuity products offer sales inducements to contract holders in the form of enhanced crediting rates or bonus payments in the initial period of the contract. Certain of our life insurance products offer persistency bonuses credited to the contract holders balance after the policy has been outstanding for a specified period of time. These enhanced rates and persistency bonuses are considered sales inducements in accordance with GAAP. Such amounts are deferred and amortized in the same manner as deferred acquisition costs. Sales inducements deferred totaled $4.4 million, $11.5 million and $20.0 million in 2012, 2011 and 2010, respectively. Amounts amortized totaled $27.1 million, $28.7 million and $31.2 million in 2012, 2011 and 2010, respectively. The unamortized balance of deferred sales inducements was $126.5 million and $149.2 million at December 31, 2012 and 2011, respectively. The balance of insurance liabilities for persistency bonus benefits was $34.6 million and $50.0 million at December 31, 2012 and 2011, respectively.

Out-of-Period Adjustments

We recorded the net effect of out-of-period adjustments which had the impact of decreasing our net income by $6.6 million (or two cents per diluted share) in 2012. Specific accounts were impacted as follows: a $12.1 million increase to insurance policy benefits; a $4.3 million increase to net realized gains; a $1.8 million increase to other expenses; a $.6 million decrease to net investment income related to special purpose portfolios; and a $3.6 million decrease to tax expense. We evaluated these errors taking into account both qualitative and quantitative factors and considered the impact of the errors in relation to 2012, as well as the materiality to the periods in which they originated. The impact of correcting these errors in prior years was not significant to any individual period. Management believes these errors are immaterial to the consolidated financial statements.

Recently Issued Accounting Standards

Accounting Standard Adopted on a Retrospective Basis

In October 2010, the Financial Accounting Standards Board ("FASB") issued authoritative guidance that modified the definition of the types of costs incurred by insurance entities that could be capitalized in the acquisition of new and renewal contracts. The guidance impacts the timing of GAAP reported financial results, but has no impact on cash flows, statutory financial results or the ultimate profitability of the business.

The guidance specifies that an insurance entity shall only capitalize incremental direct costs related to the successful acquisition of new or renewal insurance contracts. The guidance also states that advertising costs should be included in deferred acquisition costs only if the capitalization criteria in the direct-response advertising guidance is met. The guidance was effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011, and was adopted by the Company on January 1, 2012. As permitted by the guidance, we elected to apply the provisions on a retrospective basis. The guidance reduced the balance of deferred acquisition costs, its amortization and the amount of costs capitalized. We are able to defer most commission payments, plus other costs directly related to the production of new business. The change did not impact the balance of the present value of future profits. Therefore, in contrast to the reduction in amortization of deferred acquisition costs, there was no change in the amortization of the present value of future profits.

The adoption of ASU 2010-26 has been reflected in the accompanying updated financial statements. The revision of the financial statements affected prior period information as follows (dollars in millions, except per share amounts):



	December 31, 2011
	Amounts prior to adoption of ASU 2010-26		Effect of adoption of ASU 2010-26			As reported
Deferred acquisition costs	$	1,418.1	$	(621.0	)	$	797.1
Income tax assets, net	630.5		234.9			865.4
Other assets	316.9		(24.7		)	292.2
Total assets	33,332.7		(410.8		)	32,921.9

Other liabilities	548.3		8.0			556.3
Total liabilities	28,300.1		8.0			28,308.1

Accumulated other comprehensive income	625.5		156.1			781.6
Retained earnings (accumulated deficit)	42.8		(574.9		)	(532.1		)
Total shareholders' equity	5,032.6		(418.8		)	4,613.8
Total liabilities and shareholders' equity	33,332.7		(410.8		)	32,921.9



	Year ended
	December 31, 2011
	Amounts prior to adoption of ASU 2010-26		Effect of adoption of ASU 2010-26			As reported
Amortization	$	432.4	$	(135.0	)	$	297.4
Other operating costs and expenses	496.5		208.0			704.5
Total benefits and expenses	3,745.4		73.0			3,818.4
Income before income taxes	379.2		(73.0		)	306.2
Tax expense on period income	139.7		(26.2		)	113.5
Net income	382.5		(46.8		)	335.7

Earnings per common share:
Basic:
Net income	$	1.54	$	(.19	)	$	1.35
Diluted:
Net income	1.31		(.16		)	1.15



	Year ended
	December 31, 2010
	Amounts prior to adoption of ASU 2010-26		Effect of adoption of ASU 2010-26			As reported
Amortization	$	443.8	$	(118.8	)	$	325.0
Other operating costs and expenses	502.9		187.4			690.3
Total benefits and expenses	3,790.4		68.6			3,859.0
Income before income taxes	293.5		(68.6		)	224.9
Tax expense on period income	103.9		(24.6		)	79.3
Net income	284.6		(44.0		)	240.6

Earnings per common share:
Basic:
Net income	$	1.13	$	(.17	)	$	.96
Diluted:
Net income	.99		(.15		)	.84



	Year ended
	December 31, 2011
	As originally reported			Effect of adoption of ASU 2010-26			As adjusted
Cash flows from operating activities:
Deferrable policy acquisition costs	$	(428.7	)	$	212.0		$	(216.7	)
Other operating costs	(472.3		)	(212.0		)	(684.3		)
Net cash used by operating activities	774.8			—			774.8



	Year ended
	December 31, 2010
	As originally reported			Effect of adoption of ASU 2010-26			As adjusted
Cash flows from operating activities:
Deferrable policy acquisition costs	$	(418.2	)	$	193.0		$	(225.2	)
Other operating costs	(444.8		)	(193.0		)	(637.8		)
Net cash used by operating activities	734.0			—			734.0

Adopted Accounting Standards

In June 2011, the FASB issued authoritative guidance to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in shareholders' equity. Such guidance requires that all non-owner changes in shareholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income and the total of comprehensive income. The guidance was applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this guidance resulted in a change in the presentation of our financial statements but did not have any impact on our financial condition, operating results or cash flows.

In May 2011, the FASB issued authoritative guidance which clarifies or updates requirements for measuring fair value and for disclosing information about fair value measurements. The guidance clarifies: (i) the application of the highest and best use and valuation premise concepts; (ii) measuring the fair value of an instrument classified in a reporting entity's shareholders' equity; and (iii) disclosure of quantitative information about the unobservable inputs used in a fair value measurement that is categorized within Level 3 of the fair value hierarchy. The guidance changes certain requirements for measuring fair value or disclosing information about fair value measurements including: (i) measuring the fair value of financial instruments that are managed within a portfolio; (ii) application of premiums and discounts in a fair value measurement; and (iii) additional disclosures about fair value measurements. Such additional disclosures include a description of the valuation process used for measuring Level 3 instruments and the sensitivity of the Level 3 fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, if any. The guidance was effective prospectively for interim and annual periods beginning after December 15, 2011. Refer to the note to our consolidated financial statements entitled "Fair Value Measurements" for additional disclosures required by this guidance. The adoption of this guidance expanded our disclosures, but did not have a material impact on our financial condition, operating results or cash flows.

In March 2010, the FASB issued authoritative guidance clarifying the scope exception for embedded credit derivatives and when those features would be bifurcated from the host contract. Under the new guidance, only embedded credit derivative features that are in the form of subordination of one financial instrument to another would not be subject to the bifurcation requirements. Accordingly, entities will be required to bifurcate any embedded credit derivative features that no longer qualify under the amended scope exception, or, for certain investments, an entity can elect the fair value option and record the entire investment at fair value. This guidance was effective for fiscal quarters beginning after June 15, 2010. The adoption of this guidance did not have a material impact on our consolidated financial statements.

In January 2010, the FASB issued authoritative guidance which requires additional disclosures related to purchases, sales, issuances and settlements in the rollforward of Level 3 fair value measurements. This guidance was effective for reporting periods beginning after December 15, 2010. The adoption of this guidance did not have a material impact on our consolidated financial statements.

In January 2010, the FASB issued authoritative guidance which requires new disclosures and clarifies existing disclosure requirements related to fair value. An entity is also required to disclose significant transfers in and out of Levels 1 and 2 of the fair value hierarchy. In addition, the guidance amends the fair value disclosure requirement for pension and postretirement benefit plan assets to require this disclosure at the investment class level. The guidance was effective for interim and annual reporting periods beginning after December 15, 2009. Such disclosures are included in the note to the consolidated financial statements entitled "Fair Value Measurements". The adoption of this guidance did not have a material impact on our consolidated financial statements.