INCOME TAXES

The Company's interim tax expense is based upon the estimated annual effective tax rate for the respective period. Under authoritative guidance, certain items are required to be excluded from the estimated annual effective tax rate calculation. Such items include changes in judgment about the realizability of deferred tax assets resulting from changes in projections of income expected to be available in future years, and items deemed to be unusual, infrequent, or that can not be reliably estimated. In these cases, the actual tax expense or benefit applicable to that item is treated discretely and is reported in the same period as the related item. The components of income tax expense are as follows (dollars in millions):



	Three months ended
	March 31,
	2016			2015
Current tax expense	$	4.1		$	2.9
Deferred tax expense	10.9			26.4
Income tax expense calculated based on estimated annual effective tax rate	15.0			29.3
Income tax expense on discrete items:
Change in valuation allowance	(20.0		)	—
Other items	—			.2
Total income tax expense	$	(5.0	)	$	29.5

A reconciliation of the U.S. statutory corporate tax rate to the estimated annual effective rate, before discrete items, reflected in the consolidated statement of operations is as follows:



	Three months ended
	March 31,
	2016		2015
U.S. statutory corporate rate	35.0	%	35.0	%
Non-taxable income and nondeductible benefits, net	.8		(.8	)
State taxes	1.2		1.4
Estimated annual effective tax rate	37.0	%	35.6	%

The components of the Company's income tax assets and liabilities are summarized below (dollars in millions):



	March 31, 2016			December 31, 2015
Deferred tax assets:
Net federal operating loss carryforwards	$	883.4		$	916.3
Net state operating loss carryforwards	13.9			14.1
Tax credits	57.2			55.3
Capital loss carryforwards	12.2			13.8
Investments	19.7			26.5
Insurance liabilities	624.8			600.3
Other	63.9			63.0
Gross deferred tax assets	1,675.1			1,689.3
Deferred tax liabilities:
Present value of future profits and deferred acquisition costs	(303.4		)	(305.4		)
Accumulated other comprehensive income	(298.6		)	(223.8		)
Gross deferred tax liabilities	(602.0		)	(529.2		)
Net deferred tax assets before valuation allowance	1,073.1			1,160.1
Valuation allowance	(193.5		)	(213.5		)
Net deferred tax assets	879.6			946.6
Current income taxes accrued	(50.8		)	(47.8		)
Income tax assets, net	$	828.8		$	898.8

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 income tax assets on an ongoing basis. The realization of our deferred tax assets depends upon generating sufficient future taxable income of the appropriate type during the periods in which our temporary differences become deductible and before our capital loss carryforwards and life and non-life NOLs expire.

Based on our assessment, it appears more likely than not that $879.6 million of our net deferred tax assets of $1,073.1 million will be realized through future taxable earnings. Accordingly, we have established a deferred tax valuation allowance of $193.5 million at March 31, 2016 ($176.5 million of which relates to our net federal operating loss carryforwards; $10 million relates to state operating loss carryforwards; and $7 million relates to capital loss carryforwards). We will continue to assess the need for a valuation allowance in the future. If future results are less than projected, an increase to the valuation allowance may be required to reduce the deferred tax asset, which could have a material impact on our results of operations in the period in which it is recorded.

We use a deferred tax valuation model to assess the need for a valuation allowance. Our model is adjusted to reflect changes in our projections of future taxable income including changes resulting from investment strategies, reinsurance transactions and the impact of the sale of Conseco Life Insurance Company ("CLIC", a wholly owned subsidiary prior to its sale in July 2014). Our estimates of future taxable income are based on evidence we consider to be objective and verifiable. In the first three months of 2016, we reduced the valuation allowance for deferred tax assets by $20.0 million primarily related to higher expected non-life income from: (i) our recently announced investment in Tennenbaum Capital Partners, LLC ("TCP"); and (ii) approximately $250 million of additional investments to be made over time in various TCP managed funds and strategies. The investment in TCP is further discussed in the note to the consolidated financial statements entitled "Subsequent Event".

Our projection of future taxable income for purposes of determining the valuation allowance is based on our adjusted average annual taxable income which is assumed to remain flat for two years and then increase by 3 percent for the next five years, and level taxable income is assumed thereafter. Our deferred tax valuation model was adjusted to reflect our investment in TCP. In the projections used for our analysis, our adjusted average taxable income (based on the level of recent normalized taxable income) of approximately $345 million has not changed, however, the amount characterized as non-life taxable income increased by approximately $10 million and the amount characterized as life taxable income decreased by $10 million. Accordingly, our adjusted average taxable income is comprised of $85 million of non-life taxable income and $260 million of life taxable income.

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 Internal Revenue Code (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). This limitation is the primary reason a valuation allowance for NOL carryforwards is required.

Section 382 of the Code imposes limitations on a corporation's ability to use its NOLs when the company undergoes an ownership change. Future transactions and the timing of such transactions could cause an ownership change for Section 382 income tax purposes. Such transactions may include, but are not limited to, additional repurchases under our securities repurchase program, issuances of common stock and acquisitions or sales of shares of CNO stock by certain holders of our shares, including persons who have held, currently hold or may accumulate in the future five percent or more of our outstanding common stock for their own account. Many of these transactions are beyond our control. If an additional ownership change were to occur for purposes of Section 382, we would be required to calculate an annual restriction on the use of our NOLs to offset future taxable income. The annual restriction would be calculated based upon the value of CNO's equity at the time of such ownership change, multiplied by a federal long-term tax exempt rate (2.65 percent at March 31, 2016), and the annual restriction could limit our ability to use a substantial portion of our NOLs to offset future taxable income. We regularly monitor ownership change (as calculated for purposes of Section 382) and, as of March 31, 2016, we were below the 50 percent ownership change level that would trigger further impairment of our ability to utilize our NOLs.

As of March 31, 2016, we had $2.5 billion of federal NOLs. The following table summarizes the expiration dates of our loss carryforwards assuming the Internal Revenue Service ("IRS") ultimately agrees with the position we have taken with respect to the loss on our investment in Conseco Senior Health Insurance Company ("CSHI") and other uncertain tax positions(dollars in millions):



Year of expiration	Net operating loss carryforwards						Total loss
	Life			Non-life			carryforwards
2023	$	449.4		$	1,916.8		$	2,366.2
2025	—			91.5			91.5
2026	—			207.4			207.4
2027	—			4.9			4.9
2028	—			203.7			203.7
2029	—			146.6			146.6
2032	—			44.0			44.0
Subtotal	449.4			2,614.9			3,064.3
Less:
Unrecognized tax benefits	(342.9		)	(197.4		)	(540.3		)
Total	$	106.5		$	2,417.5		$	2,524.0

In addition, at March 31, 2016, we had $34.9 million of capital loss carryforwards that expire in 2020.

We had deferred tax assets related to NOLs for state income taxes of $13.9 million and $14.1 million at March 31, 2016 and December 31, 2015, respectively. The related state NOLs are available to offset future state taxable income in certain states through 2025.

We recognized an $878 million ordinary loss on our investment in CSHI which was worthless when it was transferred to an independent trust in 2008. Of this loss, $742 million has been reported as a life loss and $136 million as a non-life loss. The IRS has disagreed with our ordinary loss treatment and believes that it should be treated as a capital loss, subject to a five year carryover. If the IRS position is ultimately determined to be correct, $473 million would have expired unused in 2013. Due to this uncertainty, we have not recognized a tax benefit of $166.0 million. However, if this unrecognized tax benefit would have been recognized, we would also have established a valuation allowance of $34.0 million at March 31, 2016.

The IRS has completed the examination for 2004 and 2008 through 2010 and has proposed two adjustments to which we disagree, including the adjustment to classify the loss on our investment in CSHI as a capital loss as described above. The Company is contesting these adjustments through the IRS Appeals Office. Although the resolution of the Appeals could occur in the next 12 months, there is no reasonable basis to estimate the changes in unrecognized tax benefits that may occur. The IRS has also begun an examination of 2011 and 2012. In connection with this exam, we have agreed to extend the statute of limitations to September 10, 2017. The Company’s various state income tax returns are generally open for tax years beginning in 2012, based on individual state statutes of limitation. Generally, for tax years which generate NOLs, capital losses or tax credit carryforwards, the statute remains open until the expiration of the statute of limitations for the tax year in which such carryforwards are utilized. The outcome of tax audits cannot be predicted with certainty. If the Company’s tax audits are not resolved in a manner consistent with management’s expectations, the Company may be required to adjust its provision for income taxes.

We currently expect to utilize all of our remaining life NOLs in the second quarter of 2016, absent a favorable outcome on the classification of the loss on our investment in CSHI. After all of the life NOLs are utilized, we will begin making cash tax payments equal to the effective federal tax rate applied to 65 percent of our life insurance company taxable income due to the limitations on the extent to which we can use non-life NOLs to offset life insurance company taxable income. We will continue to pay tax on only 65 percent of our life insurance company taxable income until all non-life NOLs are utilized or expire.