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						Nine months ended
	September 30,						September 30,
	2017			2016			2017			2016
Current tax expense	$	25.9		$	46.8		$	68.5		$	51.6
Deferred tax expense (benefit)	18.2			(29.9		)	55.1			10.1
Valuation allowance applicable to current year income	(2.2		)	(10.5		)	(2.2		)	(10.5		)
Income tax expense calculated based on estimated annual effective tax rate	41.9			6.4			121.4			51.2
Income tax expense on discrete items:
Change in valuation allowance	(12.8		)	16.0			(12.8		)	(11.0		)
Other items	—			8.3			—			8.3
Total income tax expense	$	29.1		$	30.7		$	108.6		$	48.5

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:



	Nine months ended
	September 30,
	2017		2016
U.S. statutory corporate rate	35.0	%	35.0	%
Valuation allowance	(.6	)	(6.1	)
Non-taxable income and nondeductible benefits, net	(1.5	)	(1.0	)
State taxes	1.3		1.8
Estimated annual effective tax rate	34.2	%	29.7	%

The effective tax rate for the nine months ended September 30, 2017 and 2016 included reductions in the deferred tax valuation allowance of $2.2 million and $10.5 million, respectively, reflecting higher current year expected taxable income than previously reflected in our deferred tax valuation allowance model in each year.

Our total tax expense for the nine months ended September 30, 2017, includes $12.8 million of reductions to the deferred tax valuation allowance primarily related to the recognition of capital gains. Our total tax expense for the nine months ended September 30, 2016, includes $11.0 million of reductions to the deferred tax valuation allowance related to adjustments to future expected taxable income reflected in our deferred tax valuation allowance model and $8.3 million of increased tax expense primarily related to IRS exam adjustments. The reduction to the deferred tax valuation allowance primarily relates to higher expected non-life income consistent with our current investment strategies, the impacts of the recapture of certain reinsurance agreements and IRS examination adjustments.

Effective January 1, 2017, the Company adopted new authoritative guidance related to several aspects of the accounting for share-based payment transactions, including the income tax consequences. Under the new guidance, any excess tax benefits are recognized as an income tax benefit in the income statement. The new guidance is applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings for all tax benefits that were not previously recognized because the related tax deduction had not reduced taxes payable. The Company had NOL carryforwards of $15.7 million related to deductions for stock options and restricted stock on the date of adoption. However, a corresponding valuation allowance of $15.7 million was recognized as a result of adopting this guidance. Therefore, there was no impact to our consolidated financial statements related to the initial adoption of this provision of the new guidance.

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



	September 30, 2017			December 31, 2016
Deferred tax assets:
Net federal operating loss carryforwards	$	841.8		$	882.9
Net state operating loss carryforwards	12.2			12.3
Investments	13.7			17.8
Insurance liabilities	678.9			668.4
Other	60.1			66.3
Gross deferred tax assets	1,606.7			1,647.7
Deferred tax liabilities:
Present value of future profits and deferred acquisition costs	(275.0		)	(277.8		)
Accumulated other comprehensive income	(516.9		)	(344.1		)
Gross deferred tax liabilities	(791.9		)	(621.9		)
Net deferred tax assets before valuation allowance	814.8			1,025.8
Valuation allowance	(240.9		)	(240.2		)
Net deferred tax assets	573.9			785.6
Current income taxes prepaid (accrued)	(6.5		)	4.1
Income tax assets, net	$	567.4		$	789.7

Our income tax expense includes deferred income taxes arising from temporary differences between the financial reporting and tax bases of assets and liabilities 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 NOLs expire.

Based on our assessment, it appears more likely than not that $573.9 million of our net deferred tax assets of $814.8 million will be realized through future taxable earnings. Accordingly, we have established a deferred tax valuation allowance of $240.9 million at September 30, 2017 ($230.9 million of which relates to our net federal operating loss carryforwards and $10.0 million relates to state operating 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, the impact of the sale or reinsurance of business and the recapture of business previously ceded. Our estimates of future taxable income are based on evidence we consider to be objective and verifiable.

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 increase by 3 percent for the next five years, and level taxable income is assumed thereafter. In the projections used for our analysis, our adjusted average taxable income of approximately $335 million consisted of $85 million of non-life taxable income and $250 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 NOLs 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 (1.93 percent at September 30, 2017), 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 September 30, 2017, we were below the 50 percent ownership change level that would trigger further impairment of our ability to utilize our NOLs.

As of September 30, 2017, we had $2.4 billion of federal NOLs (all of which were non-life NOLs). The following table summarizes the expiration dates of our loss carryforwards (dollars in millions):



	Net operating loss
Year of expiration	carryforwards
2023	$	1,818.5
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 NOLs	$	2,405.1

We also had deferred tax assets related to NOLs for state income taxes of $12.2 million and $12.3 million at September 30, 2017 and December 31, 2016, respectively. The related state NOLs are available to offset future state taxable income in certain states through 2025.

All of the life NOLs were utilized by December 31, 2016. Accordingly, we began making estimated federal tax payments equal to the prescribed 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. Under current law, we will continue to pay tax on 65 percent of our life insurance company taxable income until all non-life NOLs are utilized or expire.

The Internal Revenue Service ("IRS") is conducting an examination of 2013 through 2014. In connection with this exam, we have agreed to extend the statute of limitation for 2013 through September 30, 2018. The Company’s various state income tax returns are generally open for tax years beginning in 2014, 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 the tax audit cannot be predicted with certainty. If the Company’s tax audit is not resolved in a manner consistent with management’s expectations, the Company may be required to adjust its provision for income taxes.