CNO

Business Context and Reporting Period

Company: CNO Financial Group, Inc. (Conseco, Inc.)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Business Overview: Conseco is a holding company for a group of insurance companies operating in the U.S., focusing on supplemental health, annuity, and individual life insurance for senior and middle-income markets. The company emerged from bankruptcy reorganization in 2003. Operations are managed through four segments: Bankers Life (career agents), Conseco Insurance Group (independent producers), Colonial Penn (direct marketing), and Other Business in Run-off (primarily legacy long-term care).

Key Financial Metrics

Liquidity and Debt: Corporate notes payable totaled $1,193.7 million. The company holds $84.3 million in unrestricted cash at the holding company level. Investment borrowings totaled $913.0 million, primarily collateralized borrowings from the Federal Home Loan Bank.

Material Changes vs. Prior Period

• Net Loss: The company reported a net loss of $179.9 million in 2007, a significant decline from a net income of $106.0 million in 2006. This was driven by increased insurance policy benefits, investment losses, and litigation costs.
• Investment Losses: Net realized investment losses increased to $155.4 million in 2007 from $47.2 million in 2006. This included $48.7 million in losses from sales of fixed maturities (partially sub-prime related) and $106.7 million in writedowns for other-than-temporary declines in fair value.
• Segment Performance:
  • Other Business in Run-off: Reported a pre-tax loss of $183.0 million, compared to a loss of $42.5 million in 2006. This segment, dominated by legacy long-term care, saw a benefit ratio of 188.7% due to adverse claim experience and reserve strengthening ($118 million increase in Q2 2007 alone).
  • Conseco Insurance Group: Reported a pre-tax loss of $104.8 million, down from income of $20.0 million in 2006. This was impacted by a $76.5 million loss on an annuity coinsurance transaction and litigation settlement costs.
  • Bankers Life: Remained profitable with pre-tax income of $224.4 million, though down slightly from $249.0 million in 2006.
• Restatements: The company restated financial statements for 2006 and 2005 due to errors in actuarial reporting and the elimination of a "prospective revision" accounting methodology for long-term care rate increases, which was deemed inconsistent with GAAP by the SEC.

Guidance, Outlook, Risks, and Unusual Items

Management Commentary and Outlook

Management's 2008 goals include maintaining growth at Bankers Life and Colonial Penn, improving the profitability mix at Conseco Insurance Group, and aggressively seeking actuarially justified rate increases for long-term care business. The company aims to achieve an 11% operating return on equity in 2009. However, the company faces significant headwinds from its legacy long-term care block, which requires continued capital contributions (e.g., $202 million contributed to Conseco Senior in 2007) and rate hikes to remain solvent.

Material Risks and Contingencies

• Internal Control Weakness: The company identified a material weakness in internal controls over financial reporting related to actuarial processes, leading to the restatement of prior years. Remediation is ongoing.
• Long-Term Care (LTC) Reserves: The "Other Business in Run-off" segment continues to experience adverse claim development. If rate increases are not approved by regulators, the company may be required to establish premium deficiency reserves, further impacting earnings.
• Financial Strength Ratings: In August 2007, A.M. Best downgraded primary subsidiaries to "B+ (Good)" with a negative outlook, and Conseco Senior to "C++ (Marginal)." S&P and Moody's also maintained negative outlooks. These ratings impact the ability to sell annuities and life products.
• Investment Portfolio: Exposure to sub-prime residential mortgage-backed securities resulted in writedowns and sales at a loss. The portfolio also faces interest rate risk, with a duration gap between assets (7.6 years) and liabilities (7.9 years).
• Litigation: Significant costs were incurred related to the "In Re Conseco Life Insurance Company Cost of Insurance Litigation" settlement.

Unusual Items

• Annuity Coinsurance Transaction: A $76.5 million pre-tax loss was recognized in 2007 upon ceding 100% of older equity-indexed and fixed annuity business to REALIC (Swiss Re).
• Deferred Tax Valuation Allowance: The company increased its valuation allowance by $68.0 million in 2007, reflecting uncertainty regarding the realization of deferred tax assets due to recent losses.

Investor Verification Checklist

• Restatement Impact: Verify the full extent of the restatements for 2005-2007 and the specific adjustments to insurance liabilities and amortization expenses.
• Long-Term Care Rate Approvals: Monitor the status of pending rate increase filings for the "Other Business in Run-off" segment and the likelihood of regulatory approval.
• Capital Contributions: Assess the company's ability and willingness to continue making capital contributions to Conseco Senior to maintain statutory solvency.
• Investment Writedowns: Review the composition of the investment portfolio, specifically the exposure to sub-prime securities and the potential for further other-than-temporary impairment charges.
• Internal Control Remediation: Confirm the completion of remediation efforts for the material weakness in internal controls over actuarial reporting.
• Debt Covenants: Verify compliance with the Second Amended Credit Facility covenants, particularly the debt-to-total capitalization ratio and interest coverage ratio.