CNO Financial Group, Inc. — 2018 First-Quarter Form 10-Q
Business context and reporting period
CNO is a U.S. insurance holding company serving middle-income pre-retiree and retired customers through Bankers Life, Washington National, Colonial Penn and a long-term-care block in run-off. Products include health insurance, annuities, individual life insurance and related services. The filing covers the three months ended March 31, 2018, with comparative results for the three months ended March 31, 2017. Financial statements are unaudited.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total revenues | $1,007.8 million | $1,070.7 million | Down 5.9% |
| Income before taxes | $108.1 million | $96.7 million | Up 11.8% |
| Net income | $84.3 million | $62.3 million | Up 35.3% |
| Diluted EPS | $0.50 | $0.36 | Up $0.14 |
| Net margin | 8.4% | 5.8% | Improved |
| Net operating income | $73.9 million | $59.8 million | Up 23.6% |
| Pre-tax operating earnings | $94.9 million | $92.9 million | Up 2.2% |
| Net cash from operating activities | $72.2 million | $143.4 million | Down $71.2 million |
- Insurance policy income was $659.9 million versus $663.8 million. General-account net investment income increased to $329.1 million from $312.0 million.
- Net realized investment losses were $15.2 million, compared with $7.9 million of gains in the prior-year quarter. No impairment losses were recognized in Q1 2018, compared with $8.4 million in Q1 2017.
- Income tax expense declined to $23.8 million from $34.4 million, reflecting the lower 21% statutory corporate tax rate under the Tax Cuts and Jobs Act. The estimated annual effective tax rate was 22.0%, versus 35.6%.
- Comprehensive income was a loss of $217.2 million, compared with income of $169.5 million, primarily because of a $301.5 million after-tax decline in other comprehensive income from investment-market movements.
- Total assets were $32.8 billion and shareholders’ equity was $4.6 billion at March 31, 2018. Book value per share was $27.59, compared with $29.05 at year-end 2017; book value excluding accumulated other comprehensive income increased to $22.25 from $21.79.
- Unrestricted cash was $610.8 million; total cash including cash held by variable interest entities was $726.4 million at quarter-end, down from $757.3 million at year-end 2017.
- Corporate direct obligations were $915.1 million, including $825.0 million of senior notes and $100.0 million drawn under the revolving credit facility. Insurance investment borrowings were $1.65 billion, and VIE borrowings were $1.41 billion.
- The estimated consolidated statutory risk-based-capital ratio was 427%, within management’s stated target range of 425% to 450%. The debt-to-total-capital ratio under the revolving credit agreement was 20.1%, below the 35% covenant limit.
Material changes versus the prior comparable period
- Net income growth was supported by lower taxes, favorable fair-value changes in fixed-index-annuity embedded derivative liabilities and lower insurance policy benefits. Fair-value changes contributed $25.1 million to non-operating income, versus a $4.4 million loss in Q1 2017.
- Bankers Life pre-tax operating earnings were essentially flat at $89.5 million. Premium collections declined 2.2% to $672.5 million, while its long-term-care interest-adjusted benefit ratio improved to 70.2% from 72.5%.
- Washington National pre-tax operating earnings increased to $34.3 million from $23.5 million, driven primarily by favorable supplemental-health claims experience. Premium collections rose 1.8% to $176.2 million.
- Colonial Penn reported a pre-tax operating loss of $1.5 million, versus a $0.3 million loss, reflecting unfavorable mortality and a $1.1 million out-of-period reserve adjustment. Premium collections increased 1.1% to $75.3 million.
- Total premium collections declined 1.3% to $928.1 million, and first-year collections declined 4.1% to $331.1 million.
- Accumulated other comprehensive income declined to $894.3 million from $1.21 billion, mainly because of unrealized investment losses. The company adopted financial-instrument guidance that reclassified $16.3 million from accumulated other comprehensive income to retained earnings without changing total equity.
- New revenue-recognition guidance increased Q1 2018 fee revenue by $7.3 million and distribution expense by $8.8 million, producing a $1.5 million reduction in pre-tax income relative to the prior accounting method for the quarter. Annual fee revenue and distribution expense are not expected to change.
Guidance, outlook, commentary and risks
- Management expects Medicare supplement benefit ratios at Bankers Life to remain approximately 71% to 74% during the remainder of 2018, long-term-care interest-adjusted benefit ratios at Bankers Life to range from 75% to 80%, and Washington National supplemental-health interest-adjusted benefit ratios to range from 58% to 61%.
- Colonial Penn expects earnings before realized investment gains or losses and taxes of approximately $10 million to $20 million during the remainder of 2018.
- CNO continues to expect approximately $300 million of annual free-cash-flow generation and intends to deploy free cash flow toward growth investments, potential long-term-care risk-reduction transactions, dividends and share repurchases.
- Management is considering long-term-care risk-transfer transactions. Such a transaction could require a substantial ceding commission, produce an initial loss, reduce cash flow and increase the deferred-tax valuation allowance.
- The company’s long-term-care business is sensitive to morbidity, persistency, rate increases, reserve assumptions and investment yields. The run-off long-term-care segment had an interest-adjusted benefit ratio of 117.9% and management described its results as volatile.
- Key risks include low or changing interest rates, investment losses and impairments, credit and liquidity risk, reinsurer default, regulatory approval of subsidiary dividends, insurance claims experience, litigation, tax-asset recoverability, debt covenants and insurance-company financial-strength ratings.
- The IRS is examining tax years 2013 and 2014. CNO is also involved in litigation and arbitration involving Beechwood Re and related parties; outcomes and potential losses beyond recorded provisions are not clearly estimable.
- At March 31, 2018, fixed maturities had $130.2 million of gross unrealized losses, and 5.4% of the portfolio was below investment grade. Management did not identify the unrealized losses as other-than-temporary, but future market or credit developments could result in realized losses.
Important facts for investors to verify
- Whether operating earnings remain positive after separating recurring insurance performance from volatile investment gains, embedded-derivative fair-value changes and VIE results.
- The sustainability of the 2018 tax benefit, including final accounting for the Tax Cuts and Jobs Act and the $89.1 million deferred-tax valuation allowance.
- Long-term-care reserve adequacy, benefit-ratio trends, approved rate increases and the terms and economics of any proposed reinsurance or risk-transfer transaction.
- Cash generation and holding-company liquidity, including the ability of regulated insurance subsidiaries to remit dividends and service corporate debt.
- Credit quality and unrealized-loss trends in the investment portfolio, including below-investment-grade securities, structured securities, VIE assets and collateral supporting FHLB borrowings.
- The status and potential financial impact of the Beechwood Re arbitration, regulatory examinations, the IRS audit and other legal proceedings.
- The effect of lower premium collections and first-year sales on future revenue, acquisition-cost amortization and growth.