CNO Financial Group, Inc. — 2016 Form 10-K Summary
Business context and reporting period
CNO Financial Group is a U.S. insurance holding company serving middle-income pre-retirees and retirees through Bankers Life, Washington National and Colonial Penn. Products include health insurance, annuities, individual life insurance and related services, distributed through career agents, independent producers and direct marketing. The filing covers the fiscal year ended December 31, 2016; fourth-quarter 2016 information is included in the annual results.
In the fourth quarter, CNO began reporting a separate long-term-care-in-run-off segment after recapturing business previously ceded to Beechwood Re Ltd. (“BRe”).
Key financial metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Total revenues | $3,985.1 million | $3,811.9 million | Up 4.5% |
| Income before income taxes | $353.2 million | $367.7 million | Down 3.9% |
| Net income | $358.2 million | $270.7 million | Up 32.3% |
| Diluted earnings per share | $2.01 | $1.39 | Up 44.6% |
| Net operating income | $262.5 million | $274.7 million | Down 4.4% |
| Net cash from operating activities | $759.5 million | $743.9 million | Up 2.1% |
| Total assets | $32.0 billion | $31.1 billion | Up 2.7% |
| Shareholders’ equity | $4.49 billion | $4.14 billion | Up 8.4% |
| Corporate notes payable | $912.9 million | $911.1 million | Broadly stable |
Premium collections increased 6.1% to $3.61 billion. First-year collections rose 12% to $1.34 billion, while renewal collections rose 2.7% to $2.27 billion. Annuity collections increased 20.6% to $971.5 million, driven primarily by fixed-index annuities. Life collections increased 4.7% to $768.3 million; health collections were broadly stable at $1.87 billion.
Net investment income increased to $1.33 billion from $1.23 billion. The average yield on general-account invested assets declined to 5.41% from 5.63%, while the average fixed-maturity portfolio yield was 5.5% and the average credited or accruing rate on applicable insurance liabilities was 4.5%.
Operating earnings before taxes declined to $410.3 million from $422.8 million. Bankers Life operating earnings increased to $397.9 million from $369.6 million; Washington National declined to $102.9 million from $111.5 million; Colonial Penn declined to $1.7 million from $5.6 million; and long-term care in run-off generated a $3.9 million operating loss.
The reported net-income benefit was materially affected by tax items, including a $118.7 million fourth-quarter tax benefit from an IRS settlement involving NOL positions. The effective tax rate was negative 1.4%, compared with 26.4% in 2015.
Cash flow, capital, debt and liquidity
- Operating cash flow was $759.5 million. Investing activities used $742.4 million, primarily reflecting $6.16 billion of investment purchases partly offset by investment sales and maturities. Financing activities provided $29.5 million.
- Unrestricted consolidated cash and cash equivalents were $478.9 million at year-end. CNO, CDOC and other non-insurance subsidiaries held $107.6 million of unrestricted cash and cash equivalents, $84.3 million of fixed-income investments and $71.7 million of equity securities.
- Corporate debt consisted of $325 million of 4.5% senior notes due 2020, $500 million of 5.25% senior notes due 2025 and $100 million drawn under a $150 million revolving credit facility maturing in 2019.
- Aggregate corporate indebtedness was $925 million, with approximately $44 million of estimated 2017 cash interest and principal service requirements. The debt-to-total-capital ratio was 16.9% under GAAP and 19.1% excluding accumulated other comprehensive income.
- The estimated consolidated statutory RBC ratio was 459%, compared with a 250% minimum covenant requirement. Insurance subsidiaries paid $274.3 million of dividends to CDOC, while CNO contributed $200 million of capital to insurance subsidiaries following the BRe recapture.
- The company paid $54.8 million of common dividends, or $0.31 per share, and repurchased 11.7 million shares for $203.0 million. Repurchases were suspended for the remainder of 2016 after the BRe transaction.
Material changes versus the prior comparable period
- The BRe reinsurance agreements were terminated in September 2016 and the ceded long-term-care business was recaptured. CNO recorded a $75.4 million pretax loss, including a $17.9 million write-off of reinsurance receivables and estimated transaction expenses of $10 million. The transaction reduced reinsurance receivables by approximately $500 million and required $200 million of capital contributions.
- The recaptured run-off block generated a $9.2 million pretax loss in 2016, including a $5.3 million net realized investment loss. Its benefit ratio was 365.8% and its interest-adjusted benefit ratio was 213.5%.
- Long-term-care performance in the Bankers Life segment remained a major pressure point. The benefit ratio improved to 135.0% from 139.2%, but remained above 100%; the interest-adjusted benefit ratio improved to 76.7% from 82.8%.
- Corporate operating costs increased materially, contributing to a corporate operating loss of $88.3 million versus $63.9 million. Management cited higher legal costs, corporate initiatives, Department of Labor compliance costs, compensation and severance.
- Net realized investment results improved to an $8.3 million gain from a $36.6 million loss. However, CNO recognized $32.3 million of other-than-temporary impairment losses through earnings.
- Accumulated other comprehensive income increased to $622.4 million from $402.8 million, primarily due to higher unrealized investment gains. Book value per share increased to $25.82 from $22.49.
Guidance, outlook, commentary and risks
- For 2017, management expected Bankers Life Medicare supplement benefit ratios of 71% to 74%, Bankers Life long-term-care interest-adjusted benefit ratios of 77% to 82%, and Washington National supplemental-health interest-adjusted benefit ratios of 58% to 61%.
- Colonial Penn expected 2017 earnings before realized investment gains or losses and taxes of $5 million to $15 million, but anticipated a first-quarter loss of $1 million to $3 million due to seasonal advertising spending.
- Management anticipated approximately $200 million to $275 million of 2017 share repurchases, subject to business conditions and alternatives such as investment, dividends, acquisitions and potential long-term-care reinsurance.
- CNO intends to reduce its relative legacy long-term-care exposure, but a future reinsurance transaction could require a substantial ceding commission and produce an initial loss, reduce liquidity and limit share repurchases.
- Low interest rates could compress investment spreads, increase deficiency reserves and reduce future earnings. Management estimated a pretax charge of approximately $35 million from an immediate and permanent 10-basis-point reduction in assumed spreads on interest-sensitive products.
- Long-term-care results remain sensitive to morbidity, mortality, persistency, rate-increase approvals and investment yields. A 50-basis-point reduction in the ultimate new-money rate assumption for the run-off block was estimated to produce a $10 million pretax charge; a 5-percentage-point increase in the 2016 Bankers Life long-term-care loss ratio would have reduced earnings by approximately $25 million.
- The Department of Labor fiduciary rule was expected to generate implementation costs of $8 million to $10 million in 2017 and approximately $2 million annually thereafter, although its timing and substance were subject to possible modification.
- Material risks include investment losses, credit deterioration, policy surrenders, reinsurer default, regulatory restrictions on subsidiary dividends, litigation, cybersecurity and operational failures, agent retention, competition, debt covenants and the potential loss of deferred tax assets.
- Management stated that current holding-company liquidity, operating cash flows and other transactions were expected to be sufficient for debt service and corporate obligations, but provided no assurance because liquidity depends on regulatory approvals, subsidiary performance and market conditions.
Important facts for investors to verify
- Reconcile GAAP net income of $358.2 million with net operating income of $262.5 million and isolate the $118.7 million IRS settlement benefit, the $75.4 million BRe recapture loss and other non-operating items.
- Review the actuarial assumptions, reserve adequacy and future-loss reserves for both the Bankers Life long-term-care block and the newly recaptured run-off block.
- Monitor approvals and economics of future long-term-care premium-rate increases or reinsurance transactions.
- Assess holding-company liquidity, subsidiary dividend capacity, the $2019–2025 debt maturities and compliance with the revolving-credit covenants.
- Evaluate the quality and valuation sensitivity of the $26.2 billion investment portfolio, including $3.07 billion of below-investment-grade fixed maturities, $5.4 billion of structured securities and $1.72 billion of VIE investments.
- Track the realizability of $785.6 million of net deferred tax assets, the $240.2 million valuation allowance and the ability to use approximately $2.5 billion of federal NOLs.
- Review the BRe arbitration, related litigation and the Washington National legal judgment involving $4.7 million of compensatory and $6.0 million of punitive damages, subject to post-trial motions.