CNO Financial Group, Inc. — 2013 Q3 Form 10-Q Summary
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 legacy businesses. Products include health insurance, annuities, individual life insurance and long-term care coverage. This unaudited Form 10-Q covers the three and nine months ended September 30, 2013, compared with the corresponding 2012 periods.
Key financial metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Total revenues | $1,093.8 million | $1,093.0 million | $3,317.9 million | $3,281.9 million |
| Income before taxes | $114.4 million | $(158.8) million | $263.7 million | $38.0 million |
| Net income | $283.0 million | $(5.0) million | $372.0 million | $119.8 million |
| Diluted EPS | $1.23 | $(0.02) | $1.59 | $0.45 |
| Operating income before taxes, excluding specified investment, derivative and debt items | $114.0 million | $35.3 million | $295.6 million | $185.9 million |
| Net cash from operating activities | Not separately provided for the quarter | Not separately provided for the quarter | $472.1 million | $424.6 million |
Net margins were approximately 25.9% in Q3 2013 and 11.2% for the first nine months of 2013, based on GAAP net income divided by total revenues. These margins were materially affected by discrete tax benefits and other unusual items.
- At September 30, 2013, total assets were $33.9 billion, shareholders’ equity was $4.8 billion and unrestricted cash was $376.7 million.
- Investment assets totaled $27.3 billion, including $23.5 billion of fixed maturities available for sale. Below-investment-grade fixed maturities represented approximately 12% of the fixed-maturity portfolio by amortized cost.
- Total insurance-product liabilities were approximately $24.7 billion.
- Direct corporate obligations were $868.6 million, down from $1.0 billion at December 31, 2012. Investment borrowings were $1.85 billion, primarily collateralized Federal Home Loan Bank borrowings.
- Corporate debt-to-total-capital was 15.4%, or 17.3% excluding accumulated other comprehensive income. The debt covenant ratio was 17.5%, versus a maximum of 27.5%; interest coverage was 8.70x versus a minimum of 2.50x.
- The consolidated insurance-subsidiary risk-based capital ratio was 392%, and combined statutory capital and surplus was $1.90 billion.
Material changes versus the prior comparable period
- Q3 net income improved by $288.0 million from the prior-year loss, while nine-month net income increased by $252.2 million. The principal driver was the absence of the $198.5 million Q3 2012 loss on extinguishment of debt, together with substantial tax valuation-allowance benefits.
- The company recognized a $206.7 million Q3 2013 reduction in the valuation allowance for deferred tax assets, including a $197.4 million reduction recognized in the quarter. The nine-month benefit was $222.2 million. The company also recognized a $71.8 million benefit related to an IRS closing agreement concerning cancellation-of-indebtedness income.
- Operating income before taxes and specified items increased 223% in Q3 and 59% for the first nine months. Bankers Life remained the largest contributor, with nine-month operating income of $227.5 million, essentially flat with 2012. Other CNO Business improved to $12.3 million from a $54.0 million loss, primarily due to lower benefits, amortization, legal and operating costs.
- Washington National operating income declined to $89.3 million from $92.5 million, reflecting higher supplemental-health benefit ratios and runoff of Medicare supplement business. Colonial Penn remained loss-making, although its nine-month loss narrowed to $8.4 million from $11.8 million.
- Bankers Life premium collections increased 2.8% in the first nine months, led by life and annuity sales. Washington National collections increased 2.6%, while Colonial Penn collections increased 7.0%. Legacy Other CNO collections declined 5.4% as policies lapsed or surrendered.
- Net realized investment gains fell to $18.4 million from $63.9 million. Other-than-temporary impairment losses recognized in earnings declined to $3.5 million from $34.5 million.
- Accumulated other comprehensive income declined to $634.0 million from $1.20 billion, primarily reflecting lower unrealized investment gains. Book value per common share declined to $21.56 from $22.80, while book value excluding accumulated other comprehensive income increased to $18.70 from $17.39.
Guidance, outlook, commentary and risks
- Management expected 2013 Colonial Penn operating loss before realized investment gains and taxes of $5 million to $10 million, with approximately break-even results in Q4.
- Management expected Other CNO Business normalized earnings before specified items and taxes of $5 million to $20 million in 2013, noting volatility from thin margins, litigation and runoff blocks.
- Management expected Q4 benefit ratios to approximate Q3 levels for Bankers Life long-term care, Washington National supplemental health and Bankers Life Medicare supplement products.
- The company anticipated repurchasing $250 million to $300 million of securities during 2013. It repurchased 7.0 million common shares for $87.3 million and $63.8 million principal amount of 7.0% debentures during the first nine months; remaining repurchase authority was $128.4 million.
- The 7.0% debentures were substantially repurchased or converted; $3.5 million principal remained outstanding at September 30, 2013. The company also amended its senior secured credit agreement, reducing applicable interest spreads.
- Major risks include low interest rates, investment losses and impairments, long-term-care morbidity and persistency, adequacy of insurance reserves, regulatory approval of dividends and rate increases, litigation, tax-asset recoverability, debt covenants, insurance-company ratings and holding-company liquidity.
- The company settled the Lifetrend class action subject to final court approval and maintained an estimated liability. It also disclosed continuing regulatory examinations involving unclaimed-property laws and Death Master File practices.
- Deferred tax assets remain dependent on future taxable income. A failure to achieve projected earnings, an adverse IRS determination, or an ownership change under Section 382 could require additional valuation allowances and reduce future earnings and equity.
- Management stated that existing holding-company liquidity, operating cash flows and other transactions were expected to fund debt service and corporate needs, but acknowledged that regulatory, market and operating conditions could impair liquidity.
Most important facts for investors to verify
- Separate recurring operating performance from the $222.2 million nine-month deferred-tax valuation-allowance benefit and other discrete tax items.
- Assess sustainability of Bankers Life earnings, particularly the 129.1% nine-month long-term-care benefit ratio and the effect of future rate increases and claims experience.
- Review the quality, duration, unrealized losses and below-investment-grade exposure of the $23.5 billion fixed-maturity portfolio, including structured securities and VIE investments.
- Confirm the ability of insurance subsidiaries to upstream dividends and the effect of regulatory approval requirements on holding-company debt service.
- Monitor Conseco Life’s materially weaker ratings and capital position, as well as consolidated RBC and debt-covenant compliance.
- Follow developments in Lifetrend, Washington National long-term-care litigation, regulatory examinations and IRS examinations.
- Reconcile GAAP earnings and cash flow with management’s non-GAAP EBIT and operating-income measures before evaluating valuation or trend performance.