CNO Financial Group, Inc. — Q1 2013 Form 10-Q Summary
Business context and reporting period
CNO is a U.S. insurance holding company serving senior and middle-income markets through Bankers Life, Washington National, Colonial Penn and legacy “Other CNO Business” operations. Products include health insurance, annuities, individual life insurance and related products, distributed through career agents, independent producers and direct marketing. The unaudited filing covers the three months ended March 31, 2013, compared with the three months ended March 31, 2012.
Key financial metrics
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Total revenues | $1,142.6 million | $1,123.9 million | +1.7% |
| Income before taxes | $34.6 million | $92.3 million | -62.5% |
| Net income | $11.9 million | $59.1 million | -79.9% |
| Diluted EPS | $0.05 | $0.21 | Down $0.16 |
| Net operating income | $49.7 million | $40.6 million | +22.4% |
| EBIT | $92.7 million | $81.3 million | +14.0% |
| Operating cash flow | $114.6 million | $78.2 million | +$36.4 million |
| Total assets at period-end | $34.9 billion | $34.1 billion at Dec. 31, 2012 | +$767.8 million |
| Shareholders’ equity at period-end | $5.03 billion | $5.05 billion at Dec. 31, 2012 | -$20.7 million |
GAAP net margin was approximately 1.0% in Q1 2013 versus approximately 5.3% in Q1 2012. The decline primarily reflects a $57.7 million loss on extinguishment of debt, lower realized investment gains and a $6.0 million after-tax out-of-period adjustment. Excluding major non-operating items, underlying operating performance improved, with net operating income increasing to $49.7 million.
- Insurance policy income increased to $691.2 million from $686.3 million.
- Net investment income increased to $429.6 million from $410.8 million.
- Net realized investment gains decreased to $15.3 million from $22.9 million; no other-than-temporary impairment losses were recognized in Q1 2013 versus $7.9 million in Q1 2012.
- Total benefits and expenses increased to $1,108.0 million from $1,031.6 million, driven in part by higher insurance policy benefits and the debt extinguishment loss.
- Cash and unrestricted cash equivalents declined to $251.6 million from $582.5 million. Cash used in investing activities was $852.7 million, partly offset by $407.2 million of financing cash inflows.
Segment performance and material changes
| Segment | Q1 2013 pre-tax operating result | Q1 2012 | Primary change |
|---|---|---|---|
| Bankers Life | $62.1 million | $70.5 million | Lower result; higher long-term-care and other health benefit ratios and a $9.2 million out-of-period adjustment affected results. |
| Washington National | $29.4 million | $24.7 million | Improved primarily from lower operating expenses. |
| Colonial Penn | $(5.4) million | $(9.8) million | Loss narrowed, helped by lower marketing expenses. |
| Other CNO Business | $3.6 million | $(2.3) million | Improved mainly from a $20.5 million litigation charge recorded in Q1 2012 that did not recur. |
| Corporate operations | $(12.1) million | $(19.3) million | Improved operating expenses, but affected by the debt extinguishment loss below the operating line. |
- Total premium collections increased modestly at Bankers Life to $590.2 million, Washington National to $151.1 million and Colonial Penn to $57.2 million. Other CNO Business collections declined to $48.6 million.
- Bankers Life’s long-term-care benefit ratio rose to 129.4% from 110.9%; its interest-adjusted ratio was 81.7% versus 65.5%. Management expected an approximately 75% interest-adjusted ratio for 2013, excluding the out-of-period adjustment effect.
- Management expected Bankers Life’s 2013 Medicare supplement benefit ratio to be approximately 71% and Washington National’s supplemental-health interest-adjusted benefit ratio to be approximately 50%.
- Colonial Penn expected a 2013 operating loss before realized investment gains and taxes of $5 million to $10 million.
- Other CNO Business expected 2013 normalized earnings before specified investment and derivative items and taxes of $5 million to $20 million.
Debt, liquidity and capital
- Direct corporate obligations were $934.2 million at March 31, 2013, down from $1,004.2 million at December 31, 2012. Direct obligations included $631.2 million under the senior secured credit agreement, $275.0 million of 6.375% senior secured notes and $33.7 million of remaining 7.0% convertible debentures, net of discounts.
- The company repurchased $59.3 million principal amount of 7.0% debentures for $124.8 million in cash and recognized a $57.7 million loss on extinguishment. Remaining debentures become convertible beginning June 30, 2013, subject to specified conditions; CNO expected to exercise its right to terminate conversion rights in Q3 2013 if conditions were met.
- Investment borrowings totaled $1.88 billion, primarily $1.85 billion of collateralized Federal Home Loan Bank borrowings, supported by approximately $2.3 billion of investments.
- Corporate debt-to-total-capital was 15.7%, or 19.5% excluding accumulated other comprehensive income. The senior secured credit agreement ratios were within covenants: debt-to-total-capitalization 20.3% versus a 27.5% maximum, interest coverage 7.51x versus a 2.50x minimum, and consolidated statutory RBC 366% versus a 250% minimum.
- Insurance subsidiaries paid $81 million of extraordinary dividends to CDOC in Q1. Management expected total dividends to the holding company of $250 million to $300 million during 2013, subject to regulatory approval.
- Holding companies had $102.2 million of unrestricted cash and cash equivalents, $64.0 million of fixed-income investments and $77.9 million of equity securities and other invested assets. Management believed available liquidity and expected cash flows would support debt service and corporate obligations, but provided no assurance.
Guidance, outlook, risks and unusual items
- The filing provides no consolidated GAAP earnings guidance. Outlook is provided by segment as described above.
- A $6.0 million after-tax out-of-period adjustment reduced Q1 2013 net income by approximately $0.02 per diluted share. The adjustment increased insurance policy benefits by $6.7 million and amortization by $2.5 million, partially offset by a $3.2 million tax reduction.
- Long-term-care claims and reserve assumptions remain significant risks. Future experience regarding mortality, morbidity, utilization, persistency, rate increases and claims duration could require reserve or amortization changes.
- Low interest rates could reduce investment income, product spreads, demand and sales, and could result in accelerated amortization, asset write-downs or additional insurance liabilities.
- Investment risks include credit deterioration, structured-security cash-flow changes, unrealized losses and potential future impairment charges. Fixed maturities totaled $24.9 billion at fair value, including $5.6 billion of structured securities and $2.8 billion of below-investment-grade securities.
- Conseco Life had comparatively weak financial strength ratings and was near a regulatory RBC action threshold. Future dividend and surplus-debenture payments depend on insurance subsidiary capital, statutory results and regulatory approvals.
- Material litigation and regulatory matters include the Valulife/Valuterm and Lifetrend cost-of-insurance cases, with settlements or settlement discussions subject to court approval and possible additional costs. The company also remains subject to broad insurance regulatory examinations, including an unclaimed-property examination involving 38 states and the District of Columbia.
- Tax assets are subject to realization risk. The company reported approximately $3.7 billion of federal NOLs and $0.8 billion of capital-loss carryforwards, with significant valuation allowances and unresolved IRS positions that could affect future tax benefits.
Investor verification checklist
- Reconcile reported net income with net operating income and quantify the continuing effect of the debt extinguishment loss and out-of-period adjustment.
- Monitor Bankers Life long-term-care claims, benefit ratios, rate increases, lapses and reserve adequacy.
- Verify the timing and regulatory approval of expected $250 million to $300 million of subsidiary dividends.
- Assess Conseco Life’s RBC ratio, statutory surplus and potential capital-support requirements.
- Track remaining convertible debentures, potential dilution of approximately 6.2 million shares and any Q3 2013 conversion-rights termination.
- Review litigation settlement approvals, ultimate costs and any changes to insurance policy terms or rate increases.
- Evaluate investment portfolio credit quality, structured-security exposure, unrealized losses and future impairment sensitivity.
- Assess liquidity after investment purchases, debt repayments, dividends and securities repurchases; the filing states that future liquidity is subject to regulatory, market and operating conditions.