CNO Financial Group, Inc. — 2011 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2011, including fourth-quarter results. CNO is a U.S. insurance holding company serving middle-income and senior customers through Bankers Life, Washington National, Colonial Penn, Other CNO Business and corporate operations. Products include supplemental health, Medicare supplement, long-term care, annuities and life insurance.
Financial performance and position
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Total revenues | $4,124.6 million | $4,083.9 million | +1.0% |
| Income before taxes | $379.2 million | $293.5 million | +29.2% |
| Net income | $382.5 million | $284.6 million | +34.4% |
| Diluted EPS | $1.31 | $0.99 | +32.3% |
| Net margin | 9.3% | 7.0% | +2.3 percentage points |
| Net cash from operating activities | $774.8 million | $734.0 million | +5.6% |
| Total assets | $33.3 billion | $31.9 billion | +4.5% |
| Shareholders’ equity | $5.0 billion | $4.3 billion | +16.4% |
- Premium collections were $3.58 billion, broadly flat with 2010. Life collections increased 6.1%, while health collections declined 1.5% and annuity collections declined 2.0%.
- Net investment income was $1,354.1 million, down slightly from $1,366.9 million. Net realized investment gains increased to $61.8 million from $30.2 million; impairment losses recognized through earnings declined to $34.6 million from $149.8 million.
- Operating earnings before investment gains, embedded-derivative fair-value changes, corporate interest, debt extinguishment and taxes increased to $216.0 million from $181.9 million. Segment operating earnings were led by Bankers Life at $327.2 million, followed by Washington National at $99.2 million and Colonial Penn at $27.3 million.
- Operating cash flow was positive, but investing activities used $1.34 billion, principally because investment purchases exceeded sales and maturities. Ending unrestricted consolidated cash was $436.0 million.
- Total insurance-product liabilities were $24.7 billion. Investments totaled $26.4 billion, including $23.5 billion of available-for-sale fixed maturities; 91% of fixed maturities were investment grade.
- Direct corporate obligations totaled $857.9 million, while aggregate principal indebtedness was $873.2 million. Scheduled 2012 cash service for corporate debt was approximately $109 million, including interest.
Material changes versus the prior comparable period
- Net income benefited from stronger segment operating results, higher realized investment gains and a $143.0 million reduction in the deferred-tax-asset valuation allowance. The allowance remained substantial at $938.4 million.
- Bankers Life operating earnings increased 15.2%, supported by lower health benefits and higher investment income, despite higher amortization and weaker total premium collections.
- Washington National operating earnings declined 5.2%, primarily reflecting higher supplemental-health benefits and a higher overall health benefit ratio of 77.8% versus 76.7%.
- Other CNO Business improved to $13.4 million of operating earnings from an $11.5 million loss, but remains exposed to runoff blocks, particularly long-term care and interest-sensitive life products.
- Bankers Life long-term-care benefit ratio remained above 100% at 112.6%, while the Other CNO Business long-term-care benefit ratio worsened to 226.4% from 210.8%.
- Corporate notes payable declined by $140.6 million. CNO repurchased $69.8 million of common stock, or approximately 11.1 million shares, under its repurchase program. No common dividends were paid or declared because of debt restrictions.
- Accumulated other comprehensive income rose to $625.5 million from $238.3 million, primarily from higher unrealized investment gains.
- The company sold a trading portfolio used to offset fair-value volatility from fixed-index annuity embedded derivatives. The change increased earnings volatility and reduced 2011 earnings by approximately $15.1 million.
Fourth-quarter 2011 results
| Metric | Q4 2011 | Q4 2010 |
|---|---|---|
| Revenues | $1,051.1 million | $1,075.8 million |
| Income before taxes | $115.9 million | $111.3 million |
| Net income | $73.1 million | $168.2 million |
| Diluted EPS | $0.26 | $0.56 |
Fourth-quarter 2010 net income included a favorable $56.9 million income-tax benefit; fourth-quarter 2011 included $42.8 million of tax expense. This tax comparison materially affected the year-over-year net-income and EPS decline.
Guidance, outlook, risks and unusual items
- Management did not provide formal quantitative earnings guidance. Its 2012 priorities were increasing EPS, growing sales profitably, improving efficiency, managing long-term-care profitability, improving or disposing of underperforming blocks and deploying excess capital.
- Management stated that existing holding-company cash, operating cash flows and other transactions were expected to support debt service and corporate obligations, but cautioned that liquidity depends on regulatory approvals, subsidiary earnings, investment markets and other conditions.
- Insurance subsidiaries had a consolidated risk-based-capital ratio of 358%, above the 250% post-2011 debt-covenant requirement. The debt-to-total-capitalization ratio was 17.1% versus a 30% maximum, and interest coverage was 5.0x versus a 2.0x minimum.
- Holding-company liquidity is constrained because CNO depends on dividends, surplus-debenture interest and service payments from insurance subsidiaries. Extraordinary dividends totaled $235.0 million in 2011, and future payments require regulatory approval because direct subsidiaries had negative earned surplus.
- Low interest rates may compress investment spreads, reduce annuity sales and require additional reserve or acquisition-cost adjustments. The average fixed-maturity yield was 5.9% versus a 4.4% average credited or accruing rate on insurance liabilities.
- Long-term-care profitability remains a significant risk. Rate increases require regulatory approval, may cause lapses or adverse selection, and may be insufficient to offset claims and persistency experience.
- Legal and regulatory matters include cost-of-insurance and sales-practice class actions, regulatory examinations and an unclaimed-property examination involving 31 states. Management did not believe probable losses, after existing provisions, would materially affect consolidated results, but stated that outcomes cannot be predicted with certainty.
- The company expects adoption of new insurance acquisition-cost accounting guidance on a retrospective basis. It estimated a book-value reduction of approximately $580 million, or $1.96 per diluted share, and a 2011 earnings reduction of approximately $47 million, or $0.15 per diluted share, if the guidance had been effective.
- An out-of-period adjustment increased 2011 insurance policy benefits by $9.7 million and reduced net income by $6.3 million, or approximately $0.02 per diluted share.
Most important facts for investors to verify
- Whether long-term-care rate approvals and claims experience improve, particularly for Bankers Life and the high-loss Other CNO Business block.
- The sustainability of investment spreads, realized gains and unrealized investment gains in a prolonged low-rate or stressed credit environment.
- Holding-company cash generation, subsidiary dividend approvals and the ability to meet scheduled debt service and covenant requirements.
- The ultimate impact of the pending acquisition-cost accounting change on book value, EPS comparability and reported historical results.
- Recoverability of the $650.1 million net deferred-tax asset, including the $938.4 million valuation allowance, NOL expiration schedule and unresolved IRS positions.
- Potential losses, settlements or operating restrictions arising from litigation, regulatory investigations, unclaimed-property examinations and cost-of-insurance disputes.
- Reinsurance counterparty exposure, including $3.1 billion of reinsurance receivables and $13.6 billion of ceded life insurance in force.