CNO Financial Group, Inc. — Form 10-Q Summary
Business context and reporting period
CNO 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 products distributed through career agents, independent producers and direct marketing. This unaudited filing covers the three and six months ended June 30, 2014; the comparable periods are 2013.
The company agreed to sell Conseco Life Insurance Company (CLIC) to Wilton Re. The sale closed July 1, 2014 for estimated net proceeds of approximately $216 million. CLIC was classified as held for sale at June 30, 2014.
Financial results and key metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenues | $1,093.0 million | $1,081.5 million | $2,177.7 million | $2,224.1 million |
| Income before taxes | $114.4 million | $114.7 million | $(55.2) million | $149.3 million |
| Net income (loss) | $78.1 million | $77.1 million | $(149.9) million | $89.0 million |
| Diluted EPS | $0.35 | $0.34 | $(0.69) | $0.38 |
| Net realized investment gains | $12.4 million | $3.2 million | $35.8 million | $18.5 million |
| Operating earnings before taxes | $96.9 million | $98.2 million | $188.9 million | $169.5 million |
| Net operating income | $63.7 million | $63.9 million | $123.6 million | $109.5 million |
Q2 pretax and net margins were approximately 10.5% and 7.1%, respectively, broadly consistent with 2013. Six-month margins were adversely affected by the CLIC sale loss.
- Operating earnings increased 15.0% in the first six months, led by Bankers Life operating earnings of $171.6 million versus $141.2 million.
- Washington National operating earnings declined to $63.4 million from $69.8 million, while Colonial Penn improved to a $2.4 million operating loss from a $4.2 million loss.
- Premium collections increased 1.9% to $1.212 billion in the first six months. Bankers Life collections rose 1.9%, Washington National rose 0.9% and Colonial Penn rose 6.4%.
- Health performance remained mixed: Bankers Life’s six-month long-term-care benefit ratio was 131.6%, or 80.1% on an interest-adjusted basis; Washington National’s supplemental-health interest-adjusted ratio was 53.9%.
- Cash and unrestricted cash equivalents declined to $378.8 million from $699.0 million at December 31, 2013. Six-month operating cash flow was $(314.9) million versus $289.9 million, primarily because of a $590.3 million payment to a reinsurer related to long-term-care business.
- Total assets were $34.914 billion and shareholders’ equity was $4.844 billion at June 30, 2014. Accumulated other comprehensive income increased to $926.1 million from $731.8 million, primarily reflecting investment-market gains.
- Corporate notes payable totaled $827.3 million, including $555.5 million outstanding under the Senior Secured Credit Agreement and $275.0 million of 6.375% senior secured notes. Investment borrowings totaled $1.508 billion, largely collateralized Federal Home Loan Bank borrowings.
Material changes versus the prior comparable period
- The six-month net loss reflects a $278.6 million pretax loss, or approximately $298.0 million after tax, on the CLIC sale. CLIC contributed $23.4 million of pretax earnings in the six months before closing.
- The CLIC transaction resulted in assets held for sale of $4.519 billion and liabilities held for sale of $4.298 billion at June 30. CNO received estimated net proceeds of $216 million at closing.
- The company recaptured a block of life insurance business from Wilton Re on July 1, 2014 for $28.0 million and expects to recognize an approximately $4.5 million after-tax gain in the third quarter.
- Management changed segment reporting beginning in 2014: the former Other CNO Business segment was eliminated, and certain continuing CLIC overhead was reallocated to Bankers Life and Washington National.
- Six-month consolidated revenues fell 2.1%, primarily because of lower CLIC activity and the termination or run-off of certain businesses, while operating earnings increased due to stronger in-force business and lower debt-related costs.
- The company repurchased 7.8 million shares for $136.6 million during the first six months and paid $26.3 million of dividends. The quarterly dividend increased to $0.06 per share from $0.03.
- The company recorded a $2.4 million out-of-period increase in operating expenses, reducing net income by $1.6 million. A 2013 out-of-period adjustment had reduced that period’s net income by $6.0 million.
Guidance, outlook, commentary and risks
- Management expected 2014 Bankers Life benefit ratios of approximately 70% for Medicare supplement and approximately 79% on an interest-adjusted basis for long-term care.
- Washington National’s 2014 interest-adjusted supplemental-health benefit ratio was expected to be approximately 54%.
- Colonial Penn was expected to be approximately break-even for 2014 before realized investment gains or losses and income taxes.
- Management anticipated repurchasing $350 million to $400 million of securities during 2014, subject to market and business conditions. Remaining repurchase authority was $260.8 million at June 30.
- Wilton Re transition and support agreements are expected to generate $30 million in the year ending June 30, 2015 and $20 million in the following year, with additional fees of approximately $0.2 million annually for certain services through June 2019. Management cautioned that failure to reduce overhead as these fees decline could pressure results.
- Key risks include sustained low interest rates, investment losses or impairments, mortality and morbidity experience, health-care utilization, long-term-care claims and reserve adequacy, inability to obtain health-insurance rate increases, policy lapses and surrenders, regulatory restrictions on subsidiary dividends, debt covenant compliance, litigation and regulatory examinations, tax-asset recoverability, and changes in financial-strength ratings.
- The company had a consolidated statutory risk-based capital ratio of 437%, debt-to-total-capitalization ratio of 17.6% under the credit agreement, interest coverage of 9.81 times and combined statutory capital and surplus of $2.057 billion at June 30, 2014, compared with covenant minimums of 250%, 27.5%, 2.50 times and $1.300 billion, respectively.
- Management stated that available holding-company liquidity and expected operating cash flows should be sufficient for debt service and other obligations, but noted that regulatory, market and operating conditions could reduce liquidity.
Most important facts for investors to verify
- Final CLIC sale proceeds, final purchase-price adjustments, and the effect of the transaction on future revenue, capital and taxes.
- Whether the expected third-quarter after-tax gain from the Wilton Re recapture is realized and how the recaptured business affects Bankers Life results.
- Long-term-care reserve adequacy, benefit ratios, approved rate increases and the effectiveness of reinsurance arrangements.
- Cash generation after the $590.3 million reinsurance payment, subsidiary dividend capacity and holding-company liquidity.
- Continuation and funding of share repurchases and dividends relative to debt covenants and insurance-company capital requirements.
- Performance of the investment portfolio, including $2.5985 billion of below-investment-grade fixed maturities, $4.341 billion of structured securities and $34.9 million of unrealized losses on fixed maturities.
- Recoverability of deferred tax assets: net deferred tax assets were $763.4 million after a $296.0 million valuation allowance, and the company had approximately $3.3 billion of federal net operating losses subject to IRS and ownership-change uncertainties.
- Status and potential exposure from litigation, the multistate unclaimed-property examination and other regulatory matters.