CNO Financial Group, Inc. quarterly report, Q3 FY2012

CNO Financial Group, Inc. — Form 10-Q Summary

Business context and reporting period

CNO is a holding company for U.S. insurance businesses serving senior and middle-income markets through Bankers Life, Washington National and Colonial Penn. Products include health insurance, annuities, individual life insurance and related products. The filing covers the quarter and nine months ended September 30, 2012, compared with the corresponding 2011 periods. Results are unaudited and prior periods were retrospectively adjusted for ASU 2010-26, which changed deferred acquisition cost capitalization.

Key financial metrics

Metric	Q3 2012	Q3 2011	9M 2012	9M 2011
Total revenues	$1,093.0 million	$992.3 million	$3,281.9 million	$3,073.5 million
Net income (loss)	$(5.0) million	$179.5 million	$119.8 million	$271.3 million
Diluted earnings per share	$(0.02)	$0.61	$0.45	$0.92
Operating income	$25.6 million	$32.8 million	$120.4 million	$120.5 million
Net cash from operating activities	Not separately presented	Not separately presented	$424.6 million	$562.2 million

Revenue growth reflected higher insurance policy income, net investment income and investment gains. Benefits and expenses increased to $1,251.8 million in Q3 and $3,243.9 million for the nine months.
Q3 pretax loss was $158.8 million; nine-month pretax income was $38.0 million. The Q3 loss primarily reflected a $198.5 million loss on extinguishment of debt.
Income taxes included a $143.0 million reduction in the deferred-tax-asset valuation allowance in both the Q3 and nine-month 2012 periods. Without this reduction, nine-month net income before the valuation allowance change was a $23.2 million loss.
Shareholders’ equity increased to $5,252.9 million from $4,613.8 million at December 31, 2011, primarily because accumulated other comprehensive income increased to $1,421.1 million from $781.6 million.
Unrestricted cash and cash equivalents were $415.3 million at September 30, 2012, compared with $436.0 million at year-end 2011. Total assets were $34.0 billion and total liabilities were $28.8 billion.
Net realized investment gains were $9.1 million in Q3 and $63.9 million for the nine months, including $34.5 million of other-than-temporary impairment losses for the nine months.

Material changes versus the prior comparable period

Net income declined sharply in Q3 because of the $198.5 million debt-extinguishment loss, compared with $1.1 million in Q3 2011. The nine-month debt-extinguishment loss was $199.2 million versus $3.1 million in 2011.
Net operating income was broadly unchanged for the nine months at $120.4 million versus $120.5 million, despite improved Washington National and Bankers Life results and deterioration in Other CNO Business.
Segment EBIT for the nine months declined to $253.9 million from $289.8 million. Bankers Life increased to $227.2 million from $213.7 million and Washington National increased to $92.5 million from $67.3 million; Other CNO Business declined to a $54.0 million loss from $15.3 million of income.
Bankers Life premium collections declined 9.5% for the nine months to $1,740.8 million, primarily because annuity collections declined 29%. Life collections increased 23% and Medicare supplement collections increased 1.6%.
Colonial Penn premium collections increased 6.8% to $161.8 million, while the segment remained unprofitable before investment gains because of marketing costs and the accounting treatment of direct-response advertising.
Other CNO Business recognized approximately $43 million of pretax reserve increases in Q3, compared with approximately $13 million in Q3 2011, primarily from lower projected future investment yields.
Q3 included $21 million of additional charges related to tentative settlements in Valulife/Valuterm litigation; cumulative 2012 charges for those tentative settlements were approximately $41.5 million.

Debt, liquidity and capital

In September 2012, CNO completed a recapitalization: it issued $275.0 million of 6.375% senior secured notes due 2020 and borrowed $675.0 million under new term loan facilities. Proceeds were used principally to repurchase $200.0 million of 7.0% debentures, repay the prior credit agreement and fund the 9.0% notes tender offer.
Direct corporate obligations were $1,035.1 million at September 30, 2012, versus $857.9 million at December 31, 2011. Scheduled principal payments total $365.5 million through 2017 and $678.7 million thereafter.
Corporate debt-to-total-capital was 16.5%; excluding accumulated other comprehensive income, it was 21.3%. The new credit agreement requires debt-to-total-capital of no more than 27.5%; the reported ratio under that agreement was 21.5%.
Insurance subsidiaries had a consolidated risk-based capital ratio of 361% and combined statutory capital and surplus of $1,766.8 million, compared with covenant minimums of 250% and $1,300.0 million, respectively.
Holding companies and non-insurance subsidiaries held $209.4 million of unrestricted cash and cash equivalents, $57.2 million of fixed-income investments and $47.0 million of equity securities and other invested assets.
Management expected total 2012 dividends from insurance subsidiaries of $250 million to $275 million, subject to regulatory approval. It also anticipated 2012 share repurchases near the high end of a $150 million to $170 million range; $99.5 million had been repurchased through September 30.

Outlook, management commentary and risks

Management expects investment yields to decline in future periods because of challenging market conditions and continued low interest rates. A hypothetical sustained low-rate scenario could produce a $20 million to $50 million after-tax charge, lower future investment income and reduce statutory RBC by approximately 10 percentage points.
Management estimated that a permanent 10-basis-point reduction in assumed spreads could generate an approximately $55 million pretax charge, while a 50-basis-point reduction in assumed investment earnings rates for certain products could generate an approximately $50 million pretax charge.
Bankers Life expected approximately $35 million of long-term-care rate increases after all state approvals; approximately $34 million had been approved by September 30, 2012. Rate increases may also increase lapses and reduce sales.
Key risks include low interest rates, mortality and morbidity experience, long-term-care claims, investment impairments, policyholder surrenders and lapses, inability to obtain health-rate increases, regulatory limits on dividends, debt covenants, liquidity, ratings, litigation and the recoverability of deferred tax assets.
CNO had $3.9 billion of federal NOLs and $0.9 billion of capital-loss carryforwards. Their utilization depends on future taxable income and unresolved IRS positions involving cancellation-of-indebtedness income and the Senior Health loss. A future valuation-allowance increase could materially reduce earnings and equity.
Material legal and regulatory matters include Valulife/Valuterm and Lifetrend class actions, long-term-care and sales-practice matters, and regulatory examinations. Management did not believe existing litigation was probable to have a material consolidated effect, but stated that adverse outcomes could materially affect results and cash flows.

Investor verification checklist

Reconcile reported GAAP earnings with management’s non-GAAP operating income and quantify the effects of debt extinguishment, investment gains, derivative valuation changes and the tax valuation-allowance reduction.
Review the new secured debt agreements, amortization schedule, mandatory-prepayment provisions and restrictions on dividends and share repurchases.
Assess liquidity at the holding company, expected insurance-subsidiary dividends and the requirement for regulatory approval of extraordinary dividends.
Monitor long-term-care benefit ratios, reserve developments, rate-increase approvals and the effect of low investment yields on insurance liabilities and acquisition-cost amortization.
Evaluate the investment portfolio’s credit quality, structured-securities exposure, below-investment-grade holdings and future impairment sensitivity.
Track the Valulife/Valuterm and Lifetrend litigation, related settlement charges and any resulting policy or claims-administration changes.
Confirm the status of IRS examinations and the potential effect of NOL limitations or changes in the deferred-tax-asset valuation allowance.