CNO Financial Group, Inc. quarterly report, Q1 FY2016

CNO Financial Group, Inc. — 2016 Q1 Form 10-Q Summary

Business context and reporting period

CNO is a holding company for U.S. insurance businesses serving primarily middle-income and senior customers through Bankers Life, Washington National and Colonial Penn. Products include health insurance, annuities, individual life insurance and related services. This unaudited filing covers the three months ended March 31, 2016, compared with the three months ended March 31, 2015, and the balance sheet is compared with December 31, 2015.

Key financial metrics

Metric	Q1 2016	Q1 2015	Change
Total revenues	$960.4 million	$978.3 million	Down $17.9 million
Income before income taxes	$40.5 million	$82.3 million	Down $41.8 million
Net income	$45.5 million	$52.8 million	Down $7.3 million
Diluted earnings per share	$0.25	$0.26	Down $0.01
Net margin	4.7%	5.4%	Lower
Net cash from operating activities	$140.4 million	$122.5 million	Up $17.9 million
Cash and cash equivalents	$635.7 million	$426.9 million	Up $208.8 million year over year

Insurance policy income increased to $644.4 million from $636.5 million, while general-account net investment income declined to $291.0 million from $300.1 million. Total benefits and expenses rose to $919.9 million from $896.0 million. The reported tax benefit included a $20.0 million reduction in the valuation allowance for deferred tax assets; tax expense on period income was $15.0 million.

Pre-tax operating earnings, a non-GAAP measure, were $77.6 million versus $93.0 million. Net operating income was $49.6 million versus $60.1 million, and diluted net operating income per share was $0.27 versus $0.30.

Financial condition, debt and liquidity

Total assets were $31.46 billion at March 31, 2016, compared with $31.13 billion at December 31, 2015. Shareholders’ equity increased to $4.23 billion from $4.14 billion, primarily reflecting net income and a $137.7 million increase in after-tax accumulated other comprehensive income, partly offset by share repurchases and dividends.
Corporate notes payable were $911.5 million. Investment borrowings were $1.55 billion, borrowings related to variable-interest entities were $1.66 billion, and total liabilities were $27.23 billion.
Corporate debt-to-total-capital was 17.7%; the debt-to-total-capital ratio under the revolving credit agreement was 20.3%, against a 30.0% maximum. Estimated consolidated statutory risk-based capital was 441%, versus a 250% covenant minimum.
The revolving credit agreement had $100.0 million outstanding, $50.0 million of additional availability and a May 2019 maturity. Direct corporate obligations included $325.0 million of 4.500% senior notes due 2020 and $500.0 million of 5.250% senior notes due 2025.
Holding companies and other non-insurance subsidiaries held $122.6 million of unrestricted cash and cash equivalents, $122.8 million of fixed-income investments and $129.3 million of equity securities. Insurance subsidiaries paid $88.7 million of extraordinary dividends to CDOC during the quarter, subject to regulatory constraints.
The company repurchased 5.3 million shares for $90.0 million and declared $12.6 million of dividends, or $0.07 per share. Remaining repurchase authority was $365.7 million.

Material changes versus the prior comparable period

Net income declined 14%, although the decline was moderated by the $20.0 million deferred-tax valuation allowance release.
Pre-tax operating earnings declined 17%, driven primarily by lower earnings at Bankers Life and Washington National and increased corporate expenses.
Bankers Life pre-tax operating earnings declined to $77.6 million from $82.2 million. Premium collections increased 13% to $660.7 million, including a 36% increase in annuity collections. Its long-term-care interest-adjusted benefit ratio improved to 75.3% from 83.0%, including an $8 million favorable reserve release related to policyholder actions after rate increases.
Washington National pre-tax operating earnings declined to $26.3 million from $28.5 million, while premium collections increased 4.3% to $165.5 million. The supplemental-health interest-adjusted benefit ratio was broadly stable at 57.7% versus 57.6%.
Colonial Penn’s operating loss increased to $6.8 million from $5.9 million. Premium collections rose 7.7% to $70.1 million, but higher direct-response advertising costs affected results.
Corporate operations’ operating loss increased to $19.5 million from $11.8 million, including $6.0 million of unfavorable fair-value changes related to the agent deferred-compensation plan and approximately $3 million of accelerated stock-compensation expense associated with retirement-eligible employees.
Net realized investment results changed from an $8.9 million gain to a $0.9 million loss. Q1 2015 included an $11.3 million gain on dissolution of a variable-interest entity; Q1 2016 included $10.0 million of impairment losses, including $6.3 million on an energy-sector issuer and $3.7 million on a direct loan.
After-tax other comprehensive income increased to $137.7 million from $108.9 million, primarily reflecting higher unrealized investment gains.

Guidance, outlook, risks and unusual items

Management expected Bankers Life’s Medicare supplement benefit ratio to remain between 70% and 73% during 2016. The long-term-care interest-adjusted benefit ratio was expected to be 81% to 86%, excluding reserve impacts from rate increases. Washington National’s supplemental-health interest-adjusted benefit ratio was expected to be 56% to 59%.
Colonial Penn expected 2016 earnings to range from breakeven to $6 million; management noted uncertainty regarding television advertising costs during the U.S. presidential election year.
Management anticipated repurchasing approximately $275 million to $375 million of common stock during 2016, subject to business and market conditions and competing uses of capital.
CNO continued to target a reduction of its relative long-term-care exposure by approximately one-half over three to six years. Potential reinsurance could require a substantial ceding commission, create an initial loss and reduce cash available for repurchases.
Investment risks include low interest rates, energy-sector credit exposure, below-investment-grade securities, structured securities, unrealized losses and possible additional impairments. Fixed maturities had $291.9 million of gross unrealized losses, including $107.8 million in the energy sector; management stated it did not currently expect the losses to be other-than-temporary.
Long-term-care profitability depends on morbidity, persistency, premium-rate increases and investment yields. The company increased related future loss reserves by $8.9 million in Q1, and those reserves totaled $167.2 million at March 31, 2016.
The company had approximately $2.5 billion of federal net operating losses. It expected to use remaining life NOLs in Q2 2016, absent a favorable resolution of the IRS dispute concerning the classification of a historical loss on Conseco Senior Health Insurance Company. Future tax benefits depend on taxable income, IRS outcomes and ownership-change limitations under Section 382.
Pending or threatened litigation and regulatory matters include a multi-state unclaimed-property examination involving 38 states and the District of Columbia. Management did not believe currently pending matters were probable of having a material adverse effect after existing provisions, but stated that outcomes remain difficult to predict.
In April 2016, CNO announced a minority investment in Tennenbaum Capital Partners and plans to invest approximately $250 million over time in TCP-managed funds and strategies. The filing does not provide the investment amount for the minority interest.

Most important facts for investors to verify

Whether the $20.0 million deferred-tax valuation allowance release is sustainable and whether future tax cash payments increase after life NOLs are utilized.
Progress and economics of any planned long-term-care reinsurance transaction, including ceding commissions, capital effects and tax consequences.
Actual long-term-care and Medicare supplement claims experience, rate approvals, persistency and reserve adequacy.
Energy-sector and below-investment-grade portfolio performance, including potential future impairments or realized losses.
Availability of dividends from regulated insurance subsidiaries and compliance with debt, RBC and liquidity requirements.
Capital allocation among share repurchases, dividends, TCP-related investments, insurance-company capital needs and potential reinsurance.
Management’s non-GAAP operating earnings measures should be reconciled to GAAP net income; the filing cautions that these measures are not substitutes for GAAP profitability or operating cash flow.