CNO Financial Group, Inc. quarterly report, Q2 FY2015

CNO Financial Group, Inc. — Q2 2015 Form 10-Q Summary

Business context and reporting period

CNO is a U.S. insurance holding company serving middle-income pre-retiree and retired customers through Bankers Life, Washington National and Colonial Penn. Products include health insurance, annuities and individual life insurance, distributed through career agents, independent producers and direct marketing. The filing covers the three and six months ended June 30, 2015; results are unaudited.

Key financial metrics

Metric	Q2 2015	Q2 2014	Six months 2015	Six months 2014
Total revenues	$959.5 million	$1,093.0 million	$1,937.8 million	$2,177.7 million
Income before taxes	$72.7 million	$114.4 million	$155.0 million	$(55.2) million
Net income (loss)	$46.8 million	$78.1 million	$99.6 million	$(149.9) million
Diluted EPS	$0.24	$0.35	$0.50	$(0.69)
Net operating income	$60.8 million	$71.3 million	$120.9 million	$131.2 million
Pre-tax operating earnings	$93.8 million	$108.7 million	$186.8 million	$200.7 million
Net cash from operating activities	Not separately presented	Not separately presented	$330.4 million	$(314.9) million

GAAP net margin was approximately 4.9% in Q2 and 5.1% for the first six months. Revenue declined primarily because CNO Financial Life Insurance Company was sold on July 1, 2014 and therefore contributed no 2015 revenue; the prior-year period included CLIC revenue and the loss on its sale.

June 30, 2015 total assets were $31.0 billion and shareholders’ equity was $4.4 billion, compared with $31.2 billion and $4.7 billion, respectively, at December 31, 2014.
Unrestricted cash and cash equivalents were $453.9 million, down from $611.6 million at year-end 2014. Cash held by variable interest entities was $150.6 million.
Corporate notes payable totaled $925.0 million. Investment borrowings totaled $1.5 billion and borrowings related to variable interest entities totaled $1.5 billion.
Corporate debt to total capital was 17.5%; the debt covenant ratio was 19.8% against a maximum of 30.0%. Estimated consolidated statutory risk-based capital was 443%, versus a covenant minimum of 250%.
Book value per common share was $22.56, compared with $23.06 at December 31, 2014; excluding accumulated other comprehensive income, it was $19.43 versus $19.00.

Material changes versus the prior comparable period

Q2 revenue fell 12.2% and six-month revenue fell 11.0%, largely reflecting the absence of CLIC after its 2014 sale and lower investment income.
Q2 net income decreased 40.1%, while six-month net income improved from the prior-year loss caused by the CLIC sale. Six-month 2014 included a $278.6 million pre-tax loss on the sale of CLIC.
Pre-tax operating earnings declined 13.7% in Q2 and 6.9% for the six months. Bankers Life was broadly stable, while Washington National declined materially and Colonial Penn remained near break-even.
Washington National supplemental-health claims deteriorated. The company recorded approximately $9 million of unfavorable prior-period claim development in Q2 and $12 million for the first six months, primarily due to longer and more expensive cancer-treatment patterns.
Bankers Life long-term-care benefit ratios increased to 140.7% in Q2 and 139.2% for the six months, versus 131.2% and 131.6%, respectively. Interest-adjusted ratios were 84.6% and 83.8%, versus 79.2% and 80.1%.
Net realized investment results shifted from a $35.8 million gain in the first six months of 2014 to a $1.2 million loss in 2015. The 2015 result included $9.2 million of impairment losses, partly offset by an $11.3 million gain on dissolution of a variable interest entity.
Other comprehensive income was a loss of $220.3 million for the first six months, principally reflecting lower unrealized investment gains. Accumulated other comprehensive income declined to $605.0 million from $825.3 million.
The company repurchased 10.9 million shares for $186.9 million in the first six months and had $234.1 million of remaining authorization at June 30. The quarterly dividend was increased to $0.07 per share from $0.06.

Debt refinancing, liquidity and outlook

In May 2015, CNO issued $325.0 million of 4.500% senior notes due 2020 and $500.0 million of 5.250% senior notes due 2025, and drew $100.0 million under a new $150.0 million revolving credit facility. Proceeds refinanced the prior secured credit agreement and redeemed the 6.375% senior notes.
The refinancing generated a $32.8 million pre-tax loss on debt extinguishment, including redemption premiums and write-offs of unamortized issuance costs.
Management expects to repurchase approximately $350 million to $425 million of common stock during 2015, absent compelling alternatives. The filing does not provide formal consolidated earnings guidance.
Management expects Colonial Penn to report $3 million to $6 million of 2015 earnings before realized investment gains or losses and income taxes.
Management expects Bankers Life’s Medicare supplement benefit ratio to remain in the 70% range and its long-term-care interest-adjusted benefit ratio to remain around 84% for the remainder of 2015.
Following the claim review, management expects Washington National supplemental health’s interest-adjusted benefit ratio to be approximately 58% for the remainder of 2015.
Management believes holding-company cash, operating cash flows and other sources will be sufficient for debt service and corporate needs, but acknowledges that liquidity depends on insurance subsidiary dividends, regulatory approvals, investment markets and business conditions.

Risks, contingencies and unusual items

Low interest rates may reduce investment income, annuity and life margins, product demand and the recoverability of deferred acquisition costs and future profits.
Long-term-care morbidity, supplemental-health claims, mortality, persistency, premium adequacy and the ability to obtain approved rate increases remain significant insurance risks.
The investment portfolio included $20.2 billion of available-for-sale fixed maturities, including $2.5 billion below investment grade and $168.6 million of gross unrealized losses. Energy and pipeline securities represented $1.9 billion and $45.3 million of unrealized losses; prolonged low oil prices could cause additional deterioration.
The company had approximately $2.9 billion of federal net operating losses and a $246.0 million valuation allowance against deferred tax assets. Realization depends on future taxable income. The IRS continues to dispute the tax treatment of a historical $878 million loss related to Conseco Senior Health Insurance Company.
Insurance subsidiary dividends are subject to state regulatory approval. The subsidiaries paid $112.8 million of extraordinary dividends to CDOC during the first six months of 2015.
Debt agreements contain financial and operating covenants. A covenant breach could accelerate the company’s debt, and the filing states that CNO would not have sufficient liquidity to repay all indebtedness if acceleration occurred.
Pending and potential litigation, regulatory examinations, healthcare reform, proposed fiduciary rules, derivatives regulation, cyber incidents and operational disruptions could materially affect results. Management does not currently believe pending legal matters will have a material adverse effect, but cannot predict outcomes with certainty.
The filing states that no material changes occurred in market risks or internal controls during the period.

Important facts for investors to verify

Whether Washington National’s revised supplemental-health claims assumptions and the projected 58% interest-adjusted benefit ratio are sustained.
Whether Bankers Life long-term-care claims, reserve timing and interest-adjusted benefit ratios develop as projected.
The effect of sustained low interest rates on investment income, annuity sales, insurance margins, deferred acquisition costs and policyholder behavior.
Actual cash available at the holding company, future dividend approvals from insurance subsidiaries and compliance with debt covenants.
Progress and economics of the 2015 debt refinancing, share repurchase program and planned $350 million to $425 million of repurchases.
Recoverability of deferred tax assets, resolution of the IRS dispute and potential changes to the $246.0 million valuation allowance.
Credit quality and unrealized-loss trends in the energy/pipeline, below-investment-grade and variable-interest-entity portfolios.