CNO

Business Context and Reporting Period

Company: Conseco, Inc. (CNO Financial Group, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2009
Business Overview: Conseco is a holding company for a group of insurance companies operating in the U.S., focusing on supplemental health, annuity, and individual life insurance products for senior and middle-income markets. The company operates through three primary segments: Bankers Life, Colonial Penn, and Conseco Insurance Group. A significant portion of its former long-term care business (Senior Health) was transferred to an independent trust in late 2008 and is reported as discontinued operations.

Key Financial Metrics

Investment Portfolio: Total investments were $18,556.9 million. The portfolio includes $15,396.8 million in actively managed fixed maturities (fair value) with significant unrealized losses. Net realized investment losses for the quarter were $6.9 million, driven by $92.0 million in other-than-temporary impairment (OTTI) losses recognized in earnings, partially offset by $85.1 million in net gains from sales.

Material Changes vs. Prior Period

• Profitability Turnaround: The company reported a net income of $24.5 million in Q1 2009, compared to a net loss of $7.2 million in Q1 2008. This improvement was driven by a reduction in net realized investment losses (from $45.6 million in 2008 to $6.9 million in 2009) and improved operating income across segments.
• Segment Performance:
  • Bankers Life: Income before taxes increased to $42.3 million from $12.3 million, aided by higher annuity sales and improved benefit ratios in long-term care.
  • Conseco Insurance Group: Income before taxes rose to $34.4 million from $14.5 million, despite a 15% decline in premium collections due to lower annuity sales.
  • Colonial Penn: Income before taxes increased slightly to $5.2 million from $3.1 million.
• Debt Restructuring: On March 30, 2009, the company amended its Second Amended Credit Facility. This resulted in higher interest rates, a 1% fee on the outstanding balance, and stricter covenants. Fees of $9.5 million related to this modification were expensed in Q1 2009.
• Accounting Changes: The company adopted FSP FAS 115-2, which changed the recognition of OTTI losses. This resulted in an $8.7 million increase to net income as the non-credit portion of impairment losses was moved to other comprehensive loss.

Guidance, Outlook, Risks, and Contingencies

Liquidity and Capital Resources:

• The company faces significant debt service obligations, requiring over $165 million in cash in the next 12 months.
• Management projects a net cash decrease of $7.8 million over the next 12 months, leaving an expected ending cash balance of $6.1 million without additional financing or asset sales.
• Dividends and surplus debenture interest payments from insurance subsidiaries to the holding company require regulatory approval, which is not guaranteed.

Financial Strength Ratings:

• A.M. Best: Downgraded to "B" (Fair) with a negative outlook (March 4, 2009).
• S&P: Downgraded to "BB-" (Vulnerable) with a negative outlook (February 26, 2009).
• Moody's: Downgraded to "Ba2" (Vulnerable) with a negative outlook (March 3, 2009).

Risks and Contingencies:

• Debt Covenants: Margins between current financial status and covenant requirements are relatively small. Failure to meet covenants could trigger a default.
• 2010 Debt Obligation: Holders of $293 million in convertible debentures have the right to require repurchase on September 30, 2010. Current credit facility terms prohibit using cash to repay these debentures without an amendment or waiver.
• Investment Portfolio: Significant unrealized losses ($3.2 billion) in the fixed maturity portfolio. Further downgrades or OTTI charges could materially impact earnings and capital ratios.
• Internal Controls: A material weakness in internal controls over financial reporting regarding the actuarial reporting process for the Conseco Insurance Group segment remains unremediated as of March 31, 2009.
• Litigation: The company is involved in various legal proceedings, including securities litigation and cost of insurance litigation, with potential liabilities that are difficult to estimate.

Key Facts for Investor Verification

• Debt Repayment Capability: Verify the company's ability to refinance or repay the $293 million debenture obligation due in September 2010, given current credit facility restrictions.
• Regulatory Approvals: Monitor the approval status of extraordinary dividends and surplus debenture interest payments from insurance subsidiaries, which are critical for holding company liquidity.
• Covenant Compliance: Track the company's aggregate risk-based capital ratio and other financial covenants under the amended credit facility to assess default risk.
• Investment Impairments: Assess the potential for further other-than-temporary impairment charges given the $3.2 billion in unrealized losses in the fixed maturity portfolio.
• Internal Control Remediation: Confirm progress on remediation of the material weakness in actuarial reporting controls to ensure reliability of future financial statements.