Business Context and Reporting Period
Company: Conseco, Inc. (CNO Financial Group, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2007
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. Operations are managed through three primary segments: Bankers Life, Conseco Insurance Group, and Colonial Penn, plus a run-off segment and corporate operations.
Key Financial Metrics
| Metric (Dollars in Millions) | Six Months Ended June 30, 2007 | Six Months Ended June 30, 2006 |
|---|---|---|
| Total Revenues | $2,283.7 | $2,205.8 |
| Net Income (Loss) | $(49.5) | $42.3 |
| Net Income (Loss) Applicable to Common Stock | $(63.6) | $23.3 |
| Earnings Per Share (Basic & Diluted) | $(0.40) | $0.15 |
| Net Cash Provided by Operating Activities | $327.1 | $471.2 |
| Total Assets | $33,437.9 | $32,717.3 |
| Total Liabilities | $29,062.6 | $28,004.2 |
| Total Shareholders' Equity | $4,375.3 | $4,713.1 |
| Investment Borrowings | $868.9 | $418.3 |
| Notes Payable (Direct Corporate) | $1,197.8 | $1,000.8 |
Material Changes vs. Prior Period
- Profitability Decline: The Company reported a net loss of $49.5 million for the six months ended June 30, 2007, compared to net income of $42.3 million in the prior year period. This reversal was driven primarily by increased insurance policy benefits and litigation settlement costs.
- Run-off Segment Losses: The "Other Business in Run-off" segment generated a pre-tax loss of $164.4 million (vs. $32.4 million income in 2006). This was caused by a $118 million increase in claim liabilities for long-term care policies due to adverse development and updated actuarial assumptions.
- Litigation Settlement Costs: The Company recognized $48.0 million in costs related to the proposed settlement of the "Cost of Insurance Litigation" (In Re Conseco Life Insurance Co.), compared to $174.7 million in the prior year period. The settlement received final court approval in July 2007.
- Investment Realized Losses: Net realized investment losses totaled $63.2 million, including $53.0 million in writedowns related to a pending coinsurance transaction where the Company intends to transfer assets to Reassure America Life Insurance Company (REALIC).
- Debt and Liquidity: Investment borrowings increased significantly to $868.9 million (from $418.3 million) due to $400 million in advances from the Federal Home Loan Bank of Indianapolis. Corporate notes payable increased to $1,197.8 million following a $200 million increase in the credit facility.
- Equity Conversion: All Class B mandatorily convertible preferred stock ($667.8 million) was converted into common stock in May 2007, increasing outstanding shares by 37.8 million.
Guidance, Outlook, Risks, and Unusual Items
- Rating Downgrades: On August 7, 2007 (post-period), A.M. Best downgraded primary insurance subsidiaries to "B+ (Good)" with a negative outlook, and Conseco Senior to "C++ (Marginal)". S&P affirmed "BB+" for primary subsidiaries but downgraded Conseco Senior to "CCC-" with a negative outlook.
- Long-Term Care Rate Increases: Management is aggressively seeking rate increases on long-term care policies in the run-off segment. Approximately 80% of requested increases have been approved, but full realization may take up to five years. Failure to obtain necessary increases could require premium deficiency reserves.
- Pending Coinsurance Transaction: A transaction to coinsure approximately $3 billion of equity-indexed and fixed annuity business with REALIC is expected to close before the end of 2007. Upon closing, the Company expects to record additional charges of approximately $63 million.
- Internal Control Weakness: Management concluded that disclosure controls and procedures were not effective as of June 30, 2007, due to a material weakness in the actuarial reporting process identified in the prior year. Remediation efforts are ongoing.
- Regulatory Investigations: The Company is subject to a multistate examination of long-term care claims administration and a Congressional investigation into long-term care insurance practices.
Investor Verification Checklist
- Long-Term Care Reserve Adequacy: Verify the assumptions used for the $118 million reserve increase in the run-off segment and the likelihood of future adverse development.
- Litigation Settlement Implementation: Monitor the implementation of the "Cost of Insurance Litigation" settlement and any potential for costs to exceed the accrued $48.0 million.
- Credit Facility Covenants: Confirm compliance with the Second Amended Credit Facility covenants, specifically the debt-to-total capitalization ratio (20% at June 30, 2007) and interest coverage ratio.
- Rating Agency Impact: Assess the impact of recent A.M. Best and S&P downgrades on policyholder lapses, agent retention, and the cost of capital.
- Coinsurance Transaction Closing: Track the regulatory approval status and closing timeline of the REALIC coinsurance deal to understand the timing of the expected $63 million charge.
- Investment Portfolio Quality: Review the $666.9 million in gross unrealized losses on fixed maturities and the $1.7 billion below-investment grade portfolio for potential future impairments.