CNO Financial Group, Inc. — 2020 Q3 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 health, annuity, individual life and related products. Products are distributed through career agents, independent producers and direct marketing. The unaudited filing covers the three and nine months ended September 30, 2020, with comparisons to 2019.
Beginning in 2020, CNO reorganized reporting around annuity, health and life product lines, plus investment and fee revenue activities. Prior-period information was reclassified to conform to the new structure.
Financial performance and key metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Total revenues | $1,013.5 million | $944.0 million | $2,744.9 million | $2,946.8 million |
| Income before taxes | $166.4 million | $53.5 million | $200.8 million | $166.8 million |
| Net income | $129.2 million | $42.0 million | $190.0 million | $131.4 million |
| Diluted EPS | $0.91 | $0.27 | $1.32 | $0.83 |
| Net operating income | $112.6 million | $69.2 million | $276.3 million | $211.4 million |
| Operating earnings before taxes | $145.3 million | $87.9 million | $353.0 million | $268.0 million |
| Operating cash flow | Not separately provided | Not separately provided | $541.8 million | $510.9 million |
Q3 revenue increased 7.4%, while nine-month revenue declined 6.8%, primarily reflecting investment-related volatility and lower non-operating items. Q3 net income increased 208%, and nine-month net income increased 45%. Net operating income increased 63% in Q3 and 31% for the first nine months.
Total insurance product margin was $244.8 million in Q3 and $690.9 million for the first nine months, compared with $200.1 million and $588.9 million, respectively, in the prior-year periods. Nine-month margins benefited from favorable health claims and actuarial assumption changes, partly offset by lower life margins and lower investment income.
- Annuity margin: $45.3 million in Q3 and $228.6 million for nine months, compared with $56.2 million and $169.6 million in 2019.
- Health margin: $152.2 million in Q3 and $334.6 million for nine months, compared with $89.3 million and $269.9 million.
- Life margin: $47.3 million in Q3 and $127.7 million for nine months, compared with $54.6 million and $149.4 million.
Net realized investment gains were $16.3 million in Q3, versus $2.3 million in 2019, but net realized investment losses were $55.4 million for the first nine months, versus gains of $23.7 million in 2019. The nine-month loss included a $31.4 million increase in credit-loss and impairment charges.
Accumulated other comprehensive income increased to $1,801.6 million at September 30, 2020 from $1,372.5 million at December 31, 2019, primarily reflecting higher unrealized investment gains. Total shareholders’ equity increased to $5,083.9 million from $4,677.0 million.
Balance sheet, debt and liquidity
- Total assets were $34.6 billion at September 30, 2020, compared with $33.6 billion at year-end 2019.
- Fixed maturities available for sale were $22.7 billion, including $3.0 billion of gross unrealized gains and $83.9 million of gross unrealized losses. Approximately 95.9% of the portfolio’s fair value was investment grade.
- Unrestricted cash and cash equivalents were $735.6 million; unrestricted cash held by CNO, CDOC and other non-insurance subsidiaries was $235.9 million.
- Direct corporate obligations were $990.1 million, consisting of $500 million of 5.25% senior notes due 2025 and $500 million of 5.25% senior notes due 2029. No amounts were outstanding under the $250 million revolving credit facility.
- FHLB investment borrowings were $1.6 billion and were collateralized by investments with an estimated fair value of $2.1 billion. Borrowings related to consolidated VIEs were $1.2 billion.
- Corporate debt-to-total-capital was 16.3%, compared with 17.5% at December 31, 2019. Estimated consolidated statutory RBC was 428%, compared with 408% at year-end 2019.
- Free cash flow at the holding company was approximately $268 million for the first nine months. Insurance subsidiaries paid $180.8 million of dividends to the holding company, subject to regulatory constraints.
Cash and cash equivalents increased by $131.9 million during the first nine months. Operating cash flow of $541.8 million was partly offset by $429.8 million used in investing activities and $19.9 million provided by financing activities.
Material changes versus the prior comparable period
- Health margins improved substantially, mainly due to lower claims as policyholders deferred medical care during the pandemic. Management estimated a favorable Q3 impact of approximately $58 million on health margins, including approximately $36 million from Medicare supplement, $16 million from long-term care and $6 million from supplemental health.
- Life margins declined; management estimated COVID-19-related adverse mortality impacts of approximately $9 million in Q3 and $19 million for the first nine months on traditional life, plus approximately $3 million and $4 million, respectively, on interest-sensitive life.
- An actuarial unlocking exercise in Q2 reduced future new-money-rate assumptions and changed fixed-index-annuity option-cost assumptions. The new-money-rate and persistency changes reduced pretax earnings by $45.6 million, while lower future option costs increased pretax earnings by $91.5 million, for a net favorable pretax effect of $45.9 million.
- The actuarial changes reduced estimated future margins by approximately $280 million, although no loss-recognition charge was required in Q2.
- The company increased its Global Resolution Agreement liability by $23.5 million in Q2 as information became available to better estimate the ultimate obligation.
- Collected premiums from annuity and interest-sensitive life products declined 11% in Q3 and 14% for the first nine months, primarily because of lower fixed-index-annuity collections.
- The company repurchased 10.0 million shares for $163.0 million during the first nine months and had $369.3 million of remaining repurchase authority at September 30. The quarterly dividend was increased to $0.12 per share from $0.11.
Guidance, outlook, management commentary and risks
The filing does not provide a conventional quantitative earnings forecast. Management expects fourth-quarter Worksite Division sales to improve with open enrollment but remain significantly below fourth-quarter 2019 levels. Consumer sales improved as agents and customers adopted virtual transactions.
Management modeled two hypothetical COVID-19 scenarios. Under the more adverse scenario, management stated that it expected to maintain target RBC levels, debt-to-capital ratios, minimum holding-company liquidity, the quarterly dividend and capacity for share repurchases; however, the scenarios are not predictions and actual outcomes could differ materially.
- COVID-19 may affect sales, mortality, morbidity, persistency, claims, investment income, asset values, capital, reserves, deferred acquisition costs, present value of future profits and deferred tax assets.
- Health margin benefits from delayed care are expected to normalize and could reverse into higher claims costs. Additional life claims and longer-term health complications remain possible.
- Persistently low interest rates may reduce investment income and product spreads, increase amortization or reserve requirements, and reduce future margins. The filing states that further credit-loss charges remain possible.
- The investment portfolio includes $5.8 billion of structured securities and $1.2 billion of below-investment-grade investments held by consolidated VIEs, which may be exposed to defaults, downgrades and valuation volatility.
- Insurance subsidiary dividends and surplus-debenture payments may require regulatory approval. Reinsurer defaults, litigation, regulatory actions, cybersecurity events and operating disruptions are additional risks.
- Pending litigation includes claims related to the former Platinum/Beechwood reinsurance transactions. The Cyganowski matter was fully concluded in 2020, while the Wilmington, KPMG and Delaware Chancery matters remained pending or subject to appeal.
Important facts for investors to verify
- Whether favorable pandemic-related health claims experience reverses as deferred medical care normalizes.
- Actual COVID-19 mortality, lapse and sales trends, particularly in the Worksite Division and life products.
- Future credit losses, impairments, defaults and unrealized losses in fixed maturities, VIE investments, mortgage loans and structured securities.
- The effect of sustained low interest rates on investment yields, product spreads, embedded derivatives, reserves and deferred acquisition costs.
- Whether regulatory approvals support future dividends from insurance subsidiaries and continued holding-company liquidity.
- The ultimate outcome and potential exposure from pending litigation, regulatory examinations and the Global Resolution Agreement.
- The impact of the pending long-duration insurance-contract accounting standard, expected to be effective for CNO in 2023; the filing states that the adoption impact had not yet been determined.