CNO Financial Group, Inc. annual report, FY2020

CNO Financial Group, Inc. — 2020 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2020. The filing is an annual report, not a standalone quarterly filing, but it includes unaudited fourth-quarter data. CNO is a U.S. insurance holding company focused on middle-income pre-retirees and retirees, offering annuity, health, life and related products through Bankers Life, Washington National and Colonial Penn brands. In 2020, CNO reorganized reporting around annuity, health, life, investment and fee-revenue segments; prior periods were reclassified.

Financial performance and condition

Metric	2020	2019	Change
Total revenues	$3.821 billion	$4.016 billion	Down 4.8%
Net income	$301.8 million	$409.4 million	Down 26.3%
Diluted EPS	$2.11	$2.61	Down $0.50
Net operating income	$362.3 million	$290.0 million	Up 24.9%
Net operating income per diluted share	$2.53	$1.85	Up 36.8%
Net cash from operating activities	$735.5 million	$696.7 million	Up 5.6%
Total assets	$35.340 billion	$33.631 billion	Up 5.1%
Shareholders’ equity	$5.484 billion	$4.677 billion	Up 17.3%

GAAP net income was reduced by $119.5 million of net non-operating losses, including $31.1 million of net realized investment losses, a $79.1 million unfavorable change in fixed-index annuity embedded derivative liabilities, and a $16.3 million unfavorable fair-value change in the agent deferred compensation plan. Net operating income excludes these and other items and is not a GAAP measure.

Product margins: Total insurance product margin increased to $921.5 million from $789.1 million. Annuity margin rose to $296.7 million from $230.1 million; health margin rose to $459.8 million from $362.9 million; and life margin declined to $165.0 million from $196.1 million. Income from insurance products increased to $363.8 million from $246.1 million.

Premium collections: Total collected premiums declined to $3.696 billion from $3.826 billion. Annuity collections declined 10.8% to $1.165 billion; health collections declined 1.0% to $1.692 billion; and life collections increased 3.5% to $839.6 million. Fixed-index annuities represented $1.122 billion of collections.

Margins and COVID-19 effects: Management estimated that COVID-19 favorably affected 2020 health margins by approximately $97 million, primarily because policyholders deferred medical care. Life margin included approximately $38 million of adverse COVID-19 mortality impact. Management expects deferred care effects to normalize and could lead to higher future claims.

Liquidity, capital and debt

• Unrestricted cash and cash equivalents held by CNO, CDOC and other non-insurance subsidiaries totaled $388.1 million at December 31, 2020. Consolidated unrestricted cash was $937.8 million.
• Free cash flow at the holding company was $387 million in 2020. Management expects cash flows and existing liquidity to support debt service, corporate expenses and other obligations, but future liquidity depends materially on subsidiary dividends and regulatory approvals.
• Direct corporate debt had a principal amount of $1.150 billion: $500 million of 5.250% senior notes due 2025, $500 million of 5.250% senior notes due 2029 and $150 million of 5.125% subordinated debentures due 2060. Carrying value was $1.136 billion.
• Approximately $61 million of cash was expected to be required for 2021 debt service. The $250 million revolving credit facility had no outstanding balance at year-end and matures October 13, 2022.
• Debt-to-total-capital was 17.2%; the revolving-credit covenant ratio was 26.4% against a maximum of 35.0%. Estimated consolidated statutory RBC was 411%, compared with 408% in 2019 and a 250% minimum under the revolving credit agreement.
• Insurance subsidiaries paid $294.1 million of dividends to CDOC in 2020. Such payments require regulatory approval because of negative earned surplus at immediate insurance subsidiaries and may be restricted in the future.
• CNO repurchased 14.5 million shares for $263.0 million and declared $67.4 million of common dividends, or $0.47 per share. Repurchase authority remaining at year-end was $269.3 million.

Material changes versus prior periods

• The 2020 operating model consolidated the prior distribution-based segments into product-line reporting and centralized marketing, finance, training and recruiting functions.
• Operating earnings improved despite lower reported revenue, primarily from favorable health claims experience, actuarial assumption changes, and higher annuity and health margins.
• The second-quarter 2020 actuarial unlocking produced a $45.6 million unfavorable impact from lower assumed future new-money rates, offset by a $91.5 million favorable impact from lower assumed future fixed-index option costs. Fourth-quarter assumption updates favorably affected annuity margin by $16.1 million and unfavorably affected life margin by $4.3 million.
• Worksite life and health sales declined 43% in 2020, while Consumer Division health sales declined 16%. Consumer life sales increased 19%. Overall health and life sales, measured by new annualized premiums, declined 6%.
• Shareholders’ equity increased substantially, principally due to $813.6 million of after-tax other comprehensive income from unrealized investment gains, partly offset by repurchases and dividends.
• In November 2020, CNO issued the $150 million subordinated debentures for general corporate purposes.
• In February 2021, after year-end, CNO acquired DirectPath for approximately $50 million plus a potential earn-out, funded with holding-company cash.

Guidance, outlook, risks and unusual items

Management did not provide a specific earnings or revenue outlook in the filing. It modeled two hypothetical COVID-19 scenarios for 2021: one assuming sufficient vaccine effectiveness and approximately 360,000 additional U.S. COVID-19 deaths, and another assuming insufficient vaccine effectiveness, approximately 500,000 additional deaths and recessionary conditions. Management stated that even under the more adverse scenario it expected to maintain target RBC levels, debt ratios, minimum holding-company liquidity, the quarterly dividend and modest share-repurchase capacity; these scenarios are not forecasts.

• Interest-rate and spread risk: Low rates can reduce investment yields and spreads, while approximately 60% of fixed-interest annuity and universal-life products with guaranteed minimum rates were already credited at their minimum rates. Further spread compression could reduce profitability.
• Investment risk: Investments totaled $27.584 billion, including $23.384 billion of available-for-sale fixed maturities. Approximately 90% of invested assets were fixed maturities and mortgage loans. Below-investment-grade fixed maturities represented 10% of the amortized-cost fixed-maturity portfolio; consolidated VIE investments were primarily below-investment-grade bank loans.
• Insurance and reserve risk: Insurance product liabilities totaled $25.1 billion. Mortality, morbidity, lapse, surrender, persistency, claims and investment-yield assumptions could require reserve increases or additional amortization of acquisition costs.
• Long-term care: Net long-term-care reserves were $2.601 billion. Rate increases require regulatory approval, and insufficient approvals could result in premium deficiency reserves or write-offs of insurance acquisition costs.
• Reinsurance risk: Reinsurance receivables were $4.584 billion, concentrated among major reinsurers. CNO remains liable to policyholders if reinsurers fail to perform.
• Litigation and regulatory matters: The filing describes ongoing litigation involving Wilmington Trust, KPMG and Platinum-related reinsurance arrangements, as well as unclaimed-property examinations. Management did not believe currently known matters were probable of having a material consolidated effect, but stated outcomes are uncertain. The Global Resolution Agreement liability increased by $23.5 million in 2020.
• Accounting and valuation: The fair value of fixed-index annuity embedded derivatives was $1.645 billion and depended on significant unobservable assumptions. The long-duration insurance contract accounting standard is effective for CNO January 1, 2023, and its impact had not been determined.

Investor verification checklist

• Reconcile GAAP net income of $301.8 million with non-GAAP net operating income of $362.3 million and assess the recurring nature of excluded items.
• Test whether the approximately $97 million favorable COVID-related health-margin effect reverses as deferred care normalizes.
• Monitor mortality, morbidity, persistency, surrender rates and reserve adequacy, particularly for long-term-care and life products.
• Review investment credit migration, unrealized gains, realized losses, structured securities, VIE loans and future allowance-for-credit-loss changes.
• Confirm continued regulatory approval and availability of subsidiary dividends needed for holding-company liquidity and debt service.
• Evaluate refinancing requirements for the $500 million of senior notes due in 2025 and compliance with debt covenants.
• Assess sensitivity to low interest rates, embedded-derivative assumptions and the pending 2023 long-duration contract accounting adoption.
• Review the outcome and potential exposure from the pending litigation, Global Resolution Agreement and other regulatory examinations.