CNO Financial Group, Inc. annual report, FY2018

CNO Financial Group, Inc. 2018 Form 10-K Summary

Business context and reporting period

CNO Financial Group is a U.S. insurance holding company serving middle-income pre-retirees and retirees through Bankers Life, Washington National, Colonial Penn and a long-term-care-in-run-off segment. Products include health insurance, annuities and individual life insurance, distributed through career agents, independent producers and direct marketing.

The filing covers the fiscal year ended December 31, 2018. Although the request references 2018 Q4, the filing is an annual Form 10-K; fourth-quarter results are separately disclosed in unaudited quarterly data.

Financial results and key metrics

Metric	2018	2017
Total revenues	$4.314 billion	$4.297 billion
Net income (loss)	$(315.0) million	$175.6 million
Diluted EPS	$(1.90)	$1.02
Net operating income	$303.1 million	$300.9 million
Pre-tax operating earnings	$381.2 million	$454.7 million
Net cash from operating activities	$317.8 million	$633.3 million
Total assets	$31.440 billion	$33.110 billion
Shareholders’ equity	$3.371 billion	$4.848 billion
Corporate notes payable	$916.8 million	$914.6 million

Collected premiums increased 2.6% to $3.785 billion. Annuity collections rose 12.9% to $1.165 billion, while health collections declined 2.6% to $1.826 billion and life collections increased 1.6% to $794.8 million.
Net investment income declined to $1.306 billion from $1.551 billion, primarily reflecting lower income from policyholder and special-purpose portfolios and unfavorable fixed-index option valuation changes.
Net realized investment gains were $352.1 million, including a $363.4 million gain on assets transferred in the long-term-care reinsurance transaction. Excluding that transfer gain, the company recorded net realized investment losses before the transaction gain.
Insurance liabilities totaled $23.5 billion. The fixed-maturity portfolio was $18.448 billion, with 87% classified as investment grade based on estimated fair value.
Operating cash flow was $317.8 million, including a $365.0 million cash payment to the reinsurer. Investing cash flow was $(525.7) million, and financing cash flow was $107.2 million.
The company declared $65.1 million of common dividends, or $0.39 per share, and repurchased $100.9 million of common stock.

Fourth-quarter 2018 results

Fourth-quarter revenue was $778.2 million, compared with $1.090 billion in fourth-quarter 2017.
Fourth-quarter income before taxes was $37.1 million and net income was $28.3 million, or $0.17 diluted EPS.
The third quarter contained the principal impact of the long-term-care transaction, including a $529.8 million quarterly net loss. The fourth quarter returned to profitability, but quarterly results remain sensitive to investment markets and actuarial assumptions.

Material changes versus the prior comparable period

CNO completed a September 27, 2018 100% indemnity coinsurance transaction with Wilton Re covering legacy, pre-2003 comprehensive and nursing-home long-term-care policies with statutory reserves of approximately $2.7 billion.
The transaction required an $825 million ceding commission and produced a pre-tax loss of $704.2 million, or a $661.1 million after-tax charge. It materially increased reinsurance receivables and reduced retained long-term-care exposure.
Long-term-care reserves, net of reinsurance receivables, fell to $2.459 billion from $5.648 billion. The company expects the run-off segment to produce approximately breakeven normalized earnings over the long term, although quarterly volatility may continue.
Pre-tax operating earnings declined 16.2% to $381.2 million. Bankers Life earnings declined to $340.6 million, while Washington National increased to $121.9 million; Colonial Penn declined to $14.8 million.
Shareholders’ equity declined by $1.477 billion, primarily due to the net loss, a $1.018 billion after-tax decline in accumulated other comprehensive income and share repurchases.
Book value per common share declined to $20.78 from $29.05; book value excluding accumulated other comprehensive income declined to $19.69 from $21.79.
Bankers Life’s long-term-care benefit ratio increased to 119.0% from 116.2%; the run-off segment’s ratio increased to 182.8% from 163.6%. Washington National’s supplemental-health benefit ratio improved to 79.5% from 83.2%.

Guidance, outlook, commentary and unusual items

Management targets long-term growth through new products, technology investment, expanded investment-advisory capabilities, and reaching somewhat younger and wealthier middle-market consumers.
Management expects 2019 Colonial Penn earnings before investment gains or losses and taxes of $12 million to $20 million, with a first-quarter loss of $1 million to $3 million due to seasonal advertising spending.
Management expects 2019 Bankers Life Medicare supplement benefit ratios of 73% to 77% and interest-adjusted long-term-care benefit ratios of 74% to 79%. Washington National expects a 2019 supplemental-health interest-adjusted benefit ratio of 55% to 58%.
Free cash flow before statutory capital required to support growth is expected to be $300 million to $350 million annually. Management stated that it intends to deploy free cash flow among business investment, acquisitions, dividends and share repurchases.
Holding-company liquidity was $200.4 million of unrestricted cash and cash equivalents plus $20.0 million of fixed-income investments. Management expects to maintain at least $150 million of holding-company liquidity.
Direct corporate debt totaled $925.0 million of principal, including $100.0 million drawn under a $250.0 million revolving facility, $325.0 million of 2020 notes and $500.0 million of 2025 notes. The company expects approximately $145 million of 2019 cash debt service based on year-end terms.
The estimated consolidated statutory RBC ratio was 393%, above the 250% debt-covenant minimum, but below management’s long-term target range of 400% to 425%.
Interest-rate risk remains significant. A 10-basis-point permanent reduction in assumed spreads on interest-sensitive products was estimated to produce an approximately $52 million pre-tax charge; a 200-basis-point permanent decline in new-money rates was estimated to produce an approximately $50 million charge for certain reserves and reduce future non-interest-sensitive margins by $551 million.
Major risks include long-term-care morbidity and persistency, the ability to obtain regulatory rate increases, low interest rates, investment losses, policy surrenders, reinsurer credit risk, regulatory and litigation exposure, cybersecurity and the availability of dividends from regulated insurance subsidiaries.
The company recorded a $104.6 million increase in its deferred-tax-asset valuation allowance during 2018. Net deferred tax assets were $604.7 million, supported by projections of future taxable income.

Most important facts for an investor to verify

Verify the final economics, collateral and ongoing obligations of the Wilton Re long-term-care transaction, including the $825 million ceding commission and approximately $2.8 billion of related policy liabilities at year-end.
Assess whether retained long-term-care benefit ratios, morbidity, mortality and persistency assumptions support reported reserves and projected margins.
Reconcile GAAP net loss with management’s non-GAAP net operating income and determine how much recurring earnings depend on investment spreads and assumption updates.
Review 2020 debt refinancing or repayment plans, revolving-credit maturity provisions and compliance with debt, RBC and minimum-net-worth covenants.
Evaluate holding-company liquidity and the regulatory approval required for future insurance-subsidiary dividends and surplus-debenture interest payments.
Assess the recoverability of the $604.7 million net deferred tax asset and the potential effect of Section 382 ownership restrictions on approximately $3.3 billion of federal NOLs.
Review pending litigation and regulatory matters, including the Beechwood Re arbitration, the Platinum-related receiver action and the global unclaimed-property resolution.
Monitor investment-portfolio credit quality, including below-investment-grade securities, structured securities, unrealized losses and consolidated VIE exposures.