CNO Financial Group, Inc. — 2018 Q3 Form 10-Q Summary
Business context and reporting period
CNO is a U.S. insurance holding company serving middle-income pre-retirees and retirees through Bankers Life, Washington National, Colonial Penn, long-term care in run-off, and corporate operations. Products include health insurance, annuities, individual life insurance and related services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, compared with the corresponding 2017 periods.
On September 27, 2018, Bankers Life ceded its legacy, pre-2003 comprehensive and nursing-home long-term care policies to Wilton Re under 100% indemnity coinsurance. The ceded block had approximately $2.7 billion of statutory reserves and was moved to the long-term care in-run-off segment for reporting purposes.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Total revenues | $1,481.2 million | $1,079.3 million | $3,535.3 million | $3,207.1 million |
| Income before taxes | $(539.8) million | $129.9 million | $(301.9) million | $355.1 million |
| Net income (loss) | $(529.8) million | $100.8 million | $(343.3) million | $246.5 million |
| Diluted EPS | $(3.22) | $0.59 | $(2.07) | $1.43 |
| Net operating income | $87.5 million | $76.7 million | $243.3 million | $215.1 million |
| Pre-tax operating earnings | $109.0 million | $115.8 million | $308.0 million | $329.8 million |
| Net cash from operating activities | Not provided for the quarter | Not provided for the quarter | $115.0 million | $449.5 million |
Reported revenue included $363.4 million of gains on assets transferred in the reinsurance transaction. These gains were more than offset by a $1,067.6 million pretax loss related to the transaction, producing a $704.2 million net pretax loss after transaction-related investment gains. The after-tax charge was $661.1 million.
- Insurance policy income was $656.9 million in Q3 and $1,976.6 million for the first nine months, compared with $659.3 million and $1,987.2 million, respectively, in 2017.
- Net realized investment gains were $394.6 million in Q3 and $390.4 million for the first nine months, compared with $29.2 million and $52.3 million, respectively, in 2017. The 2018 nine-month amount included the $363.4 million reinsurance-transfer gain and gains from the sale of the company’s interest in Tennenbaum Capital Partners.
- Net operating income increased 14.1% in Q3 and 13.1% for the first nine months, despite lower pre-tax operating earnings, primarily due to lower operating tax expense.
- Total premium collections increased 4.5% to $922.1 million in Q3 and 1.8% to $2,797.8 million for the first nine months. First-year collections increased 9.4% in Q3 and 3.2% year to date.
- Total assets were $31.65 billion at September 30, 2018, compared with $33.11 billion at December 31, 2017. Shareholders’ equity declined to $3.62 billion from $4.85 billion, primarily reflecting the net loss, dividends, share repurchases and a $792.3 million after-tax decline in other comprehensive income.
- Accumulated other comprehensive income declined to $403.5 million from $1,212.1 million, principally due to lower unrealized investment gains.
Segment performance and margins
| Pre-tax operating earnings | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Bankers Life | $94.4 million | $95.3 million | $262.6 million | $268.1 million |
| Washington National | $30.3 million | $27.5 million | $90.0 million | $74.6 million |
| Colonial Penn | $6.1 million | $9.0 million | $10.0 million | $16.7 million |
| Long-term care in run-off | $2.1 million | $10.6 million | $22.6 million | $42.2 million |
| Corporate operations | $(23.9) million | $(26.6) million | $(77.2) million | $(71.8) million |
- Bankers Life premium collections rose 6.5% in Q3 and 2.6% year to date, led by fixed-index annuities. Its Medicare supplement benefit ratio increased to 75.6% from 72.0% in Q3 and to 74.0% from 70.8% year to date.
- Bankers Life long-term care benefit ratios increased to 122.5% in Q3 and 119.4% year to date. The interest-adjusted ratios were 79.0% and 76.4%, respectively.
- Washington National benefited from stronger supplemental-health results. Its supplemental-health interest-adjusted benefit ratio improved to 56.9% in Q3 and 56.0% year to date, compared with 59.0% and 60.0% in the prior-year periods.
- Long-term care in run-off had a 194.1% Q3 benefit ratio and a 179.7% year-to-date benefit ratio; interest-adjusted ratios were 90.4% and 78.2%, respectively.
Debt, liquidity and capital
- Direct corporate obligations were $916.2 million at September 30, 2018, consisting principally of $325 million of 4.5% senior notes due 2020, $500 million of 5.25% senior notes due 2025 and $100 million drawn on the revolving facility.
- Investment borrowings were $1.65 billion, borrowings related to variable-interest entities were $1.42 billion, and total liabilities were $28.03 billion.
- Unrestricted cash was $539.2 million; cash including amounts held by variable-interest entities was $595.6 million, down from $871.8 million at September 30, 2017.
- Holding companies held $145.6 million of unrestricted cash and cash equivalents plus $20.3 million of fixed-income investments. Management expects to maintain at least $150 million of holding-company liquidity.
- The consolidated statutory risk-based capital ratio was approximately 450%, within management’s target range of 425% to 450%. The debt-to-total-capital ratio under the revolving credit agreement was 22.6%, versus a maximum covenant of 35%.
- The company paid $48.6 million of common dividends and repurchased $60.5 million of stock during the first nine months. Remaining repurchase authorization was $325.1 million.
Material changes, outlook and risks
- The Wilton Re transaction materially reduced exposure to the legacy long-term care block but caused a substantial one-time loss, an $825 million ceding commission, a $265 million capital contribution to the insurance subsidiaries and significant cash and asset transfers.
- Beginning in Q4 2018, management expects the long-term care in-run-off segment to contain only the block recaptured in 2016 and to produce normalized earnings before realized investment gains of approximately breakeven over the long term, although quarterly results may remain volatile.
- Management expected the Q4 2018 Bankers Life Medicare supplement benefit ratio to range from 71% to 74%, the Bankers Life long-term care interest-adjusted benefit ratio to range from 74% to 79%, and the Washington National supplemental-health interest-adjusted benefit ratio to range from 56% to 59%.
- Management expected Colonial Penn 2018 earnings before realized investment gains and income taxes to range from $12 million to $18 million.
- The company recorded a $104.8 million increase in the deferred-tax valuation allowance related to the reinsurance transaction. Net deferred tax assets were $559.9 million after a $193.9 million valuation allowance. Future taxable income assumptions and NOL utilization are significant uncertainties.
- Key risks include interest-rate and investment-market volatility, insurance mortality and morbidity experience, long-term-care claims and rate approvals, reinsurer counterparty performance, regulatory limits on dividends, litigation and regulatory actions, tax-asset recoverability, debt covenant compliance and holding-company liquidity.
- The company reported $231.5 million of unfunded commitments to limited partnerships and hedge funds. Its consolidated fixed-maturity portfolio had $252.9 million of gross unrealized losses and included $2.42 billion of below-investment-grade securities at fair value.
Most important facts for investors to verify
- Reconcile the reported $529.8 million Q3 net loss and $343.3 million nine-month net loss to operating earnings, realized investment gains, the $704.2 million pretax reinsurance loss and tax valuation allowance changes.
- Assess whether the Wilton Re transaction achieves the intended reduction in long-term-care risk and how much residual exposure remains, including reinsurer credit and collateral arrangements.
- Monitor Medicare supplement and long-term-care benefit ratios, premium-rate approvals, claims trends and the company’s stated Q4 2018 ranges.
- Evaluate liquidity after the $825 million ceding commission, the $265 million capital contribution and reduced operating cash flow, including the 2020 corporate debt maturity.
- Review the sustainability of the approximately 450% statutory RBC ratio, future dividend capacity from insurance subsidiaries and the effect of the new NAIC capital formulas.
- Track deferred-tax-asset realization, the $193.9 million valuation allowance and the ability to use approximately $3.3 billion of federal NOLs.
- Review investment portfolio credit quality, unrealized losses, below-investment-grade exposure, structured securities and potential future impairment losses.