CNO Financial Group, Inc. — 2017 Q2 Form 10-Q Summary
Business context and reporting period
CNO is a holding company for U.S. insurance businesses serving primarily middle-income pre-retirees and retirees. Its principal segments are Bankers Life, Washington National, Colonial Penn, and long-term care in run-off. Products include health insurance, annuities, individual life insurance and related services, distributed through career agents, independent producers and direct marketing.
This unaudited Form 10-Q covers the three and six months ended June 30, 2017, compared primarily with the corresponding 2016 periods. The long-term care in run-off segment includes business recaptured from Beechwood Re effective September 30, 2016.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenues | $1,057.1 million | $1,003.9 million | $2,127.8 million | $1,964.3 million |
| Income before taxes | $128.5 million | $82.7 million | $225.2 million | $123.2 million |
| Net income | $83.4 million | $59.9 million | $145.7 million | $105.4 million |
| Diluted EPS | $0.48 | $0.33 | $0.84 | $0.58 |
| Net operating income | $78.6 million | $63.7 million | $138.4 million | $113.3 million |
| Pre-tax operating earnings | $121.1 million | $99.4 million | $214.0 million | $177.0 million |
| Net cash from operating activities | Not separately provided | Not separately provided | $278.5 million | $339.7 million |
Net income margins were approximately 7.9% in Q2 2017 and 6.8% for the first six months of 2017. Revenue increased approximately 5.3% year over year in Q2 and 8.3% year over year for the first six months. Net income increased approximately 39% and 38%, respectively.
- Insurance policy income was $664.1 million in Q2 and $1,327.9 million for the first six months, versus $653.6 million and $1,298.0 million, respectively, in the comparable periods.
- Net investment income increased to $366.3 million in Q2 and $753.5 million for the first six months, driven partly by higher income from policyholder and special-purpose portfolios and improved fixed-index product results.
- Net realized investment gains were $15.2 million in Q2 and $23.1 million for the first six months, compared with $12.6 million and $11.7 million in 2016. The 2017 six-month amount included $13.5 million of other-than-temporary impairment losses.
- Premium collections increased 7.2% to $925.0 million in Q2 and 6.0% to $1,865.0 million for the first six months. First-year collections increased 16% and 10%, respectively, with Bankers Life annuity collections a significant contributor.
- At June 30, total assets were $32.84 billion, shareholders’ equity was $4.78 billion, and unrestricted cash and cash equivalents were $548.8 million. Accumulated other comprehensive income increased to $894.5 million from $622.4 million at December 31, 2016.
- Direct corporate obligations were $913.9 million, investment borrowings were $1.647 billion, and borrowings related to variable interest entities were $1.533 billion.
- Operating cash flow declined to $278.5 million from $339.7 million. Investing activities used $27.9 million, financing activities used $180.7 million, and unrestricted cash increased $69.9 million to $548.8 million.
Material changes versus the prior comparable period
- Bankers Life pre-tax operating earnings rose to $202.3 million for the first six months from $170.9 million. Its Q2 long-term care interest-adjusted benefit ratio improved to 66.2% from 77.9%, helped by $9.4 million of one-time reserve releases; excluding those releases, the ratio was 74.4% versus 82.1%.
- Washington National pre-tax operating earnings declined to $47.1 million from $47.8 million for the first six months, primarily reflecting lower investment gains and the run-off of Medicare supplement and annuity blocks.
- Colonial Penn improved to $7.7 million of pre-tax operating earnings from a $3.8 million loss. Management attributed the improvement mainly to favorable mortality and lower marketing costs.
- The long-term care in run-off segment contributed $2.1 million of pre-tax operating earnings for the first six months and had an interest-adjusted benefit ratio of 116.6%.
- The company repurchased 5.4 million shares for $111.9 million during the first six months and declared $29.4 million of dividends. The quarterly dividend was increased to $0.09 per share from $0.08.
- Share count declined to 169.0 million shares outstanding at June 30 from 173.8 million at December 31, 2016. Book value per share increased to $28.28 from $25.82, while book value excluding accumulated other comprehensive income increased to $22.98 from $22.24.
- Operating cash flow was lower despite higher net income, primarily reflecting working-capital and insurance-liability cash flow changes, including higher income tax payments.
Guidance, outlook, commentary, risks and unusual items
- Management expected Bankers Life’s Medicare supplement benefit ratio to be 70% to 73% for the remainder of 2017 and its long-term care interest-adjusted benefit ratio to be 75% to 80%, excluding reserve-related effects of rate increases.
- Washington National expected its supplemental health interest-adjusted benefit ratio to be 58% to 61% for the remainder of 2017.
- Colonial Penn expected 2017 earnings before realized investment gains and taxes of $15 million to $20 million.
- Management anticipated repurchasing approximately $200 million to $275 million of common stock during 2017, subject to business and market conditions and competing capital uses.
- The long-term care block in run-off remains loss recognition business and is particularly sensitive to investment-yield assumptions. Management estimated that a 50-basis-point reduction in the ultimate new-money rate could result in a $10 million pre-tax charge.
- The company is pursuing a reduction in long-term care exposure through potential reinsurance transactions. Such a transaction could require a substantial ceding commission, produce an initial loss, increase the deferred-tax valuation allowance and reduce cash available for repurchases.
- CNO recorded a $1.1 million after-tax out-of-period adjustment in Q2 related to long-term care liability calculations, increasing diluted EPS by approximately $0.01. Management considered the adjustment immaterial to prior periods and the consolidated financial statements.
- At June 30, 2017, 95.6% of fixed maturity investments were investment grade by estimated fair value. The portfolio included $2.878 billion of below-investment-grade fixed maturities at amortized cost and $1.5 billion of energy-sector fixed maturities, which remain exposed to downgrades and commodity-price weakness.
- The company had $255.9 million of valuation allowance against deferred tax assets and $2.5 billion of federal NOLs. Failure to generate projected taxable income or an ownership change under Section 382 could reduce NOL utilization and increase future tax expense.
- Liquidity and capital constraints include regulatory approval requirements for insurance-subsidiary dividends, reliance of holding companies on subsidiary cash flows, debt covenants, reinsurer performance and potential policyholder surrenders. The estimated consolidated statutory RBC ratio was 458%.
- Material legal and regulatory matters include disputes with Beechwood Re, an appeal of a Washington National jury verdict involving $4.7 million of compensatory and reduced punitive damages, an IRS examination of 2013–2014 tax years, and a multistate unclaimed-property examination.
- Management stated that there were no material changes to market risks or previously disclosed risk factors. Forward-looking results remain sensitive to interest rates, investment performance, mortality and morbidity, claims experience, rate approvals, reinsurance, litigation and regulatory actions.
Most important facts for investors to verify
- Whether Bankers Life long-term care claims, persistency and reserve releases support the reported improvement in benefit ratios.
- The sustainability of higher investment income and the effect of interest rates, equity markets and fixed-index annuity derivative volatility.
- Future impairment losses, credit migration and realized losses in the investment portfolio, particularly energy, structured securities and below-investment-grade assets.
- The financial and capital impact of any long-term care reinsurance transaction, including ceding commissions and deferred-tax effects.
- Whether insurance subsidiaries can continue paying dividends to the holding companies and whether regulatory approvals remain available.
- Progress and potential liabilities relating to the Beechwood Re proceedings, the Washington National litigation, tax examinations and regulatory inquiries.
- Actual share repurchases, dividend capacity and compliance with debt covenants, including the 30% debt-to-total-capital limit and 250% minimum RBC covenant.