CNO Financial Group, Inc. annual report, FY2017

CNO Financial Group, Inc. — 2017 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, long-term care in run-off, and corporate operations. Products include health insurance, annuities, individual life insurance and related financial services, distributed through career agents, independent producers and direct marketing.

The filing covers the fiscal year ended December 31, 2017. Although the request references 2017 Q4, this is an annual Form 10-K; fourth-quarter results are disclosed separately in the filing.

Key financial metrics

Metric	2017	2016
Total revenues	$4,297.2 million	$3,985.1 million
Income before income taxes	$480.5 million	$353.2 million
Net income	$175.6 million	$358.2 million
Diluted EPS	$1.02	$2.01
Net operating income	$300.9 million	$262.5 million
Operating earnings before taxes	$454.7 million	$410.3 million
Net cash from operating activities	$613.1 million	$762.8 million
Total assets	$33.1 billion	$32.0 billion
Shareholders’ equity	$4.85 billion	$4.49 billion
Corporate notes payable	$914.6 million	$912.9 million

Premium collections increased 2.2% to $3.688 billion. Annuity collections rose 6.2% to $1.032 billion, life collections rose 1.8% to $782.0 million, and health collections were broadly stable at $1.875 billion. Net investment income increased 17.1% to $1.551 billion, while net realized investment gains increased to $50.3 million from $8.3 million.

Operating margin, based on net operating income divided by total revenues, was approximately 7.0% in 2017 versus 6.6% in 2016. GAAP net margin declined to approximately 4.1% from 9.0%, primarily because of tax-related charges in 2017 and a favorable tax benefit in 2016.

Operating cash flow declined by $149.7 million, while unrestricted cash and cash equivalents increased to $578.4 million from $478.9 million. The holding companies held $153.0 million of unrestricted cash and cash equivalents, $116.8 million of fixed-income investments and $126.8 million of equity securities.

Material changes versus the prior comparable period

Net operating income increased 14.7%, supported by higher segment earnings, investment income and favorable long-term care experience.
GAAP net income fell 50.9% because 2017 included $304.9 million of income tax expense, including a $172.5 million provisional charge from the Tax Cuts and Jobs Act. 2016 benefited from an IRS settlement and related tax items.
Fourth-quarter 2017 net loss was $70.9 million, or $(0.42) diluted EPS, compared with fourth-quarter 2016 net income of $234.2 million, or $1.34 diluted EPS. The fourth-quarter 2017 loss primarily reflected the $172.5 million Tax Reform Act impact.
Bankers Life adjusted EBIT increased to $418.9 million from $397.9 million. Washington National declined to $98.3 million from $102.9 million. Colonial Penn increased to $22.6 million from $1.7 million, and long-term care in run-off improved to $1.7 million from a $3.9 million loss.
Bankers Life annuity collections grew to $1.031 billion, driven by fixed-index annuities, while its long-term care collections declined to $445.3 million as the legacy block ran off.
Bankers Life’s long-term care benefit ratio improved to 132.3% from 135.0%; its interest-adjusted benefit ratio improved to 71.2% from 76.7%. The filing attributes part of the improvement to reserve releases and other favorable items.
The company repurchased 7.8 million shares for $167.1 million and paid $59.6 million of common dividends. Remaining repurchase authorization was $385.6 million at year-end.
Accumulated other comprehensive income increased to $1.212 billion from $622.4 million, largely due to higher unrealized investment gains and tax-related reclassification effects.

Debt, capital and liquidity

Aggregate corporate indebtedness was $925.0 million, consisting of $325.0 million of 4.50% senior notes due 2020, $500.0 million of 5.25% senior notes due 2025 and $100.0 million drawn under the revolving credit facility.
In October 2017, the revolving facility was increased from $150.0 million to $250.0 million and its maturity was extended, subject to provisions tied to the 2020 notes. The company had approximately $150.0 million of undrawn capacity before other limitations.
2018 corporate debt service was estimated at approximately $45 million. The debt-to-total-capitalization covenant was 35%; the company reported 20.3%. The consolidated insurance-company RBC ratio was estimated at 446%, versus a 250% covenant minimum.
Insurance subsidiaries had $1.6 billion of FHLB borrowings collateralized by investments with an estimated fair value of $1.9 billion.
Management stated that existing holding-company liquidity and expected operating cash flows should be sufficient for debt service and other obligations, while noting that dividends from insurance subsidiaries require regulatory approval and may be restricted.

Guidance, outlook, commentary and unusual items

Management expects approximately $300 million of annual free cash flow and intends to deploy it among profitable growth investments, long-term care risk reduction, dividends and share repurchases.
For 2018, Bankers Life Medicare supplement benefit ratios were expected to be 71%–74%, and its interest-adjusted long-term care benefit ratio was expected to be 75%–80%.
Washington National expected its supplemental health interest-adjusted benefit ratio to be 58%–61% in 2018.
Colonial Penn expected 2018 earnings before realized investment gains and income taxes of $10 million–$20 million, but anticipated a first-quarter loss of $1 million–$3 million due to seasonal advertising expenditures.
Management expected an effective tax rate of approximately 21%–23% beginning in 2018 and estimated future tax expense would decline by approximately $60 million annually, while cash taxes were expected to decline by only approximately $10 million annually.
CNO continues to evaluate transactions to reduce legacy long-term care exposure. A future reinsurance transaction could require a substantial ceding commission and produce a material initial loss, tax-asset valuation allowance increase, and adverse cash-flow impact.
Legacy long-term care remains the principal earnings and reserve risk. The filing reports $5.65 billion of net long-term care reserves and states that unfavorable morbidity, persistency, mortality or interest-rate changes could materially reduce earnings.
The filing identifies interest-rate spread compression, investment losses, policy surrenders, reinsurer credit risk, regulatory limits on rate increases and dividends, litigation, cyber risk, competition, agent retention and debt covenant compliance as significant risks.
The company recorded $22.8 million of investment impairment losses in 2017 and held $2.65 billion of below-investment-grade fixed maturity investments at amortized cost.
The company recorded a $1.4 million favorable net effect from out-of-period adjustments in 2017, which management considered immaterial.
PricewaterhouseCoopers issued an unqualified audit opinion and concluded that internal control over financial reporting was effective as of December 31, 2017.

Most important facts for an investor to verify

Reconcile GAAP net income and fourth-quarter loss with net operating income, the Tax Reform Act charge and other non-operating items.
Assess the sustainability of long-term care reserve assumptions, benefit ratios, rate-increase approvals and the potential cost of any risk-transfer transaction.
Review holding-company liquidity, required insurance-subsidiary dividends, debt maturities, revolving-credit covenants and the 446% RBC ratio after any tax or regulatory changes.
Evaluate investment portfolio exposure, including $27.9 billion of investments, structured securities, below-investment-grade assets and FHLB collateral requirements.
Confirm the realizability of $376.2 million of net deferred tax assets and the continued use of approximately $2.3 billion of federal NOLs, including Section 382 restrictions.
Monitor pending litigation, BRe-related arbitration and litigation, unclaimed-property examinations, guaranty-fund assessments and other regulatory proceedings.
Verify whether the stated $300 million annual free-cash-flow expectation supports planned dividends, repurchases, growth investment and potential long-term care transactions.