CNO Financial Group, Inc. — 2015 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 and Colonial Penn. Products include health insurance, annuities, individual life insurance and related services, distributed through career agents, independent producers and direct marketing. This filing covers the fiscal year ended December 31, 2015; fourth-quarter data are included in the annual filing.
Conseco Life Insurance Company was sold on July 1, 2014. Accordingly, 2015 results exclude its operations, while certain 2014 comparisons include pre-sale activity.
Key financial metrics
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Total revenues | $3,811.9 million | $4,144.7 million | Down 8.0% |
| Income before income taxes | $367.7 million | $175.1 million | Up 110.0% |
| Net income | $270.7 million | $51.4 million | Up $219.3 million |
| Diluted EPS | $1.39 | $0.24 | Up $1.15 |
| Net operating income | $274.7 million | $276.9 million | Down 0.8% |
| Net cash from operating activities | $743.9 million | $121.8 million | Strong improvement |
| Total assets | $31,125.1 million | $31,155.9 million | Essentially flat |
| Shareholders’ equity | $4,138.5 million | $4,688.2 million | Down 11.7% |
| Corporate notes payable | $911.1 million | $780.3 million | Up $130.8 million |
Management’s reported revenue decreased primarily because 2014 included CLIC activity and the continuing low-rate environment reduced investment income. Net investment income declined to $1,233.6 million from $1,427.4 million. Net realized investment losses were $36.6 million versus gains of $36.7 million in 2014.
Operating earnings before taxes were $422.8 million, compared with $427.4 million in 2014. Net operating income was $1.41 per diluted share versus $1.27. The filing does not provide a single consolidated operating margin; based on reported figures, net income was approximately 7.1% of total revenue and operating income was approximately 7.2% of total revenue.
Segment performance and material changes
- Bankers Life: Premium collections increased 0.4% to $2,491.3 million, while pre-tax operating earnings declined to $369.6 million from $386.9 million. Fixed-index annuity collections rose to $706.6 million, but long-term-care collections fell 4.8% to $476.6 million. Long-term-care benefit ratios deteriorated to 139.2% from 129.7%, and the interest-adjusted ratio increased to 82.8% from 77.2%.
- Washington National: Premium collections increased 2.9% to $649.7 million and operating earnings were broadly stable at $111.5 million. Supplemental-health collections grew 5.7%, but the benefit ratio increased to 84.0% from 80.1%, reflecting unfavorable claims development, including higher cancer-treatment costs. The interest-adjusted benefit ratio was 59.6%.
- Colonial Penn: Premium collections increased 7.3% to $262.9 million. Operating earnings improved to $5.6 million from $0.8 million, driven by growth in direct-marketed life insurance and improved marketing productivity.
- Corporate operations: Operating losses improved to $63.9 million from $71.5 million, but corporate results included a $32.8 million loss on debt extinguishment or modification and $9.0 million of transition expenses.
Total collected premiums from continuing business were $3,403.9 million, compared with $3,358.9 million in 2014. Health collections declined 0.9%, annuity collections increased 2.6%, and life collections increased 5.9%.
Cash flow, liquidity and capital
- Operating cash flow was $743.9 million. Investing activities used $1,069.6 million, primarily reflecting net investment purchases; financing activities provided $146.4 million.
- Unrestricted cash and cash equivalents declined to $432.3 million from $611.6 million. Holding companies and non-insurance subsidiaries held $130.1 million of unrestricted cash and cash equivalents, $127.2 million of fixed-income investments and $124.9 million of equity securities.
- In May 2015, CNO issued $325.0 million of 4.500% senior notes due 2020 and $500.0 million of 5.250% senior notes due 2025, and drew $100.0 million under a $150.0 million revolving credit facility. The refinancing repaid the prior credit facilities and 6.375% secured notes.
- Direct corporate debt service was expected to require approximately $43.6 million in 2016. The company’s debt-to-total-capitalization ratio was 18.0% under GAAP and 19.9% under the revolving credit agreement’s definition. The estimated consolidated insurance-company RBC ratio was 449%, above the 250% covenant requirement.
- Insurance subsidiaries paid $265.7 million of extraordinary dividends to CDOC in 2015. Future dividends require regulatory approval because relevant subsidiaries had negative earned surplus.
- CNO repurchased 20.6 million shares for $365.2 million and paid $52.0 million of common dividends. Remaining repurchase authorization was $455.7 million, and management expected approximately $275 million to $375 million of repurchases in 2016, subject to business conditions and alternatives.
Guidance, outlook, risks and unusual items
- Management expects the Medicare supplement benefit ratio to be approximately 70% to 73% in 2016, the Bankers Life long-term-care interest-adjusted benefit ratio to be approximately 81% to 86%, and the Washington National supplemental-health interest-adjusted ratio to be approximately 56% to 59%.
- Colonial Penn expected 2016 earnings before investment gains and taxes to range from breakeven to $6 million, with an anticipated first-quarter loss of $8 million to $10 million because of seasonal advertising costs and uncertainty regarding television advertising prices.
- CNO’s strategy includes reducing long-term-care exposure by approximately one-half over three to six years through growth in other businesses and possible reinsurance or other transactions.
- Long-term-care profitability remains highly sensitive to morbidity, mortality, persistency, rate approvals and investment yields. The company increased future loss reserves by $38.2 million in 2015; net long-term-care reserves were $4.875 billion.
- Management’s sensitivity analysis estimated a pre-tax charge of approximately $30 million for an immediate and permanent 10-basis-point reduction in spreads on interest-sensitive life and annuity products. A severe long-term-care investment-yield scenario could reduce margins by approximately $400 million and produce an estimated $220 million charge.
- The investment portfolio totaled $24.5 billion, including $19.9 billion of fixed maturities. Approximately 89% of fixed maturities were investment grade, while energy securities had $160.9 million of gross unrealized losses. The company recorded $39.9 million of impairment losses in earnings in 2015.
- Reinsurance exposure is material. Reinsurance receivables totaled $2.9 billion, and the company remains primarily liable to policyholders if reinsurers default. Beechwood Re, which assumed $495 million of long-term-care reserves, is not A.M. Best rated and relies on collateral trusts.
- The company has approximately $2.6 billion of federal NOLs and $946.6 million of net deferred tax assets, supported by a $213.5 million valuation allowance. IRS challenges regarding the classification of a historical $878 million CSHI loss could affect NOL utilization and tax assets.
- Pending litigation, regulatory examinations, rate approvals, low interest rates, market losses, policy surrenders, cyber and operational failures, agent retention and future regulatory changes remain material risks. Management stated that existing litigation was not probable to have a material consolidated effect, but outcomes cannot be predicted with certainty.
Most important facts for investors to verify
- Whether long-term-care claims, persistency and approved rate increases support the company’s reserve assumptions and its plan to reduce exposure.
- Whether low interest rates continue to compress investment spreads and reduce future investment income.
- The liquidity available at the holding company, including regulatory approval for extraordinary dividends and compliance with debt covenants.
- The credit quality, energy exposure, unrealized losses and impairment risk in the investment portfolio.
- The collectability of reinsurance receivables, especially the collateral supporting Beechwood Re obligations.
- The sustainability of earnings excluding tax valuation allowance benefits, investment gains or losses, fair-value changes and other unusual items.
- The impact of IRS proceedings and Section 382 ownership limitations on the $2.6 billion of federal NOLs and related deferred tax assets.