CNO Financial Group, Inc. quarterly report, Q1 FY2015

CNO Financial Group, Inc. — 2015 Q1 Form 10-Q Summary

Business context and reporting period

CNO Financial Group is a U.S. insurance holding company serving middle-income pre-retiree and retired customers 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.

The filing reports unaudited results for the three months ended March 31, 2015, compared with the three months ended March 31, 2014. The filing was dated May 5, 2015.

Key financial metrics

Metric	Q1 2015	Q1 2014
Total revenues	$978.3 million	$1,084.7 million
Income before income taxes	$82.3 million	$(169.6) million
Net income (loss)	$52.8 million	$(228.0) million
Diluted EPS	$0.26	$(1.03)
Net operating income	$60.1 million	$59.9 million
Pre-tax operating earnings	$93.0 million	$92.0 million
Net cash from operating activities	$122.5 million	$(480.3) million

Net income margin was approximately 5.4% of revenue; the filing does not present a consolidated operating margin.
Total assets were $31.6 billion at March 31, 2015, versus $31.2 billion at December 31, 2014.
Shareholders’ equity was $4.75 billion, including $934.2 million of accumulated other comprehensive income.
Unrestricted cash and cash equivalents were $426.9 million, down from $611.6 million at year-end 2014. Holding-company liquidity included $73.7 million of unrestricted cash and cash equivalents, $120.5 million of fixed-income investments and $116.8 million of equity securities.
Direct corporate obligations were $774.8 million, consisting primarily of the senior secured credit agreement and $275.0 million of 6.375% senior secured notes due October 2020. Insurance subsidiary investment borrowings were $1.52 billion, primarily collateralized Federal Home Loan Bank borrowings.
Corporate debt-to-total-capital was 14.0%; the debt-to-total-capital ratio used under the senior secured credit agreement was 17.1%, versus a 27.5% maximum covenant. Interest coverage was 16.53x versus a 2.50x minimum.
Estimated consolidated statutory risk-based capital was 428%, above the company’s stated 350% internal target and the 250% debt covenant requirement.

Material changes versus the prior comparable period

Revenue declined $106.4 million, primarily because the first quarter of 2014 included $106.5 million of revenue from CNO Life Insurance Company, which was sold on July 1, 2014. The 2014 period also included $278.6 million of loss on the sale of that subsidiary.
The company returned to GAAP profitability, with net income of $52.8 million versus a $228.0 million loss in Q1 2014. The improvement principally reflects the absence of the CLIC sale loss and related tax items.
Underlying pre-tax operating earnings increased modestly to $93.0 million from $92.0 million. Net operating income increased to $60.1 million from $59.9 million.
Operating cash flow improved by $602.8 million, largely because Q1 2014 included a $590.3 million payment to a reinsurer relating to the transfer of certain long-term care business.
Net realized investment gains declined to $8.9 million from $23.4 million. Q1 2015 included an $11.3 million gain on dissolution of a variable interest entity, $1.3 million of other-than-temporary impairment losses and net losses on investment sales.
Bankers Life pre-tax operating earnings declined to $82.2 million from $84.2 million, while Washington National declined to $28.5 million from $31.1 million. Colonial Penn’s loss narrowed slightly to $5.9 million from $6.2 million, and corporate operations improved to a loss of $11.8 million from $17.1 million.
Bankers Life premium collections declined 2.6% to $584.2 million, mainly because of lower fixed-interest annuity sales and the runoff of long-term care business. Washington National collections increased 2.6% to $158.7 million, and Colonial Penn collections increased 6.7% to $65.1 million.
Bankers Life’s long-term care benefit ratio increased to 137.8% from 131.9%; its interest-adjusted benefit ratio increased to 83.0% from 81.0%. Washington National’s interest-adjusted supplemental-health benefit ratio increased to 57.6% from 53.0%.
The company repurchased 5.3 million shares for $86.0 million and paid $12.1 million of common dividends during the quarter. Shares outstanding declined to approximately 198.6 million from 203.3 million at December 31, 2014.

Guidance, outlook, commentary, risks and unusual items

Management expected Bankers Life’s Medicare supplement benefit ratio to be in the 70% range for 2015 and its long-term care interest-adjusted benefit ratio to be approximately 84% for 2015.
Management expected Washington National’s full-year supplemental-health interest-adjusted benefit ratio to be approximately 54%, while noting elevated benefit ratios in the second quarter.
Colonial Penn expected slightly positive earnings before realized investment gains and income taxes in 2015, although direct-response advertising costs are largely expensed as incurred.
Management expected approximately $9 million of one-time transition costs related to a Cognizant services agreement, including $4.5 million incurred in Q1 and an additional $4.5 million expected in Q2.
Management anticipated repurchasing approximately $250 million to $325 million of common stock during 2015, subject to business and market conditions and competing uses of capital.
Management expected the consolidated statutory RBC ratio to be approximately 425% at December 31, 2015.
Management stated that existing holding-company cash, operating cash flows and other transactions were expected to be sufficient for debt service and other obligations, but cautioned that liquidity depends on insurance subsidiary dividends, regulatory approvals, financial markets and other factors.
Key risks include sustained low interest rates, investment losses and impairments, long-term care morbidity and reserve assumptions, health claims experience and rate approvals, policyholder persistency and surrenders, reinsurance performance, regulatory restrictions on subsidiary dividends, debt covenant compliance, tax-asset recoverability, litigation and regulatory investigations.
The company had $2.9 billion of federal net operating loss carryforwards and a $246.0 million valuation allowance against deferred tax assets. Management expected to use remaining life NOLs in 2016, absent a favorable IRS position regarding the classification of a historical CSHI investment loss.
The IRS position regarding the CSHI loss remains uncertain; the company had not recognized a $166.0 million potential tax benefit. Future ownership changes could also restrict NOL utilization under Section 382.
Fixed maturities available for sale totaled $21.1 billion at fair value, including $2.6 billion of below-investment-grade securities and $73.3 million of gross unrealized losses. Energy and pipeline securities represented the largest concentration of unrealized losses, and management identified prolonged low oil prices as a potential risk.
Pending legal and regulatory matters include a multi-state examination concerning unclaimed-property laws and use of the Social Security Administration’s Death Master File. The company did not believe probable losses, after existing provisions, would be material, but stated that outcomes remain difficult to predict.

Most important facts for investors to verify

Whether long-term care and supplemental-health claims experience, reserve development and permitted rate increases remain consistent with management’s projections.
Whether low interest rates pressure investment yields, annuity sales, insurance margins, deferred acquisition cost amortization and embedded derivative valuations.
The quality, concentration and impairment risk of the investment portfolio, particularly energy/pipeline, below-investment-grade and structured securities.
Whether insurance subsidiaries continue to generate sufficient statutory capital and obtain required approvals for dividends to the holding company.
Progress on corporate debt repayment, refinancing alternatives, share repurchases and compliance with debt covenants.
The resolution of the IRS dispute involving the CSHI loss and the recoverability of deferred tax assets and NOLs.
Actual transition costs, Colonial Penn profitability and the company’s ability to achieve the stated 2015 segment outlooks.