CNO Financial Group, Inc. — 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 and Colonial Penn. 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, 2014, compared with the corresponding 2013 periods.
Key financial metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Total revenues | $967.0 million | $1,093.8 million | $3,144.7 million | $3,317.9 million |
| Income before taxes | $154.4 million | $114.4 million | $99.2 million | $263.7 million |
| Net income (loss) | $117.4 million | $283.0 million | $(32.5) million | $372.0 million |
| Diluted EPS | $0.54 | $1.23 | $(0.15) | $1.59 |
| Pre-tax operating earnings | $119.8 million | $107.1 million | $308.7 million | $276.6 million |
Calculated net margin was approximately 12.1% in Q3 2014 versus 25.9% in Q3 2013, and approximately negative 1.0% for the first nine months of 2014 versus 11.2% in the prior-year period. The nine-month loss primarily reflects the CLIC disposal.
- Q3 operating earnings increased 11.9%; nine-month operating earnings increased 11.6%. Bankers Life drove the improvement, with operating earnings of $111.8 million in Q3 and $283.4 million for nine months.
- Washington National operating earnings declined to $27.6 million in Q3 and $91.0 million for nine months, while Colonial Penn improved to $0.4 million in Q3 but remained at a $2.0 million nine-month operating loss.
- Cash flow from operating activities was $(123.9) million for the first nine months of 2014 versus $472.1 million in 2013. The 2014 outflow included a $590.3 million payment to a reinsurer related to long-term-care business.
- Net cash provided by investing activities was $46.5 million, including $232.9 million of proceeds from the CLIC sale. Net cash used in financing activities was $169.5 million. Unrestricted cash ended at $452.1 million versus $699.0 million at December 31, 2013.
- Total assets were $31.0 billion and shareholders’ equity was $4.7 billion at September 30, 2014. Book value per common share was $22.74, compared with $22.49 at year-end 2013.
- Corporate notes payable totaled $814.0 million; investment borrowings totaled $1.5 billion; and borrowings related to variable-interest entities totaled $1.3 billion. The $275.0 million 6.375% senior secured notes mature in 2020.
- Debt-to-total-capital was 14.7% on a GAAP basis and 17.4% excluding accumulated other comprehensive income. The senior-credit-agreement debt-to-capital ratio was 17.6%, below the 27.5% covenant limit, and interest coverage was 16.62x versus a 2.50x minimum.
Material changes versus the prior comparable period
- On July 1, 2014, CNO completed the sale of Conseco Life Insurance Company to Wilton Re. Expected net cash proceeds were approximately $222 million. CNO recognized a nine-month after-tax loss of approximately $292 million, including an estimated $298 million loss in the first quarter and a $6 million reduction in the third quarter. The final sales price and net proceeds remained subject to adjustment.
- Bankers Life recaptured a block of life insurance business from Wilton Re for $28 million and recognized a $16.9 million after-tax gain in Q3. The transaction added approximately $3 million of pre-tax Bankers Life earnings in the quarter.
- CLIC-related revenue and expenses ceased after the sale, and the company revised its segment presentation. Overhead formerly allocated to CLIC was reallocated primarily to Bankers Life and Washington National.
- CNO repurchased 14.1 million common shares for $244.1 million and all outstanding warrants for $57.4 million during the first nine months. Remaining repurchase authority was $95.9 million. Management anticipated total 2014 securities repurchases of $350 million to $400 million, subject to conditions.
- The quarterly common dividend increased from $0.03 to $0.06 per share in March 2014. Dividends paid during the first nine months totaled $39.0 million, or $0.18 per share.
- Net realized investment gains increased to $39.8 million from $18.4 million. The 2014 total included $14.7 million of investment impairment losses, principally involving a commercial mortgage loan and two legacy private-company investments.
- Accumulated other comprehensive income increased to $859.3 million from $731.8 million, while the fixed-maturity portfolio declined to $20.6 billion from $23.2 billion, primarily reflecting the CLIC sale and portfolio changes.
Guidance, outlook, commentary and risks
- Management expected Colonial Penn to report approximately break-even 2014 results before realized investment gains and income taxes.
- Management expected fourth-quarter 2014 benefit ratios of approximately 70% for Washington National Medicare supplement, an interest-adjusted ratio near 79% for Bankers Life long-term care, and an interest-adjusted ratio near 54% for Washington National supplemental health.
- Management expected the consolidated statutory risk-based capital ratio to be approximately 415% at December 31, 2014, versus an estimated 425% at September 30, 2014. Combined statutory capital and surplus was $1.806 billion.
- Low interest rates could reduce investment income, insurance margins and product demand. A 50-basis-point reduction in new-money rates was estimated to reduce pre-tax investment income by approximately $7 million in the first year, with a larger cumulative effect if sustained.
- Insurance results remain sensitive to mortality, morbidity, claims utilization, persistency, reserve assumptions, health-insurance rate approvals and the ability to manage long-term-care liabilities.
- Deferred tax asset realization depends on future taxable income. Net deferred tax assets were $769.2 million after a $280.0 million valuation allowance. Additional valuation allowances could reduce earnings and equity.
- The company reported $3.1 billion of federal NOLs, subject to IRS challenges and potential Section 382 ownership-change limitations. The IRS dispute concerning the treatment of a historical $878 million CSHI loss remains material.
- Holding-company liquidity depends on dividends, surplus-debenture interest and other payments from regulated insurance subsidiaries. Extraordinary dividends generally require regulatory approval; CNO reported $143.4 million of unrestricted holding-company cash and cash equivalents at September 30, 2014.
- Legal, regulatory and unclaimed-property examinations remain possible sources of additional costs. Management did not believe pending matters were probable of having a material effect, but stated that adverse outcomes could be material.
Most important facts for an investor to verify
- Final consideration, proceeds and ultimate accounting loss from the CLIC sale.
- Whether the $590.3 million long-term-care reinsurance payment and related reserve arrangements produce further cash or earnings effects.
- Sustainability of Bankers Life operating improvement after favorable reserve development and mortality-related items.
- Future long-term-care claims, reserve adequacy, premium-rate approvals and investment-yield assumptions.
- Realization of deferred tax assets and the outcome of the IRS position on the CSHI loss.
- Availability of regulated-subsidiary dividends and compliance with debt, risk-based-capital and restricted-payment covenants.
- Credit quality, impairment exposure and liquidity of the fixed-maturity, structured-security and below-investment-grade portfolios.
- Actual 2014 share repurchases, dividend capacity and the effect of repurchases on capital and NOL utilization.