CNO Financial Group, Inc. quarterly report, Q2 FY2012

CNO Financial Group, Inc. — 2012 Q2 Form 10-Q Summary

Business context and reporting period

Unaudited results for the three and six months ended June 30, 2012, compared with the corresponding 2011 periods. CNO is an insurance holding company serving senior and middle-income markets through Bankers Life, Washington National, Colonial Penn and legacy Other CNO Business operations. Products include health insurance, annuities, individual life insurance and related products.

Financial performance and position

Metric	Q2 2012	Q2 2011	Six months 2012	Six months 2011
Total revenues	$1,065.0 million	$1,032.0 million	$2,188.9 million	$2,081.2 million
Income before taxes	$104.5 million	$71.8 million	$196.8 million	$142.2 million
Net income	$65.7 million	$46.4 million	$124.8 million	$91.8 million
Diluted EPS	$0.24	$0.16	$0.45	$0.32
Net operating income	$54.2 million	$44.5 million	$94.8 million	$87.7 million
Net cash from operations	Not separately presented for the quarter	Not separately presented for the quarter	$239.0 million	$360.8 million

Net income margins were approximately 6.2% in Q2 2012 and 5.7% for the first six months. Reported earnings benefited from net realized investment gains of $31.9 million in Q2 and $54.8 million year to date, compared with $2.9 million and $8.0 million, respectively, in 2011. The six-month effective tax rate was 36.6%, versus 35.4% in 2011.

Segment EBIT before investment gains, embedded-derivative changes and debt extinguishment: $86.3 million in Q2 and $149.9 million year to date, compared with $68.3 million and $134.0 million in the comparable 2011 periods.
Bankers Life: EBIT of $76.1 million in Q2 and $146.6 million year to date. Q2 premium collections declined 11% to $576.2 million, primarily due to lower annuity collections, while life collections increased.
Washington National: EBIT of $33.9 million in Q2 and $58.6 million year to date, aided by higher investment income and improved supplemental-health results.
Colonial Penn: EBIT of $0.6 million in Q2 and a year-to-date loss of $9.2 million, reflecting marketing investment and the accounting treatment of non-deferrable direct-response advertising costs.
Other CNO Business: EBIT of $1.9 million in Q2 and a year-to-date loss of $0.4 million, including the impact of a tentative litigation settlement charge recorded in the first quarter.

At June 30, 2012, total assets were $33.4 billion, total investments were $27.5 billion, unrestricted cash and equivalents were $190.2 million, and shareholders’ equity was $4.9 billion. Accumulated other comprehensive income increased to $990.8 million, primarily reflecting unrealized investment appreciation.

Direct corporate obligations totaled $778.2 million, including $293.0 million of 7.0% convertible debentures, $223.8 million under the senior secured credit agreement and $275.0 million of 9.0% senior secured notes. Investment borrowings totaled $1.7 billion, primarily collateralized Federal Home Loan Bank borrowings, and variable-interest-entity borrowings totaled $766.7 million.

Corporate debt to total capital was 13.7%; the credit-agreement debt-to-total-capitalization ratio was 15.7%, interest coverage was 5.24 times, and the insurance subsidiaries’ consolidated risk-based-capital ratio was 369%. Management stated that all debt covenants were satisfied at quarter-end.

Material changes versus the prior comparable period

Net income increased 42% in Q2 and 36% for the first six months, supported by higher operating income and substantially greater realized investment gains.
Operating cash flow declined to $239.0 million from $360.8 million, primarily reflecting higher insurance policy benefits and other operating cash uses.
Cash and equivalents declined by $245.8 million in the first six months to $190.2 million, after $459.5 million of investing cash outflows and $25.3 million of financing cash outflows.
Net realized investment gains increased to $54.8 million from $8.0 million. Other-than-temporary impairment losses declined to $11.4 million from $23.4 million.
The company adopted ASU 2010-26 retrospectively. Deferred acquisition costs at June 30, 2012 were reduced by $738.8 million, and reported shareholders’ equity was reduced by $493.2 million relative to amounts before adoption. The adoption changed the timing and presentation of GAAP earnings but had no impact on cash flows, statutory results or ultimate profitability.
The company repurchased 8.1 million shares for $58.2 million in the first six months and initiated a $0.02-per-share quarterly dividend, totaling $4.7 million in the second quarter.

Guidance, outlook, commentary and risks

Management anticipated total 2012 dividends from insurance subsidiaries to the holding company of approximately $200 million to $275 million, including $103.0 million paid through June 30, subject to regulatory approval.
Management expected approximately $150 million to $170 million of 2012 share repurchases, with $58.2 million completed through June 30 and $172.1 million of remaining authorization.
Management expected approximately $35 million of long-term-care rate increases after all state approvals; approximately $32 million had been approved by June 30.
Colonial Penn expected approximately break-even results for the remainder of 2012 under its then-current advertising plan.
A hypothetical prolonged low-interest-rate scenario was estimated to produce a pretax charge of $75 million to $100 million, unfavorable investment-income effects of approximately $8 million to $15 million in 2013 and $23 million to $30 million in 2014, and a potential reduction of approximately 10 percentage points in the statutory RBC ratio.
Key risks include sustained low interest rates, investment impairments and unrealized losses, mortality and morbidity experience, long-term-care reserve adequacy, policy lapses and surrenders, regulatory approval of rate increases and dividends, insurance-company financial-strength ratings, litigation, tax-asset recoverability and debt-covenant compliance.
Pending litigation includes cost-of-insurance and long-term-care matters. A tentative settlement of the Conseco Life cost-of-insurance litigation resulted in an approximately $20 million pretax charge in Q1 2012; final court approval remained outstanding. A separate regulatory settlement involving Bankers Life resulted in an approximately $10 million pretax charge in Q1 2012.
The company carries significant below-investment-grade and structured investments. Below-investment-grade fixed maturities had a fair value of $2.5 billion, or approximately 11% of the fixed-maturity portfolio, at June 30, 2012.

Most important facts for an investor to verify

Whether operating cash flow continues to cover holding-company debt service, dividends, share repurchases and required capital contributions.
The sustainability of earnings excluding realized investment gains and fair-value changes in embedded derivatives.
Long-term-care claims development, reserve deficiencies and the timing and amount of regulatory rate approvals.
The outcome and ultimate cost of pending cost-of-insurance, long-term-care and other regulatory proceedings.
The effect of prolonged low interest rates on investment spreads, deferred acquisition costs, policy reserves and RBC ratios.
The recoverability of approximately $702.0 million of net deferred tax assets, including the impact of IRS challenges and potential ownership changes under Section 382.
Future investment impairments, credit losses and valuation changes in structured securities, below-investment-grade holdings and variable-interest-entity portfolios.
Regulatory approval and actual receipt of anticipated subsidiary dividends, as well as the company’s insurance financial-strength ratings.