CNO Financial Group, Inc. — Form 10-Q Summary
Business context and reporting period
CNO Financial Group is a U.S. insurance holding company serving senior and middle-income markets through health insurance, annuity, individual life and related products. Its principal segments are Bankers Life, Washington National, Colonial Penn, Other CNO Business and corporate operations. This unaudited filing covers the three months ended March 31, 2011, compared with the three months ended March 31, 2010. Dollar amounts are in millions unless otherwise stated.
Key financial metrics
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Total revenues | $1,049.2 | $1,002.4 | 4.7% increase |
| Income before income taxes | $83.6 | $53.1 | 57.4% increase |
| Net income | $53.9 | $33.9 | 59.0% increase |
| Basic EPS | $0.21 | $0.14 | Increase |
| Diluted EPS | $0.19 | $0.13 | Increase |
| Net cash provided by operating activities | $155.3 | $181.1 | 14.2% decrease |
| Cash and unrestricted cash equivalents at period-end | $424.6 | $321.1 | 2011 ending balance |
Net margin improved to approximately 5.1% from 3.4%, while pretax margin improved to approximately 8.0% from 5.3%. Management’s non-GAAP net operating income was $51.9 million, or $0.18 per diluted share, compared with $38.2 million, or $0.14 per diluted share.
- Insurance policy income was $667.2, compared with $664.6.
- Net investment income was $373.5, compared with $339.2, driven primarily by higher general-account assets and investment income.
- Net realized investment gains were $5.1, compared with a $4.9 loss in the prior-year quarter.
- Other-than-temporary impairment losses recognized in earnings were $13.3, compared with $20.3.
- Total benefits and expenses were $965.6, compared with $949.3. Amortization increased to $136.7 from $102.6.
- Total assets were $32,067.8 at March 31, 2011, compared with $31,899.6 at December 31, 2010. Shareholders’ equity increased to $4,400.4 from $4,325.3.
Segment performance and material changes
- Bankers Life: EBIT increased to $63.9 from $53.2. Premium collections declined 0.3% to $616.2, while average insurance liabilities increased 5.7% to $12.5 billion. The long-term-care benefit ratio improved slightly to 113.4% from 114.4%, and the interest-adjusted ratio improved to 70.8% from 75.2%. Additional amortization of $23 related to higher-than-expected Medicare supplement lapses.
- Washington National: EBIT declined to $25.2 from $27.6. Premium collections increased 0.9% to $147.1, but average insurance liabilities decreased 3.5% to $2.6 billion. The all-health benefit ratio improved to 76.0% from 77.7%.
- Colonial Penn: EBIT increased slightly to $5.4 from $5.3. Premium collections increased 4.1% to $50.9, primarily from life insurance.
- Other CNO Business: EBIT improved to $7.1 from a $1.9 loss. However, its long-term-care benefit ratio worsened to 235.7% from 187.2%, and its interest-adjusted ratio increased to 148.0% from 96.8%. Management expects premiums from these closed blocks to continue declining, partly offset by rate increases.
- Corporate operations: The pretax loss improved to $23.6 from $27.6, partly due to $6.2 of income from trading activities and company-owned life insurance allocations.
Cash flow, debt and liquidity
- Operating cash flow was positive at $155.3, but lower than $181.1 in Q1 2010. Investing activities used $189.3, primarily because investment purchases exceeded sales and maturities. Financing activities used $113.3.
- Corporate notes payable declined to $949.8 from $998.5 after a $50.0 principal prepayment on the Senior Secured Credit Agreement. The prepayment generated a $1.4 loss on extinguishment of debt.
- Scheduled principal payments on direct corporate obligations total $968.0, including $25.0 during the remainder of 2011, $45.0 in 2012, $80.0 in 2013, $75.0 in 2014, $85.0 in 2015, $383.0 in 2016 and $275.0 in 2018.
- Insurance subsidiaries had $1.2 billion of collateralized Federal Home Loan Bank borrowings backed by investments with an estimated fair value of $1.5 billion.
- Holding companies held $169 of unrestricted cash. Management stated that existing cash, operating cash flow and anticipated insurance-subsidiary dividends should be sufficient for debt service and corporate obligations, while cautioning that regulatory and operating conditions could impair liquidity.
- The consolidated insurance-subsidiary risk-based capital ratio was 341%, compared with a stated internal target of approximately 300%. The Senior Secured Credit Agreement required a minimum ratio of 225% through December 31, 2011 and 250% thereafter.
Guidance, outlook, risks and unusual items
- No formal earnings or revenue guidance is provided in the filing.
- In April 2011, CNO announced that it was seeking to amend its Senior Secured Credit Agreement to reduce the interest rate and provide additional operating flexibility. The facility had a $325 principal balance, an interest rate of LIBOR plus 600 basis points, a 150-basis-point LIBOR floor and a current rate of 7.50%.
- Management expects approximately $37 of additional long-term-care rate increases to be implemented after state approvals; approximately $11 had been approved by March 31, 2011.
- Investment results remain exposed to low interest rates, credit deterioration, unrealized losses, structured securities, below-investment-grade assets and other-than-temporary impairments. The fixed-maturity portfolio had a fair value of $20.9 billion and gross unrealized losses of $282.1.
- Q1 2011 included $13.3 of impairment losses, including $6.4 on a guaranteed investment contract, $3.6 on commercial mortgage loans, $2.8 on investments held by Fall Creek and $0.5 of other losses. The remaining guaranteed investment contract had a book value of $127.4 and a stated maturity of December 31, 2029, although CNO continued to pursue commutation.
- Long-term-care reserves and claims are sensitive to lapse, morbidity, utilization, claim duration, cost of care and interest-rate assumptions. The Other CNO Business long-term-care block generated particularly adverse ratios.
- CNO had a $1.1 billion valuation allowance against deferred tax assets and reported approximately $4.3 billion of federal net operating losses and $1.0 billion of capital loss carryforwards. Future utilization depends on taxable income, IRS positions and ownership-change limitations under Section 382.
- The company faces securities, cost-of-insurance, annuity-sales-practices, long-term-care and other class-action litigation, as well as regulatory examinations. Several matters had settlements in principle or were under appeal; management stated that existing provisions were not expected to result in a material adverse effect, but outcomes remain uncertain.
- Insurance-company financial-strength ratings remained below investment grade: primary subsidiaries were rated B+ by A.M. Best, BB by S&P and Ba1 by Moody’s; Conseco Life was rated B- by A.M. Best. Downgrades could increase policy surrenders, reduce sales and raise borrowing costs.
Most important facts for investors to verify
- Whether the requested amendment to the Senior Secured Credit Agreement was completed and on what terms.
- Actual approval and implementation of the remaining long-term-care rate increases and resulting lapse, reserve and profitability trends.
- Development of Other CNO Business long-term-care claims and adequacy of reserves.
- Performance, impairments and liquidity of the investment portfolio, including the guaranteed investment contract, structured securities and below-investment-grade holdings.
- Availability and timing of future dividends from insurance subsidiaries, including required regulatory approvals and maintenance of RBC ratios.
- Recoverability of deferred tax assets and continued availability of federal NOLs under IRS and Section 382 considerations.
- Potential financial exposure from pending litigation, regulatory proceedings and settlements.
- Reconciliation of management’s non-GAAP operating measures to GAAP net income and the sustainability of earnings excluding realized investment gains and unusual items.