CNO Financial Group, Inc. quarterly report, Q3 FY2010

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

Business context and reporting period

CNO Financial Group, formerly Conseco, is a U.S. insurance holding company serving senior and middle-income markets through Bankers Life, Washington National, Colonial Penn, Other CNO Business and corporate operations. Products include health insurance, annuities, individual life insurance and related products sold through career agents, independent producers and direct marketing. The filing covers the three and nine months ended September 30, 2010, with comparative periods ended September 30, 2009. The financial statements are unaudited.

Financial performance and key metrics

Metric	Q3 2010	Q3 2009	9M 2010	9M 2009
Total revenues	$1,052.5 million	$1,118.6 million	$3,008.1 million	$3,283.7 million
Income before taxes	$77.3 million	$64.1 million	$182.2 million	$155.9 million
Net income	$49.4 million	$15.4 million	$116.4 million	$67.5 million
Diluted EPS	$0.17	$0.08	$0.42	$0.36
Net cash from operating activities	Not separately provided	Not separately provided	$524.6 million	$419.2 million

Calculated net margin was approximately 4.7% in Q3 2010 and 3.9% for the first nine months; pretax margin was approximately 7.3% and 6.1%, respectively.
Insurance policy income declined to $674.5 million in Q3 and $2,007.0 million for nine months, from $772.0 million and $2,346.1 million in the comparable periods.
General-account net investment income increased to $326.5 million in Q3 and $962.8 million for nine months, compared with $306.3 million and $923.6 million.
Net realized investment losses improved to $18.0 million for nine months from $43.5 million in 2009. Other-than-temporary impairment losses recognized in earnings were $72.7 million versus $164.3 million.
Operating cash flow increased $105.4 million year over year. Investing activities used $654.0 million, while financing activities provided $154.8 million, resulting in a $25.4 million increase in cash during the first nine months.
Cash and cash equivalents were $548.8 million at September 30, 2010, compared with $523.4 million at December 31, 2009. Holding companies held approximately $190 million of unrestricted cash.
Total assets were $32.0 billion and shareholders’ equity was $4.6 billion at September 30, 2010, compared with $30.3 billion and $3.5 billion at year-end 2009. Accumulated other comprehensive income improved to $688.1 million from a loss of $264.3 million, primarily reflecting investment valuation changes.
Direct corporate notes payable totaled $1.03 billion; investment borrowings totaled $653.9 million; and borrowings related to consolidated variable interest entities totaled $425.0 million.
Corporate debt represented 18% of total capital on a GAAP basis and 21% excluding accumulated other comprehensive income. The ratio of earnings to fixed charges was 1.57x.

Material changes versus the prior comparable period

Net income increased 221% in Q3 and 72% for the first nine months, despite lower reported revenue, primarily because 2009 included substantially higher impairment charges and a $26.7 million deferred-tax valuation allowance charge in Q3.
Bankers Life operating income before realized investment gains and taxes increased to $95.5 million in Q3 and $212.7 million for nine months, from $85.4 million and $193.4 million. However, total premium collections fell 17% in Q3 and 16% for nine months, partly because the company ceased assuming PFFS underwriting risk beginning January 1, 2010.
Washington National operating income declined to $27.2 million in Q3 and $75.9 million for nine months, from $29.1 million and $87.9 million. The decrease reflected lower life insurance activity and reduced insurance liabilities following a 2009 coinsurance transaction with Wilton Re.
Other CNO Business losses before realized investment losses widened to $24.4 million in Q3 and $17.5 million for nine months, compared with $7.5 million and $13.9 million. The third quarter included approximately $13 million of additional amortization related to lower projected investment yields and a $6 million write-off of present value of future profits for a long-term-care block.
Bankers Life’s long-term-care benefit ratio increased to 114.2% in Q3 and 113.9% for nine months, from 108.3% and 105.5%. Its interest-adjusted nine-month ratio increased to 73.5% from 68.5%.
Management changed segment reporting beginning July 1, 2010; prior-period segment information was revised to conform to the new presentation.
The company exchanged or repurchased 3.5% convertible debentures while issuing 7.0% debentures. Direct corporate obligations remained broadly stable, but the debt mix shifted toward the higher-coupon 7.0% debentures.

Guidance, outlook, risks and unusual items

No formal earnings guidance is provided in the filing. Management stated that existing holding-company cash, operating cash flows and other expected transactions were believed sufficient for debt service and corporate needs, while cautioning that liquidity depends on regulatory approvals, insurance subsidiary performance, markets and other factors.
Management expected approximately $22 million to $27 million of additional after-approval financial impact from long-term-care rate increases filed in October 2010. Approximately $9 million of additional rate increases had been approved by September 30, 2010.
Insurance subsidiary dividends are subject to state regulatory approval. The consolidated risk-based capital ratio was 320%, compared with a stated minimum of approximately 300%; future dividend approvals are not assured.
Low interest rates may reduce investment income, product spreads and the recoverability of deferred acquisition costs and present value of future profits. The company recorded significant additional amortization in Other CNO Business due to lower projected investment yields.
The investment portfolio included $21.0 billion of fixed maturities, including $3.8 billion of structured securities and $1.7 billion of below-investment-grade fixed maturities. Gross unrealized losses on fixed maturities were $220.8 million, and future impairment losses remain possible.
Consolidation of variable interest entities added $454.8 million of investments and $425.0 million of borrowings. Most VIE investments were below investment grade, creating credit and valuation exposure.
The company disclosed numerous class-action, insurance-practice and regulatory matters. Management did not expect pending litigation, after existing provisions, to materially affect financial condition, but acknowledged that adverse outcomes could exceed accrued amounts and materially affect results or cash flows.
Conseco Life finalized a regulatory settlement requiring a $10 million fund for certain Lifetrend policyholders and a $1 million assessment; the financial impact had been accrued in 2009.
Disclosure controls and procedures were not effective as of September 30, 2010 because of a material weakness in actuarial reporting controls related to certain Washington National policies. Management expected remediation by year-end 2010 but provided no assurance regarding timing.
Out-of-period adjustments increased Q3 net income by $0.3 million and reduced nine-month net income by $2.9 million; management considered the errors immaterial.

Most important facts for investors to verify

Whether the actuarial reporting material weakness was fully remediated and whether subsequent filings identify any related misstatements.
The adequacy of long-term-care and other insurance reserves, including the effect of rising benefit ratios, rate approvals, lapses and adverse claims development.
The sustainability of investment income and the sensitivity of earnings, deferred acquisition costs and insurance liabilities to prolonged low interest rates.
Future impairment charges and realized losses on structured, below-investment-grade and commercial mortgage investments.
The availability and timing of dividends from regulated insurance subsidiaries, the 320% risk-based capital ratio and compliance with debt covenants.
Required corporate debt payments, including approximately $602.1 million scheduled for 2013 and total direct corporate obligations of approximately $1.05 billion through 2016.
The ultimate cost and resolution of pending litigation, regulatory proceedings and class actions, including matters involving cost-of-insurance, annuity sales practices and Lifetrend policies.