CNO Financial Group, Inc. quarterly report, Q2 FY2020

CNO Financial Group, Inc. — 2020 Q2 Form 10-Q Summary

Reporting period: Quarterly and six-month periods ended June 30, 2020; comparative periods ended June 30, 2019. The unaudited filing covers CNO’s U.S. insurance operations serving middle-income, pre-retiree and retired customers through career agents, independent producers and direct marketing. Products include health, annuity, individual life and long-term care insurance.

Financial performance and condition

Metric	Q2 2020	Q2 2019	Six months 2020	Six months 2019
Total revenues	$1,014.2 million	$979.8 million	$1,731.4 million	$2,002.8 million
Income before taxes	$105.4 million	$47.7 million	$34.4 million	$113.3 million
Net income	$82.0 million	$37.6 million	$60.8 million	$89.4 million
Diluted EPS	$0.57	$0.24	$0.42	$0.56
Net operating income	$79.4 million	$76.4 million	$163.7 million	$142.2 million
Operating earnings before taxes	$102.2 million	$96.7 million	$207.7 million	$180.1 million
Net cash from operating activities	Not separately disclosed	Not separately disclosed	$325.0 million	$317.7 million

Insurance policy income increased to $625.3 million in the quarter and $1,254.0 million year to date. Net investment income declined, particularly in the first half, while realized investment results were a $43.8 million gain in Q2 but a $71.7 million loss year to date. The six-month result included $39.5 million of increased credit-loss and impairment allowances.

Total insurance product margin was $255.4 million in Q2 and $446.1 million year to date, compared with $199.1 million and $388.8 million, respectively, in the prior-year periods. Q2 margin benefited materially from actuarial assumption changes, especially in fixed index annuities. Life margin declined to $36.1 million from $51.7 million in Q2 and to $80.4 million from $94.8 million year to date. Long-term care margin increased to $13.2 million in Q2 and $26.5 million year to date.

At June 30, 2020, total assets were $33.98 billion, shareholders’ equity was $4.73 billion and accumulated other comprehensive income was $1.52 billion. Fixed maturities available for sale were $22.17 billion, including $2.69 billion of gross unrealized gains and $151.3 million of gross unrealized losses. Approximately 96% of the fixed-maturity portfolio by fair value was classified as investment grade.

Debt, liquidity and capital

Direct corporate obligations were $989.7 million, consisting primarily of $500 million of 5.25% senior notes due 2025 and $500 million due 2029.
Investment borrowings were $1.64 billion, primarily collateralized Federal Home Loan Bank borrowings; collateral had an estimated fair value of $2.1 billion.
Borrowings related to consolidated variable-interest entities were $1.15 billion.
No amounts were outstanding under the $250 million revolving credit facility, which matures in October 2022.
Unrestricted cash at the holding companies and other non-insurance subsidiaries was $208.0 million. Free cash flow generated in the first six months was approximately $173 million.
Estimated consolidated statutory risk-based capital was 405%, compared with 408% at December 31, 2019. Corporate debt to total capital was 17.3%; the debt covenant ratio was 23.8% versus a 35% maximum.
The company repurchased 7.1 million shares for $113.0 million during the first six months, resumed repurchases in late June after a mid-March suspension, and had $419.3 million of remaining authorization. Dividends declared were $33.4 million, or $0.23 per share; the quarterly dividend was increased to $0.12 from $0.11.

Material changes versus the prior comparable period

Q2 net income and diluted EPS increased substantially, but six-month net income and EPS declined because of investment losses, credit-loss allowances, lower investment income and the absence of the prior-year tax benefit timing.
Q2 and six-month net operating income increased to $79.4 million and $163.7 million, respectively, reflecting stronger total insurance product margin and lower allocated expenses.
Collected premiums from annuity and interest-sensitive life products fell 25% in Q2 and 15% year to date, primarily due to lower fixed-index annuity collections.
Investment income not allocated to product lines fell to $8.2 million in Q2 and $65.6 million year to date, versus $48.3 million and $91.6 million, respectively, due to lower variable investment income, alternative investment results and prepayment and call income.
The company adopted the current expected credit loss standard on January 1, 2020, reducing opening retained earnings by $17.8 million and increasing credit-loss allowances across investments, mortgage loans, VIE assets and reinsurance receivables.
A new operating model began in 2020, reporting annuity, health, life, long-term care, investment and fee-revenue segments. Prior periods were reclassified.

Outlook, unusual items and risks

Management expects consolidated results in the second half of 2020 to remain challenged, with operating earnings expected to be lower than the prior-year period because of lower investment yields and COVID-19-related claims. No formal earnings guidance is provided in the filing.
COVID-19 reduced Q2 health and life sales by 19% on a new annualized premium basis and annuity premiums collected by 29%. Worksite life and health sales declined 69% and were expected to remain challenged through Q3, with possible improvement during Q4 open-enrollment periods.
Management estimated a $20 million to $52 million adverse impact on full-year 2020 insurance product margin from COVID-19-related claims under two modeled scenarios. Q2 life margin included an estimated $14 million adverse mortality impact.
The Q2 actuarial unlocking exercise assumed a long-term average new-money rate of approximately 4%. Lower rate and persistency assumptions reduced pretax earnings by $45.6 million, while lower future option costs for fixed-index products increased pretax earnings by $91.5 million, for a net favorable impact of $45.9 million. Management estimated that future insurance margins were reduced by approximately $280 million.
A $23.5 million increase in the liability for claims and interest under the Global Resolution Agreement was recorded in Q2. The agreement relates to unclaimed contract benefits and death-record matching procedures.
The company expects continued investment-market volatility and possible additional credit-loss allowances. Sustained low interest rates could reduce investment income, product spreads, sales and the recoverability of deferred acquisition costs and other insurance intangibles.
Legal and regulatory matters include an appeal in the Wilmington Action, an ongoing Delaware Chancery Court action involving alleged fraudulent transfers of reinsurance assets, and an appeal in the KPMG Action. Management does not believe probable losses, after existing provisions, will materially affect consolidated results, but acknowledges outcomes are uncertain.
Management stated that the two COVID-19 scenarios were hypothetical and that materially worse pandemic, economic or market conditions could adversely affect liquidity, capital, reserves, investment values and results.

Investor verification checklist

Verify the sustainability of Q2 insurance margins after excluding the $45.9 million net actuarial unlocking benefit and assess the effect of lower assumed long-term investment yields.
Monitor COVID-19 mortality, health and long-term-care claim experience, policy lapses, premium deferrals and the timing of any expected reversal of deferred-care benefits.
Review subsequent changes in credit-loss allowances, defaults and valuations across corporate, commercial mortgage-backed, structured and VIE investments.
Confirm holding-company liquidity, regulatory approvals for insurance-subsidiary dividends, statutory RBC levels and compliance with debt covenants.
Assess the ability to maintain dividends and modest share repurchases while funding debt service, insurance operations and potential pandemic-related needs.
Track developments in the Global Resolution Agreement and other litigation or regulatory proceedings, including possible liabilities beyond recorded provisions.
Reconcile GAAP net income with management’s non-GAAP net operating income and evaluate the recurring nature of investment, derivative and actuarial items excluded from that measure.