CNO

Business Context and Reporting Period

Company: Conseco, Inc. (CNO Financial Group, Inc.)
Filing Type: Form 10-Q (Unaudited)
Period Ended: September 30, 2009
Business Overview: CNO is a holding company for insurance subsidiaries operating in the U.S., focusing on supplemental health, annuity, and individual life insurance products for senior and middle-income markets. Operations are managed through three segments: Bankers Life, Colonial Penn, and Conseco Insurance Group, plus Corporate operations.

Key Financial Metrics (Nine Months Ended Sept 30, 2009)

Note: The significant improvement in Net Income compared to 2008 is largely due to the absence of discontinued operations losses (Senior Health transfer) in 2009 and a reduction in valuation allowance charges.

Material Changes vs. Prior Period

• Profitability Turnaround: The Company reported a net income of $67.5 million for the nine months ended Sept 30, 2009, compared to a net loss of $679.0 million in the same period of 2008. The 2008 loss included $355.2 million in losses from discontinued operations (Senior Health long-term care business).
• Investment Impairments: Net realized investment losses were $43.5 million in 2009, driven by $164.3 million in other-than-temporary impairment (OTTI) writedowns, partially offset by $120.8 million in net gains from sales. In 2008, net realized losses were $169.4 million.
• Equity Recovery: Shareholders' equity increased by $1.7 billion to $3.33 billion, primarily driven by a $1.71 billion increase in accumulated other comprehensive income (unrealized gains on investments) as market conditions improved from 2008 lows.
• Segment Performance: Bankers Life and Colonial Penn reported increased income before taxes. Conseco Insurance Group income before taxes improved significantly from a loss in 2008 to $74.6 million in 2009, aided by a reinsurance transaction with Wilton Re.

Guidance, Outlook, Risks, and Unusual Items

Outlook and Liquidity

Management believes existing cash, operating cash flows, and planned capital transactions will be sufficient to meet debt obligations for the next 12 months. However, the Company faces significant liquidity constraints regarding the repurchase of $293 million in Existing Debentures due September 30, 2010.

Subsequent Events (Capital Transactions)

• Debt Refinancing: Entered into an agreement to issue up to $293 million of 7.0% Convertible Senior Debentures due 2016 to fund a tender offer for Existing Debentures.
• Equity Offering: Agreed to sell 16.4 million shares of common stock and warrants to Paulson & Co. for $77.9 million. Half of the proceeds are required to repay the Senior Credit Agreement.
• Tender Offer: Commenced a cash tender offer for Existing Debentures on October 15, 2009.

Risks and Contingencies

• Going Concern: The Company faces substantial doubt regarding its ability to continue as a going concern if it fails to comply with financial covenants in its Senior Credit Agreement starting in Q3 2010 (specifically risk-based capital ratios and statutory capital levels). Failure to comply could trigger a default and acceleration of debt.
• Debt Covenants: Margins for adverse development on financial covenants (Risk-Based Capital, Debt-to-Capitalization) are small. The Company is pursuing reinsurance and asset sales to improve these ratios.
• Investment Portfolio: Significant exposure to structured securities (CMBS, RMBS) with unrealized losses. Further credit downgrades or impairments could materially impact earnings and capital ratios.
• Regulatory: Ongoing regulatory examinations regarding sales practices and rate adequacy. Dividend payments from insurance subsidiaries to the holding company are restricted and require regulatory approval.

Key Facts for Investor Verification

• Debt Maturity Wall: Verify the status of the tender offer for $293 million of Existing Debentures and the closing of the new 7.0% debenture issuance to ensure liquidity for the September 2010 repurchase obligation.
• Covenant Compliance: Monitor the Company's ability to meet the stricter financial covenants (250% Risk-Based Capital ratio, $1.27B statutory capital) effective Q3 2010 under the Senior Credit Agreement.
• Investment Impairments: Review future quarters for additional other-than-temporary impairment (OTTI) charges, particularly in the commercial mortgage-backed securities and asset-backed securities portfolios.
• Deferred Tax Assets: Assess the valuation allowance on deferred tax assets ($1.2 billion). An increase in this allowance due to an inability to utilize Net Operating Losses (NOLs) could trigger a covenant breach.
• Going Concern Opinion: Confirm whether the independent auditors issue a "going concern" qualification in the 2009 10-K, which would be a material event of default under the Senior Credit Agreement.