CNO Financial Group, Inc. — 2019 Q2 Form 10-Q Summary
Business context and reporting period
CNO is a U.S. insurance holding company serving middle-income pre-retiree and retired customers through Bankers Life, Washington National and Colonial Penn. Products include health insurance, annuities, individual life insurance and related services, distributed through career agents, independent producers and direct marketing. The filing covers the quarter and six months ended June 30, 2019; financial statements are unaudited.
Operating segments were Bankers Life, Washington National, Colonial Penn, long-term care in run-off and corporate operations. The long-term care segment reflects the 2018 cession of legacy long-term care policies under 100% indemnity coinsurance, so prior-period comparisons are affected by the change in scope.
Key financial metrics
| Metric | Three months ended June 30, 2019 | Three months ended June 30, 2018 | Six months ended June 30, 2019 | Six months ended June 30, 2018 |
|---|---|---|---|---|
| Total revenues | $979.8 million | $1,046.3 million | $2,002.8 million | $2,054.1 million |
| Income before income taxes | $47.7 million | $129.8 million | $113.3 million | $237.9 million |
| Net income | $37.6 million | $102.2 million | $89.4 million | $186.5 million |
| Diluted EPS | $0.24 | $0.61 | $0.56 | $1.10 |
| Net operating income | $76.4 million | $81.9 million | $142.2 million | $155.8 million |
| Pre-tax operating earnings | $96.7 million | $104.1 million | $180.1 million | $199.0 million |
Net income margin was approximately 3.8% in the second quarter and 4.5% for the first six months, compared with approximately 9.8% and 9.1%, respectively, in the prior-year periods. The filing does not present a single consolidated operating margin; management’s non-GAAP pre-tax operating earnings margin was approximately 9.9% for the quarter and 9.0% year to date.
- Revenue mix: Insurance policy income was $618.3 million in the quarter and $1.238 billion year to date. General-account net investment income declined to $286.7 million in the quarter and $557.3 million year to date, while income from policyholder and other special-purpose portfolios increased.
- Premium collections: Total collections rose 1.5% to $962.2 million in the quarter and 1.5% to $1.904 billion year to date. First-year collections increased 14% in the quarter and 16% year to date, led by Bankers Life fixed-index annuities.
- Cash flow: Operating cash flow was $317.7 million for the first six months, compared with $243.7 million in 2018. Investing activities used $209.5 million and financing activities used $156.9 million, producing a $48.7 million decrease in cash and cash equivalents to $607.9 million, including cash held by variable interest entities.
- Balance sheet: Total assets were $32.716 billion versus $31.440 billion at December 31, 2018. Shareholders’ equity increased to $4.252 billion from $3.371 billion, primarily because accumulated other comprehensive income rose to $1.098 billion from $177.7 million as fixed-income unrealized gains increased.
- Debt and liquidity: Direct corporate obligations were $988.3 million, consisting primarily of $500 million of 2025 notes and $500 million of 2029 notes, net of issuance costs. The company had no revolving credit borrowings at quarter-end. Insurance subsidiary FHLB borrowings were $1.645 billion, collateralized by investments with fair value of approximately $2.0 billion.
- Capital: Corporate debt to total capital was 18.9%, and debt to total capital excluding accumulated other comprehensive income was 23.9%. Estimated consolidated statutory RBC was approximately 409%, compared with 393% at December 31, 2018.
Material changes versus the prior comparable period
- Second-quarter net income fell 63% and six-month net income fell 52%; diluted EPS declined from $0.61 to $0.24 in the quarter and from $1.10 to $0.56 year to date.
- Operating earnings declined 7% in the quarter and 10% year to date. Bankers Life operating earnings fell to $86.4 million from $90.7 million in the quarter and to $149.5 million from $168.2 million year to date. Washington National improved year to date, while long-term care in run-off declined substantially following the 2018 reinsurance transaction.
- Results were adversely affected by $65.5 million of year-to-date unfavorable fair-value changes in embedded derivative liabilities, compared with a $33.4 million favorable impact in 2018; $16.9 million of unfavorable agent deferred compensation valuation changes; and a $7.3 million debt extinguishment loss.
- Net realized investment gains improved to $21.4 million from a $4.2 million loss. However, 2019 included a $2.2 million investment impairment and a $5.1 million loss on dissolution of a variable interest entity.
- Bankers Life premium collections increased 8.5% year to date, primarily from fixed-index annuities. Bankers Life Medicare supplement collections declined modestly as sales shifted toward third-party Medicare Advantage products and related fee income.
- The company issued $500 million of 5.25% senior notes due 2029, using proceeds to repay $100 million under the revolving credit agreement and redeem the $325 million of 2020 notes.
- CNO acquired Web Benefits Design Corporation on April 29, 2019, for $66.7 million in cash plus an estimated $15.0 million earn-out; goodwill and other intangible assets recognized were $80.4 million.
- The quarterly dividend increased to $0.11 per share from $0.10. CNO repurchased 6.2 million shares for $102.0 million during the first six months and had $182.6 million of remaining repurchase authorization at June 30.
Guidance, outlook, commentary and risks
- Management expects 2019 free cash flow before capital needed to support growth of $300 million to $350 million, with approximately $30 million to $50 million of capital required for growth. Management intends to deploy free cash flow toward growth investments, acquisitions, dividends and share repurchases.
- For the remainder of 2019, management expects Bankers Life Medicare supplement benefit ratios of 73% to 77%, Bankers Life long-term care interest-adjusted benefit ratios of 74% to 79%, and Washington National supplemental health interest-adjusted benefit ratios of 55% to 58%.
- Colonial Penn is expected to report 2019 earnings before realized investment gains or losses and taxes of $12 million to $20 million. Long-term care in run-off is expected to produce approximately breakeven normalized earnings over the long term, although quarterly results may be volatile.
- Key risks include sustained low interest rates, lower investment yields, market volatility, investment impairments, mortality and morbidity changes, health-care utilization, inadequate rate increases, policy surrenders and persistency changes, reinsurance counterparty risk, regulatory restrictions on dividends, litigation and regulatory proceedings, tax-asset recoverability, debt covenant compliance and the ability to maintain liquidity.
- CNO is involved in litigation and arbitration related to former long-term care reinsurance arrangements with Beechwood Re and Platinum-related entities. Management does not believe currently established liabilities will have a probable material adverse effect, but states that outcomes and potential losses beyond accrued amounts cannot be reasonably estimated.
- The company maintains a $193.7 million valuation allowance against deferred tax assets. Future taxable income below projections, or an ownership change under Section 382, could limit NOL utilization and require additional tax expense.
- Upcoming accounting changes include expected-credit-loss guidance, fair-value disclosure changes and long-duration insurance-contract accounting. The filing states that the impact of credit-loss and long-duration-contract adoption has not yet been determined.
Most important facts for investors to verify
- Whether operating earnings stabilize despite lower investment yields and rising health and long-term-care benefit ratios.
- The sustainability of fixed-index annuity sales, associated option costs and the volatility from embedded-derivative fair-value changes.
- Actual free cash flow, holding-company liquidity and the ability of insurance subsidiaries to obtain regulatory approval for future dividends.
- Investment portfolio credit quality, below-investment-grade exposure, VIE borrowings and future impairment risk.
- The financial and legal consequences of the Beechwood Re and Platinum-related proceedings and any potential reinsurance recoverability issues.
- The effect of long-duration insurance accounting adoption on reserves, deferred acquisition costs, accumulated other comprehensive income and shareholders’ equity.
- Whether the deferred tax asset valuation allowance and NOL utilization assumptions remain supportable.