CNO Financial Group, Inc. quarterly report, Q3 FY2019

CNO Financial Group, Inc. — Q3 2019 Form 10-Q Summary

Business context and reporting period

CNO is a holding company for U.S. insurance businesses serving middle-income pre-retirees and retirees through Bankers Life, Washington National, Colonial Penn, long-term care in run-off and corporate operations. Products include health insurance, annuities, individual life insurance and related services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods.

Financial performance and condition

Metric	Q3 2019	Q3 2018	9M 2019	9M 2018
Total revenues	$944.0 million	$1,481.2 million	$2,946.8 million	$3,535.3 million
Income before taxes	$53.5 million	$(539.8) million	$166.8 million	$(301.9) million
Net income	$42.0 million	$(529.8) million	$131.4 million	$(343.3) million
Diluted EPS	$0.27	$(3.22)	$0.83	$(2.07)
Operating earnings before taxes	$87.9 million	$109.0 million	$268.0 million	$308.0 million
Net operating income	$69.2 million	$87.5 million	$211.4 million	$243.3 million
Net cash from operating activities	Not separately provided	Not separately provided	$510.9 million	$115.0 million

GAAP net profit margins were approximately 4.4% in Q3 2019 and 4.5% for the first nine months of 2019, based on reported revenue. These margins are not directly comparable with operating earnings margins because management’s operating measures exclude specified non-operating items.

September 30, 2019 total assets were $33.28 billion, versus $31.44 billion at December 31, 2018.
Shareholders’ equity increased to $4.55 billion from $3.37 billion, primarily reflecting $1.27 billion of after-tax accumulated other comprehensive income from investment market appreciation, partly offset by $177.3 million of share repurchases and $50.6 million of dividends.
Unrestricted cash was $760.3 million; total cash including cash held by variable interest entities was $822.0 million.
Fixed maturities available for sale had a fair value of $21.09 billion, including $2.31 billion of gross unrealized gains and $22.4 million of gross unrealized losses. Approximately 96.3% of the portfolio was classified as NAIC 1 or 2 investment grade.
Direct corporate notes payable were $988.7 million. Investment borrowings were $1.64 billion, and borrowings related to variable interest entities were $1.15 billion.
Book value per common share was $29.92, or $20.44 excluding accumulated other comprehensive income, compared with $20.78 and $19.69, respectively, at December 31, 2018.

Material changes versus the prior comparable period

Net income improved from a $529.8 million Q3 2018 loss to $42.0 million of Q3 2019 income, and from a $343.3 million nine-month loss to $131.4 million of income. The 2018 results included a $704.2 million pretax loss related to the long-term care reinsurance transaction, partly offset by a $363.4 million realized gain on transferred assets and a $147.9 million tax benefit.
Operating earnings declined to $87.9 million in Q3 and $268.0 million for nine months, from $109.0 million and $308.0 million, respectively. Bankers Life operating earnings decreased to $78.9 million in Q3 and $228.4 million year to date, while Washington National increased to $26.8 million and $83.2 million.
Net investment income from general account assets declined, reflecting lower yields and weaker alternative-investment returns, partially offset by higher invested assets.
Bankers Life premium collections increased 9.0% in Q3 and 8.7% year to date, driven primarily by fixed-index annuities. Total company premium collections increased 2.9% in Q3 and 2.0% year to date; first-year collections increased 16% in both periods.
The long-term-care run-off segment was substantially smaller after the 2018 cession of legacy long-term-care policies. Nine-month segment operating earnings fell to $9.3 million from $22.6 million.
In June 2019, CNO issued $500 million of 5.250% senior notes due 2029, used to repay the revolving credit facility and redeem the $325 million 2020 notes. The transaction produced a $7.3 million pretax debt-extinguishment loss. No direct corporate debt maturities are scheduled before May 2025.
CNO acquired Web Benefits Design Corporation on April 29, 2019, for $81.7 million, including $66.7 million paid in cash and a $15.0 million estimated earn-out.
The company repurchased 11.0 million shares for $177.3 million during the first nine months and had $107.3 million of remaining repurchase authority at September 30, 2019. The quarterly dividend increased to $0.11 per share from $0.10.

Guidance, outlook, commentary and risks

Management expected free cash flow before growth-related statutory capital needs of $300 million to $350 million for 2019, with approximately $30 million to $50 million of capital required to support growth.
Management expected the Bankers Life Medicare supplement benefit ratio to remain within 73% to 77% and its long-term-care interest-adjusted benefit ratio within 74% to 79% for the remainder of 2019.
Washington National’s supplemental-health interest-adjusted benefit ratio was expected to remain within 55% to 58% for the remainder of 2019.
Colonial Penn was expected to generate $12 million to $16 million of 2019 earnings before realized investment gains and income taxes. The segment’s results remain sensitive to direct-response marketing spending, most of which is expensed rather than deferred.
Management expected normalized long-term-care run-off earnings before realized investment gains to be approximately breakeven over the long term, but quarterly results may remain volatile.
The estimated consolidated statutory risk-based capital ratio was approximately 405%, above the company’s 400% to 425% target range and up from 393% at December 31, 2018. However, holding-company liquidity depends substantially on dividends and other payments from regulated insurance subsidiaries, many of which require regulatory approval.
Key risks include sustained low interest rates, investment losses and impairments, mortality and morbidity experience, health-care utilization, adequacy of reserves and rate approvals, reinsurance counterparty failure, litigation and regulatory actions, tax-asset recoverability, debt covenant compliance, ratings changes, operational and cybersecurity events, and the ability to retain agents and generate sales.
The company had $2.89 billion of federal net operating loss carryforwards and a $193.7 million deferred-tax valuation allowance. Failure to generate projected taxable income or a future ownership change under Section 382 could reduce the recoverability of these tax assets.
Significant legal matters remain related to the Beechwood Re and Platinum Partners long-term-care reinsurance arrangements. CNO stated that it did not believe probable liabilities, after existing provisions, would materially affect consolidated results, but acknowledged that adverse outcomes remain possible.
Management concluded that disclosure controls were effective as of September 30, 2019, and reported no material changes in internal control over financial reporting during the quarter.

Important facts for investors to verify

Reconcile GAAP earnings with management’s non-GAAP operating earnings and assess whether lower operating earnings persist after excluding market-driven items.
Monitor fixed-index annuity growth, embedded-derivative volatility and the effect of lower investment yields on spreads and acquisition-cost amortization.
Evaluate long-term-care claims, benefit ratios, reserve adequacy and the remaining exposure in the run-off portfolio.
Review holding-company liquidity, regulatory approval for subsidiary dividends, debt covenants and the $1.6 billion of collateralized FHLB borrowings.
Assess the recoverability of deferred tax assets, the $193.7 million valuation allowance and limitations on using federal NOLs.
Follow the Beechwood Re, Platinum Partners, Wilmington Trust and KPMG litigation and related settlement recoveries or costs.
Verify the company’s stated 2019 free-cash-flow outlook, capital requirements, repurchase activity and remaining repurchase authorization against subsequent filings.
Consider the impact of the pending long-duration insurance-contract accounting standard, whose effective date was delayed to January 1, 2022 and whose financial impact had not yet been determined.