CNO Financial Group, Inc. — 2018 Q2 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 and a long-term-care run-off segment. The unaudited report covers the three and six months ended June 30, 2018, compared with the corresponding 2017 periods.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenues | $1,046.3 million | $1,057.1 million | $2,054.1 million | $2,127.8 million |
| Income before taxes | $129.8 million | $128.5 million | $237.9 million | $225.2 million |
| Net income | $102.2 million | $83.4 million | $186.5 million | $145.7 million |
| Diluted EPS | $0.61 | $0.48 | $1.10 | $0.84 |
| Net operating income | $81.9 million | $78.6 million | $155.8 million | $138.4 million |
| Net cash from operating activities | Not separately provided for the quarter | Not separately provided for the quarter | $243.7 million | $286.0 million |
- Net income increased 22.5% in the quarter and 28.0% year to date. Diluted EPS benefited from lower share count, with weighted-average diluted shares declining to 168.8 million from 173.7 million year to date.
- Approximate net income margins were 9.8% in both the quarter and first six months, based on reported net income divided by total revenues.
- Premium collections increased 2.4% to $947.6 million in the quarter and 0.6% to $1.876 billion year to date.
- Operating cash flow declined year to date, while investing activities used $240.9 million, primarily reflecting $3.689 billion of investment purchases versus $3.425 billion of sales, maturities and redemptions.
- At June 30, total assets were $32.472 billion and shareholders’ equity was $4.455 billion, down from $4.848 billion at December 31, 2017. Accumulated other comprehensive income declined to $700.2 million from $1.212 billion, largely because of unrealized investment losses.
- Unrestricted cash and cash equivalents were $639.3 million; including cash held by variable interest entities, cash totaled $745.7 million.
- Direct corporate obligations were $915.7 million. Investment borrowings totaled $1.646 billion, borrowings related to variable interest entities totaled $1.418 billion, and scheduled direct corporate debt maturities included $425 million in 2020 and $500 million thereafter.
- Corporate debt was 17.1% of total capital; the debt-to-total-capital covenant ratio was 19.8%, below the 35.0% limit. Estimated consolidated statutory RBC was 444%, compared with management’s target range of 425% to 450%.
Material changes versus the prior comparable period
- Revenue declined 1.0% in the quarter and 3.5% year to date, but lower income-tax expense and favorable fair-value effects contributed to higher net income.
- Pre-tax operating earnings declined to $104.1 million from $121.1 million in the quarter and to $199.0 million from $214.0 million year to date. Bankers Life declined to $185.6 million year to date from $202.3 million, while Washington National increased to $59.7 million from $47.1 million.
- Bankers Life long-term-care benefit ratios worsened to 140.6% from 126.9% in the quarter and 137.0% from 129.8% year to date. Interest-adjusted ratios were 76.5% and 73.4%, respectively, versus 66.2% and 69.4% in the prior periods.
- Washington National supplemental-health performance improved; its interest-adjusted benefit ratio was 55.5% year to date versus 60.5% in 2017. Management lowered its expected remainder-of-2018 range to 56%–59% from 58%–61%.
- Colonial Penn year-to-date operating earnings declined to $3.9 million from $7.7 million, reflecting unfavorable mortality, an out-of-period reserve adjustment and higher marketing costs.
- Net realized investment results changed from a $23.1 million gain in the first six months of 2017 to a $4.2 million loss in 2018. No other-than-temporary impairment losses were recognized in 2018, compared with $13.5 million in 2017.
- Other comprehensive income was a loss of $194.1 million in the quarter and $495.6 million year to date, compared with income of $164.9 million and $272.1 million in the prior periods, reflecting market-driven unrealized investment losses.
- The company repurchased 3.0 million shares for $60.5 million year to date and increased its quarterly dividend to $0.10 per share from $0.09.
Guidance, outlook, risks and unusual items
- On August 1, 2018, after quarter-end, Bankers Life agreed to cede its legacy, pre-2003 comprehensive and nursing-home long-term-care policies to Wilton Re through 100% indemnity coinsurance. The block had approximately $2.7 billion of statutory reserves and requires an $825 million ceding commission.
- The transaction was subject to regulatory and customary closing conditions and was expected to close by year-end 2018. CNO expected to recognize an approximately $650 million after-tax charge, net of the gain on assets transferred, primarily from loss recognition associated with the ceding commission.
- The holding companies expected to contribute approximately $275 million to the insurance subsidiaries. Management expected holding-company liquidity of at least $150 million and stated that any short-term revolver draw to fund the transaction was not expected to exceed $50 million.
- Management expected free cash flow of approximately $300 million annually, increasing to approximately $350 million after the coinsurance transaction, subject to business and market conditions.
- Management continued to expect Colonial Penn 2018 earnings before investment gains or losses and taxes of $10 million to $20 million. No guidance was provided for the Bankers Life long-term-care interest-adjusted benefit ratio because of the proposed transaction.
- Key risks include interest-rate and investment-market volatility, insurance claims and morbidity trends, long-term-care reserve adequacy, availability and performance of reinsurance, regulatory approval of dividends and rate increases, debt covenants, liquidity, deferred-tax-asset recoverability, litigation and regulatory proceedings, and ratings or capital deterioration.
- The company had $2.2 billion of federal net operating losses, with a significant portion expiring beginning in 2023, and maintained an $89.1 million valuation allowance against deferred tax assets. Recovery depends on achieving projected future taxable income.
- Legal proceedings included arbitration and related litigation involving Beechwood Re and regulatory inquiries concerning unclaimed-property compliance. Management did not believe currently pending matters were probable to cause a material adverse effect, but stated outcomes could differ.
Most important facts for investors to verify
- Completion terms, regulatory approvals, funding and final accounting impact of the Wilton Re long-term-care coinsurance transaction.
- Whether the expected approximately $650 million after-tax charge and post-transaction capital and RBC levels are consistent with subsequent filings.
- Long-term-care claims, reserve development, benefit ratios and the adequacy of the remaining retained exposure.
- Investment portfolio credit quality, unrealized losses, below-investment-grade exposure and future impairment risk.
- Holding-company liquidity, insurance-subsidiary dividend approvals, debt maturities and compliance with revolving-credit covenants.
- Actual free cash flow, share repurchases, dividends and the effect of the transaction on capital deployment.