CNO Financial Group, Inc. — 2016 Q3 Form 10-Q Summary
Business context and reporting period
CNO is a U.S. insurance holding company serving middle-income pre-retiree and retired consumers through Bankers Life, Washington National and Colonial Penn. Products include health insurance, annuities, individual life insurance and long-term care coverage, distributed through career agents, independent producers and direct marketing. The unaudited filing covers the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Total revenues | $1,015.9 million | $904.5 million | $2,980.2 million | $2,842.3 million |
| Income before taxes | $49.3 million | $52.4 million | $172.5 million | $207.4 million |
| Net income | $18.6 million | $33.8 million | $124.0 million | $133.4 million |
| Diluted EPS | $0.11 | $0.18 | $0.69 | $0.68 |
| Pre-tax operating earnings | $98.3 million | $87.8 million | $275.3 million | $274.6 million |
| Net operating income | $64.3 million | $56.8 million | $177.6 million | $177.7 million |
| Operating cash flow | Not separately provided | Not separately provided | $581.5 million | $535.3 million |
Reported net margin was approximately 1.8% for Q3 and 4.2% for the first nine months, versus approximately 3.7% and 4.7%, respectively, in the prior-year periods. The decline in GAAP earnings primarily reflects the $75.4 million pre-tax loss on the long-term care reinsurance recapture, a $13.8 million third-quarter valuation allowance charge, and unfavorable fair-value changes on embedded derivatives during the nine-month period.
- Q3 segment pre-tax operating earnings were $88.1 million for Bankers Life, $25.2 million for Washington National and $0.9 million for Colonial Penn; corporate operations lost $15.9 million.
- Nine-month pre-tax operating earnings increased modestly to $275.3 million from $274.6 million. Bankers Life improved to $259.0 million, while Washington National declined to $73.0 million and Colonial Penn reported a $2.9 million loss.
- Premium collections increased 6.4% to $1,954.8 million at Bankers Life, 1.6% to $494.1 million at Washington National and 6.9% to $210.4 million at Colonial Penn for the first nine months.
- At September 30, total assets were $32.4 billion, including $26.7 billion of investments and $706.0 million of unrestricted cash. Shareholders’ equity was $4.49 billion, up from $4.14 billion at December 31, 2015, primarily due to net income and $452.7 million of after-tax other comprehensive income.
- Direct corporate obligations were $912.5 million, while investment borrowings were $1.65 billion and borrowings related to variable-interest entities were $1.69 billion. The company reported a 16.9% corporate-debt-to-total-capital ratio and a 20.5% debt-to-total-capital covenant ratio.
- Estimated consolidated risk-based capital was 458%, compared with a 250% minimum covenant requirement. Holding-company liquidity at September 30 included $158.4 million of unrestricted cash and cash equivalents, $16.8 million of fixed-income investments and $14.1 million of equity securities.
Material changes versus the prior comparable period
- Total revenues increased 3.1% for the first nine months, but net income declined 7.0% and income before taxes declined 16.8%.
- Net realized investment gains were $23.3 million in the first nine months of 2016 versus net realized losses of $20.8 million in 2015. The 2016 amount included $24.8 million of other-than-temporary impairment losses and a $7.3 million loss on dissolution of a variable-interest entity.
- Operating performance was broadly stable: nine-month net operating income was $177.6 million versus $177.7 million, while diluted operating EPS improved to $0.99 from $0.90 because of the lower share count.
- The company repurchased 11.7 million shares for $203.0 million during the first nine months, reducing shares outstanding to 173.5 million from 184.0 million at year-end 2015. The program was suspended for the remainder of 2016.
- Accumulated other comprehensive income increased to $855.5 million from $402.8 million, largely reflecting higher unrealized investment gains. Fixed maturities available for sale increased to $21.8 billion from $19.9 billion.
Guidance, outlook, risks and unusual items
Long-term care reinsurance recapture: In September 2016, CNO terminated its BRe reinsurance agreements and recaptured approximately $495 million of ceded long-term care reserves after concerns regarding collateral quality, valuation methodologies, conflicts of interest and regulatory compliance. The company recognized a $75.4 million pre-tax loss and a $53.1 million after-tax loss, contributed $200 million to its insurance subsidiaries and suspended share repurchases. The recaptured block includes approximately $70 million of additional premium deficiency reserves and will undergo further actuarial loss-recognition testing in the fourth quarter. Management estimated that a 50-basis-point reduction in the ultimate new-money rate assumption could produce a $15 million pre-tax charge.
Operating outlook: Management expected the Q4 2016 Medicare supplement benefit ratio at Bankers Life to be 70%–73%, the long-term-care interest-adjusted benefit ratio at 81%–86% excluding reserve-related rate-increase effects, and Washington National supplemental-health interest-adjusted benefit ratio near 59%. Colonial Penn was expected to report approximately breakeven earnings for 2016.
Tax matters: Subsequent to quarter-end, CNO reached an agreement with the IRS expected to produce an approximately $120 million tax benefit in Q4 2016, including additional life and non-life net operating losses and a reduction in previously accrued interest. The benefit was subject to executed settlement documentation. Deferred tax asset realization remains dependent on future taxable income, and additional valuation allowances could materially reduce earnings and equity.
Principal risks: Low interest rates, investment credit losses, long-term-care morbidity and persistency, inability to obtain health-insurance rate increases, reinsurer default, regulatory restrictions on subsidiary dividends, ratings downgrades, litigation and regulatory examinations, tax-audit outcomes, debt covenant compliance and market-value volatility. The company reported $3.1 billion of below-investment-grade fixed maturities at fair value and $86.4 million of gross unrealized losses on fixed maturities; energy securities represented $1.6 billion of carrying value and $28.7 million of unrealized losses.
The filing also disclosed pending arbitration and litigation against BRe and related parties, as well as continuing regulatory inquiries concerning unclaimed-property laws. Management did not believe existing litigation was probable of having a material adverse effect, but stated that outcomes are inherently uncertain.
Implementation of U.S. Department of Labor fiduciary regulations was expected to cost $8 million–$10 million in 2017 and $2 million–$3 million annually thereafter. The filing stated that disclosure controls were effective and that there were no material changes to internal control over financial reporting.
Most important facts for investors to verify
- Completion and results of the fourth-quarter actuarial loss-recognition testing for the recaptured long-term-care block, including sensitivity to investment-yield assumptions.
- Receipt and accounting treatment of the expected approximately $120 million IRS settlement benefit and any effect on deferred tax valuation allowances.
- Progress and outcome of the BRe arbitration, federal litigation and related regulatory actions concerning trust assets and reinsurance credit.
- Whether the 458% estimated consolidated RBC ratio and holding-company liquidity remain adequate after recapture-related capital needs and dividend restrictions.
- Changes in S&P and Fitch ratings, which had negative outlook or rating-watch status, and their effects on policyholder behavior, sales and financing costs.
- Future investment impairments, particularly in energy, below-investment-grade and structured securities, and the effect of sustained low interest rates on investment income and insurance liabilities.
- Whether management resumes share repurchases after 2016 and how capital is allocated between dividends, subsidiary capital support, debt reduction and buybacks.