Business Context and Reporting Period
Company: Conseco, Inc. (CNO Financial Group, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2009
Business Overview: Conseco is a holding company for a group of insurance companies operating in the U.S., focusing on supplemental health, annuity, and individual life insurance products for senior and middle-income markets. The company operates through three primary segments: Bankers Life, Colonial Penn, and Conseco Insurance Group. A significant portion of its former long-term care business (Senior Health) was transferred to an independent trust in late 2008 and is reported as discontinued operations.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2009 | Six Months Ended June 30, 2008 |
|---|---|---|
| Total Revenues | $2,165.1 million | $2,122.2 million |
| Net Income (Loss) | $52.1 million | $(495.7) million |
| Net Income (Loss) per Share (Diluted) | $0.28 | $(2.68) |
| Net Cash Provided by Operating Activities | $317.1 million | $709.6 million |
| Total Assets | $29,433.5 million | $28,763.3 million |
| Total Liabilities | $27,018.5 million | $27,133.3 million |
| Total Shareholders' Equity | $2,415.0 million | $1,630.0 million |
| Corporate Debt (Notes Payable) | $1,259.3 million | $1,311.5 million |
| Investment Borrowings | $747.6 million | $767.5 million |
Investment Portfolio: Total investments were $20.0 billion. The portfolio includes $16.9 billion in actively managed fixed maturities at fair value. The company recognized net realized investment losses of $23.2 million for the six months ended June 30, 2009, driven by $128.6 million in other-than-temporary impairment losses recognized in earnings, partially offset by $105.4 million in net gains from sales.
Material Changes vs. Prior Period
- Profitability Turnaround: The company reported a net income of $52.1 million for the six months ended June 30, 2009, a significant improvement from a net loss of $495.7 million in the same period of 2008. The 2008 loss was heavily impacted by discontinued operations related to the Senior Health transfer.
- Equity Growth: Shareholders' equity increased by $785.0 million (48%) to $2.4 billion, primarily due to net income and a $745.9 million increase in unrealized appreciation of investments recorded in accumulated other comprehensive loss.
- Segment Performance:
- Bankers Life: Income before taxes increased to $92.3 million from $36.7 million, driven by improved benefit ratios in long-term care and supplemental health lines.
- Colonial Penn: Income before taxes rose to $17.3 million from $12.1 million, reflecting growth in life insurance sales.
- Conseco Insurance Group: Income before taxes increased to $52.4 million from $33.4 million, despite higher surrenders in equity-indexed annuities.
- Debt Modification: In March 2009, the company amended its Second Amended Credit Facility, resulting in higher interest rates, stricter covenants, and a $9.5 million expense related to debt modification fees.
Guidance, Outlook, Risks, and Contingencies
Liquidity and Going Concern Risk: Management faces significant liquidity challenges regarding the $293 million in 3.50% Convertible Debentures due September 30, 2010. The amended credit facility restricts the company's ability to repay these debentures with cash unless specific conditions are met. Management is exploring exchange offers or refinancing but notes that failure to address this by March 31, 2010, could lead to a "substantial doubt" conclusion regarding the company's ability to continue as a going concern.
Covenant Compliance: The company is currently in compliance with its credit facility covenants, but margins are tight. Future covenant requirements (reverting in Q3 2010) are stricter than current levels. Failure to meet these future ratios could trigger a default.
Investment Risks: The portfolio holds significant unrealized losses ($1.99 billion gross). The company continues to monitor other-than-temporary impairments (OTTI). Below-investment grade securities represent 12% of the fixed maturity portfolio.
Regulatory and Litigation:
- Rating Downgrades: Financial strength ratings for primary subsidiaries were downgraded by A.M. Best (to "B"), S&P (to "BB-"), and Moody's (to "Ba2") in early 2009, with negative outlooks.
- Internal Controls: A material weakness in internal controls over financial reporting related to the actuarial reporting process for the Conseco Insurance Group segment remains unremediated as of June 30, 2009.
- Legal Proceedings: The company is involved in various class actions regarding cost of insurance charges, annuity marketing practices, and securities litigation. While management believes many are without merit, outcomes are uncertain.
Key Facts for Investor Verification
- Debenture Refinancing: Verify the status of discussions with debenture holders regarding the $293 million put option due September 30, 2010, and the feasibility of an exchange offer or refinancing under current credit restrictions.
- Covenant Margins: Monitor the company's ability to meet the stricter financial covenants (specifically the 250% aggregate risk-based capital ratio) required starting in the third quarter of 2010.
- Internal Control Remediation: Track progress on remediation of the material weakness in actuarial reporting controls, which is critical for audit opinions and regulatory compliance.
- Investment Impairments: Assess the potential for further other-than-temporary impairment charges given the large volume of unrealized losses in the fixed maturity portfolio, particularly in structured securities.
- Dividend Restrictions: Note that the credit facility prohibits cash dividends on common stock, and the ability of insurance subsidiaries to pay dividends to the holding company is subject to regulatory approval and statutory surplus limitations.