CNO

CNO Financial Group, Inc. (Conseco) 2006 10-K Summary

Business Context and Reporting Period

This Form 10-K covers the fiscal year ended December 31, 2006. CNO Financial Group, Inc. (Conseco) is a holding company for a group of insurance companies operating in the United States, focusing on supplemental health, annuity, and individual life insurance products for senior and middle-income markets. The company emerged from bankruptcy in 2003 and operates through three primary segments: Bankers Life (career agents), Conseco Insurance Group (independent producers), and Colonial Penn (direct marketing), plus an Other Business in Run-off segment.

Key Financial Metrics

Liquidity: The company held $385.9 million in unrestricted cash and cash equivalents as of December 31, 2006. It maintains a $675.0 million secured credit facility (Second Amended Credit Facility) with a maturity date of October 2013.

Material Changes vs. Prior Period

• Profitability Decline: Net income dropped significantly from $324.9 million in 2005 to $96.5 million in 2006. This was primarily driven by a $157.0 million charge related to a tentative litigation settlement in the Conseco Insurance Group segment and adverse development in the "Other Business in Run-off" segment.
• Run-off Segment Losses: The "Other Business in Run-off" segment, which holds legacy long-term care business, reported a pre-tax operating loss of $41.9 million in 2006 (compared to $77.2 million income in 2005). This was due to a $61 million increase in insurance policy benefits driven by higher than expected claims and persistency.
• Investment Performance: The company recorded net realized investment losses of $47.2 million in 2006, compared to $2.9 million in 2005. This included $22.4 million in writedowns of investments deemed other-than-temporarily impaired.
• Segment Growth: Despite the losses, first-year collected premiums increased 32% to $1.8 billion. The Conseco Insurance Group saw a 145% increase in first-year premiums, and Bankers Life saw a 13% increase.

Guidance, Outlook, Risks, and Unusual Items

• Rating Agency Metrics: A.M. Best affirmed a "B++ (Very Good)" rating for primary subsidiaries but set strict metrics for an upgrade. Key hurdles include generating GAAP operating earnings of at least $270 million for Bankers Life and $220 million for Conseco Insurance Group (excluding litigation charges) in 2007. The "Other Business in Run-off" segment must generate over $50 million in GAAP operating earnings to avoid a rating downgrade.
• Long-Term Care Risks: The company faces significant risk from its legacy long-term care block. Persistency rates are higher than assumed, and claim costs are rising. The company is seeking regulatory approval for rate increases on approximately 350 products, but approval is not guaranteed. If rates cannot be raised, a premium deficiency reserve may be required.
• Internal Control Weakness: The company identified a material weakness in internal controls over financial reporting related to actuarial reporting processes for single premium immediate annuities, specified disease policies, and long-term care policies. This resulted in adjustments to liabilities in 2006.
• Litigation: A tentative settlement was reached regarding a class action lawsuit concerning cost of insurance charges. The settlement is subject to court approval and could impact future cash flows.
• Outlook: Management's 2007 priorities include increasing sales growth, reducing operating expenses, and improving governance. The company expects to spend over $26 million on capital expenditures in 2007 for system conversions.

Investor Verification Checklist

• Run-off Segment Viability: Verify the progress of rate increase filings for the "Other Business in Run-off" segment and the likelihood of regulatory approval to prevent further losses.
• Internal Control Remediation: Confirm the status of remediation efforts for the identified material weakness in actuarial reporting controls.
• Litigation Settlement: Monitor the court fairness hearing and final approval status of the $157 million tentative litigation settlement.
• Rating Agency Compliance: Track the company's ability to meet the specific earnings thresholds set by A.M. Best to maintain its positive outlook and achieve a rating upgrade.
• Investment Portfolio Quality: Review the composition of the below-investment-grade fixed maturity portfolio (6.8% of total) and the potential for further writedowns.