CNO Financial Group, Inc. quarterly report, Q3 FY2023

CNO Financial Group, Inc. — Q3 2023 Form 10-Q Summary

Business context and reporting period

CNO is a holding company for U.S. insurance subsidiaries serving primarily middle-income pre-retiree and retired Americans through health, annuity, individual life and related products. Products are distributed through exclusive agents, independent producers, direct marketing, consumer channels and the Worksite Division. The filing covers the three and nine months ended September 30, 2023. Prior-period amounts were recast for adoption of ASU 2018-12, the long-duration insurance contract accounting standard, effective January 1, 2023.

Key financial metrics

Metric	Q3 2023	Q3 2022	9M 2023	9M 2022
Total revenues	$947.5 million	$905.3 million	$2,976.3 million	$2,603.2 million
Income before taxes	$215.6 million	$227.9 million	$310.7 million	$768.0 million
Net income	$167.3 million	$175.9 million	$240.2 million	$592.6 million
Diluted EPS	$1.46	$1.52	$2.08	$5.02
Net operating income	$101.3 million	$77.9 million	$222.2 million	$277.5 million
Operating EPS	$0.88	$0.67	$1.92	$2.35
Operating earnings before taxes	$129.8 million	$101.0 million	$287.4 million	$359.7 million
Net cash from operating activities	Not separately provided	Not separately provided	$406.2 million	$334.5 million

Reported net income margins were approximately 17.7% in Q3 2023 and 8.1% for the first nine months. Net operating income margins, using total revenues as a reference, were approximately 10.7% and 7.5%, respectively. These are analytical calculations and are not company-defined margins.

Total insurance product margin was $240.0 million in Q3 and $684.4 million for the first nine months, compared with $239.1 million and $702.0 million in the comparable 2022 periods.
Q3 product margins were annuity $57.0 million, health $123.2 million and life $59.8 million. Nine-month margins were $171.4 million, $347.9 million and $165.1 million, respectively.
Net investment income was $324.8 million in Q3 and $925.1 million for the first nine months from general account assets. Policyholder and other special-purpose portfolios generated $(33.0) million in Q3 and $109.4 million for the first nine months.
Total investment losses were $29.3 million in Q3 and $79.2 million for the first nine months, versus losses of $17.7 million and $99.2 million in the comparable 2022 periods.
Total assets were $33.5 billion at September 30, 2023, including $24.7 billion of investments and $460.8 million of unrestricted cash. Shareholders’ equity was $1.89 billion.
Policyholder account balances were $15.5 billion and future policy benefits were $10.8 billion at September 30, 2023.
Direct corporate obligations were $1.14 billion. Investment borrowings were $2.09 billion and borrowings related to variable interest entities were $918.5 million.
The $250 million revolving credit facility had no outstanding borrowings. Corporate debt to total capital was 37.6%, or 22.9% excluding accumulated other comprehensive loss.

Material changes versus the prior comparable period

Q3 net income declined 4.9%, while nine-month net income declined 59.5%. The nine-month comparison was significantly affected by lower favorable fair-value changes in embedded derivatives and market risk benefits.
Q3 net operating income increased 30.0%, but nine-month net operating income declined 19.9%.
Revenue increased 4.7% in Q3 and 14.3% for the first nine months, primarily reflecting higher investment income, fee revenue and life insurance policy income.
Nine-month health margin declined to $347.9 million from $364.0 million. Medicare supplement margin declined to $95.6 million from $113.1 million, and long-term care margin declined to $66.3 million from $80.3 million, due primarily to unfavorable claims experience and a smaller Medicare supplement block.
Supplemental health margin increased to $186.0 million from $170.6 million, reflecting block growth. Interest-sensitive life margin increased to $69.8 million from $58.3 million, reflecting favorable mortality and block growth.
Fixed indexed annuity premium collections declined 10% for the first nine months to $996.7 million, while fixed interest annuity collections increased 157% to $141.6 million, reflecting consumer preference for higher current credited rates.
Net cash from operating activities increased to $406.2 million from $334.5 million. Investing activities used $945.3 million, while financing activities provided $477.0 million, resulting in a $62.1 million decrease in cash and cash equivalents.
Accumulated other comprehensive loss was $1.96 billion at September 30, 2023, largely reflecting unrealized investment losses. Comprehensive income was $240.8 million for the first nine months, compared with a comprehensive loss of $1.62 billion in the prior-year period.
CNO repurchased 3.6 million shares for $85.1 million in the first nine months and declared $51.0 million of dividends. The quarterly dividend was increased to $0.15 per share from $0.14. Remaining repurchase authorization was $601.8 million at September 30, 2023.

Guidance, outlook, commentary and unusual items

Management guided to 2023 operating earnings per diluted share of $2.70 to $2.80, excluding significant items, narrowing the prior range of $2.65 to $2.85 without changing the midpoint.
Expected 2023 cash flow to the holding company was increased to $330 million to $350 million, including the impact of the intercompany reinsurance agreement, from prior guidance of $180 million to $200 million.
Management expects the full-year expense ratio to be 19.2% to 19.4%, narrowing the prior range of 19.0% to 19.4%.
Subsequent to quarter-end, CNO received approvals to form a wholly owned Bermuda captive reinsurer and cede approximately $6.2 billion of in-force fixed indexed annuity statutory reserves, in addition to new business. The initial agreement had an October 1, 2023 effective date. Additional capital could be required if Bermuda changes its capital adequacy model.
Management stated that higher interest rates should benefit operating results over time, but interest-rate volatility can affect investment values, insurance liabilities, liquidity and capital.
The company adopted ASU 2018-12, which materially changed measurement and presentation of long-duration insurance contracts, market risk benefits and deferred acquisition costs. Comparability with previously reported periods is therefore dependent on the recast amounts.
Q3 and nine-month results included substantial fair-value effects from fixed indexed annuity embedded derivatives and market risk benefits. The company reported $94.7 million of favorable related changes for the first nine months, versus $456.6 million in 2022.
At September 30, 2023, estimated consolidated statutory RBC was 392%, above the 375% target and 350% minimum reflected in the company’s risk appetite statement. Holding-company unrestricted cash was $171 million, above the $150 million minimum target.

Principal risks and contingencies

The investment portfolio had $3.58 billion of gross unrealized losses on fixed maturities, available for sale, and a $69.4 million allowance for credit losses. Management did not believe securities with unrealized losses required additional impairment, but future realized losses remain possible.
Approximately 97% of fixed maturities by estimated fair value were investment grade under NAIC designations 1 and 2. Structured securities represented approximately 33.5% of the fixed-maturity portfolio by fair value.
Insurance results remain sensitive to mortality, morbidity, health care utilization, long-term care claims, lapse and surrender behavior, policyholder withdrawals, interest rates, equity markets and the adequacy of prior reserve estimates.
Holding-company liquidity depends substantially on dividends, surplus debenture interest and other payments from insurance subsidiaries. Several payments require regulatory approval, and subsidiaries may retain capital or require additional contributions.
The company is exposed to reinsurance counterparty risk. Reinsurer failure could increase earnings, liquidity, reserve and statutory capital pressure.
Pending litigation includes a Delaware Chancery Court action involving alleged unjust enrichment and claims related to reinsurance trusts and Agera securities, as well as a class action involving former interest-sensitive whole life policyholders. The filing states that potential losses beyond accrued amounts cannot be reasonably estimated in certain matters.
The IRS is examining 2016–2018 tax returns. Failure to realize projected deferred tax assets could result in a valuation allowance, higher tax expense and lower equity.
Regulatory developments may affect risk-based capital treatment of negative interest maintenance reserve balances, collateralized loan obligations and structured-security residual tranches. Cybersecurity, privacy and insurance-product regulation also remain material risks.

Most important facts for investors to verify

Reconcile reported GAAP net income with net operating income and quantify the effect of embedded derivative, market risk benefit, investment and other non-operating items.
Assess the financial, statutory capital and liquidity effects of the Bermuda captive reinsurance transaction, including any required capital contributions and the effect on future holding-company cash flow.
Review the composition, duration, credit quality and unrealized-loss profile of the $20.3 billion fixed-maturity portfolio, including exposure to commercial mortgage-backed securities, banks, structured securities and below-investment-grade assets.
Monitor Medicare supplement and long-term care claims experience, rate increases, reserve adequacy and future margin trends.
Verify holding-company cash, subsidiary dividend approvals, debt maturities and compliance with debt covenants, including the 35% debt-to-total-capital covenant.
Evaluate the sustainability of share repurchases and the increased dividend against projected free cash flow, insurance-company capital needs and regulatory restrictions.
Confirm the assumptions underlying deferred tax asset realization, the status of the IRS examination and potential Section 382 limitations.