CNO Financial Group, Inc. — Q1 2020 Form 10-Q Summary
Business context and reporting period
CNO is a holding company for U.S. insurance businesses offering health insurance, annuities, individual life insurance and other products to middle-income, pre-retiree and retired consumers. Products are distributed through career agents, independent producers and direct marketing. This unaudited filing covers the three months ended March 31, 2020, compared primarily with the three months ended March 31, 2019.
Beginning in 2020, CNO reorganized reporting around annuity, health, life and long-term care product lines, together with investment and fee revenue segments. Prior-period information was reclassified to conform to the new structure.
Financial performance and condition
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Total revenues | $717.2 million | $1,023.0 million | Down $305.8 million |
| Income before taxes | $(71.0) million | $65.6 million | Declined $136.6 million |
| Net income (loss) | $(21.2) million | $51.8 million | Declined $73.0 million |
| Diluted EPS | $(0.15) | $0.32 | Declined $0.47 |
| Net operating income | $84.3 million | $65.8 million | Up $18.5 million |
| Net cash from operating activities | $125.7 million | $142.3 million | Down $16.6 million |
Insurance policy income increased to $628.7 million from $619.3 million. General-account net investment income increased to $280.3 million from $268.8 million, but income from policyholder and other special-purpose portfolios declined to a loss of $110.7 million from income of $87.0 million. Net realized investment losses were $115.5 million versus gains of $16.1 million in the prior-year quarter, including $55.4 million of increased credit-loss allowances and other-than-temporary impairment losses.
Operating earnings were stronger despite the GAAP loss. Total insurance product margin increased modestly to $190.7 million from $189.7 million. Annuity margin rose to $59.5 million, life margin to $44.3 million and long-term care margin to $13.3 million, while health margin declined to $73.6 million from $78.9 million. Higher investment income not allocated to product lines, increased fee income and lower unallocated expenses drove the increase in net operating income.
Comprehensive loss was $798.5 million, compared with comprehensive income of $529.0 million in Q1 2019, primarily due to a $1.325 billion decline in unrealized investment values, partially offset by related tax benefits and adjustments. Accumulated other comprehensive income fell to $595.2 million from $1.373 billion.
- Total assets were $32.735 billion at March 31, 2020, down from $33.631 billion at December 31, 2019.
- Shareholders’ equity was $3.766 billion, down from $4.677 billion, largely reflecting accumulated unrealized investment losses, the quarterly net loss and share repurchases.
- Unrestricted cash was $482.0 million; total cash including cash held by variable interest entities was $550.5 million at quarter-end.
- Fixed maturities, available for sale, had a fair value of $20.379 billion and an allowance for credit losses of $19.9 million. Approximately 96.2% of the portfolio was classified as investment grade by NAIC designations 1 and 2.
- Operating cash flow was $125.7 million. Investing activities used $178.2 million and financing activities used $51.7 million, producing a $104.2 million decrease in cash and cash equivalents.
Debt, capital and liquidity
Direct corporate obligations totaled $989.4 million, consisting primarily of $500 million of 5.25% senior notes due in 2025 and $500 million of 5.25% senior notes due in 2029. No amounts were outstanding under the $250 million revolving credit facility, which matures in October 2022. FHLB investment borrowings totaled $1.644 billion and were collateralized by investments with an estimated fair value of $2.1 billion. Borrowings related to consolidated VIEs totaled $1.152 billion.
The estimated consolidated statutory risk-based capital ratio was 406% at March 31, 2020, compared with 408% at December 31, 2019. Corporate debt to total capital was 20.8%, and the debt-to-total-capital covenant ratio was 24.3% against a maximum of 35%. Holding companies had $152.6 million of unrestricted cash and cash equivalents plus $15.5 million of fixed-income investments. First-quarter holding-company free cash flow was approximately $82 million.
CNO repurchased 5.1 million shares for $83.0 million during the quarter and declared $16.0 million of dividends, or $0.11 per share. Repurchases were suspended beginning in mid-March because of COVID-19 uncertainty. The company had $449.3 million of remaining repurchase authorization at March 31, 2020.
Material changes and unusual items
- COVID-19-driven market volatility materially affected investment valuations, credit-loss allowances, derivative values and accumulated other comprehensive income.
- Fixed-index product accounting produced substantial volatility: derivative-related losses and other market-value changes contributed to the non-operating loss, while the underlying insurance product margin remained positive.
- The company adopted the current expected credit loss standard on January 1, 2020, reducing assets and retained earnings by $17.8 million on a cumulative-effect basis.
- The CARES Act generated a $34.0 million discrete tax benefit from carrying back net operating losses. Related provisions also favorably affected statutory operating income and capital and surplus.
- The company released its remaining deferred-tax valuation allowance in Q4 2019, but future realization of deferred tax assets remains dependent on achieving projected taxable income.
- COVID-19-related claims were limited primarily to the latter half of March, but management estimated a potential full-year 2020 adverse impact on insurance product margin of approximately $20 million to $30 million under modeled scenarios.
Guidance, outlook and risks
CNO suspended previously issued 2020 guidance regarding earnings-per-share growth and share-repurchase capacity. Management expected second-quarter 2020 operating earnings to be meaningfully lower year over year, reflecting lower investment income and COVID-19-related claims. April Consumer Division life and health sales were approximately 24% below the prior year and annuity collected premiums were approximately 19% lower. Worksite Division life and health sales declined approximately 75% in April; management expected that business to remain challenged through Q3 and begin improving in Q4.
Key risks include the duration and severity of COVID-19, mortality and morbidity trends, policy lapses and surrenders, low interest rates, credit migration and defaults, additional investment losses, pressure on statutory capital, reduced sales, reinsurance counterparty risk, regulatory restrictions on subsidiary dividends, litigation and regulatory proceedings, cybersecurity and remote-work risks, and the recoverability of deferred tax assets.
Management stated that, under its modeled COVID-19 scenarios, it expected to maintain target RBC levels, debt ratios, minimum holding-company liquidity and the quarterly dividend without raising capital, although future repurchase capacity remained uncertain. The scenarios were explicitly described as hypothetical and actual results could differ materially.
Investor verification priorities
- Verify subsequent-quarter trends in sales, collected premiums, policy lapses, mortality, morbidity and insurance product margins.
- Reassess investment portfolio credit quality, unrealized losses, credit-loss allowances and exposure to energy, commercial real estate, structured securities and below-investment-grade assets.
- Monitor statutory RBC ratios, subsidiary dividend approvals, holding-company liquidity and compliance with debt covenants.
- Confirm whether share repurchases resumed and how capital deployment changed after March 31, 2020.
- Evaluate the sensitivity of fixed-index annuity liabilities, deferred acquisition costs, insurance reserves and earnings to interest rates and market volatility.
- Review developments in the Platinum-related litigation, regulatory examinations and reinsurance recoverability.
- Assess whether deferred tax assets remain realizable if operating earnings or taxable income deteriorate.