CNO Financial Group, Inc. quarterly report, Q3 FY2015

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

Reporting period: Quarter and nine months ended September 30, 2015. Financial statements are unaudited. CNO operates health insurance, annuity, individual life and related businesses serving middle-income and senior customers through Bankers Life, Washington National and Colonial Penn.

Key Financial Metrics

Metric	Q3 2015	Q3 2014	9M 2015	9M 2014
Total revenues	$904.5 million	$967.0 million	$2,842.3 million	$3,144.7 million
Income before taxes	$52.4 million	$154.4 million	$207.4 million	$99.2 million
Net income (loss)	$33.8 million	$117.4 million	$133.4 million	$(32.5) million
Diluted EPS	$0.18	$0.54	$0.68	$(0.15)
Pre-tax operating earnings	$87.8 million	$119.8 million	$274.6 million	$320.5 million
Net operating income	$56.8 million	$76.6 million	$177.7 million	$207.8 million
Net cash from operating activities	Not separately provided for the quarter	Not separately provided for the quarter	$535.3 million	$(123.9) million

GAAP net margin was approximately 3.7% in Q3 2015 and 4.7% for the first nine months. Pre-tax margins were approximately 5.8% and 7.3%, respectively. Pre-tax operating earnings and net operating income are non-GAAP measures and exclude specified investment, derivative, debt, tax and other unusual items.

Balance Sheet, Capital and Liquidity

Total assets were $31.0 billion at September 30, 2015, compared with $31.2 billion at December 31, 2014.
Shareholders’ equity declined to $4.17 billion from $4.69 billion, primarily reflecting a $314.9 million after-tax decline in other comprehensive income and $311.2 million of share repurchases, partially offset by $133.4 million of net income.
Unrestricted cash and cash equivalents were $613.8 million, broadly unchanged from $611.6 million at year-end 2014.
Direct corporate notes payable increased to $925.0 million from $794.4 million following the May 2015 refinancing. The company issued $325.0 million of 4.500% senior notes due 2020, $500.0 million of 5.250% senior notes due 2025 and drew $100.0 million under a new revolving facility.
Insurance subsidiaries had approximately $1.5 billion of Federal Home Loan Bank borrowings, collateralized by investments with a fair value of approximately $1.8 billion. Borrowings related to variable interest entities were $1.44 billion.
The estimated consolidated statutory risk-based capital ratio was 440%, above the 250% debt-covenant requirement. The company reported a 20.4% debt-to-total-capital ratio for covenant purposes versus a 30.0% maximum.
Holding-company and non-insurance subsidiaries held $112.8 million of unrestricted cash and cash equivalents, $123.4 million of fixed-income investments and $117.9 million of equity securities. Access to insurance-subsidiary dividends is subject to regulatory approval.

Material Changes Versus Prior Comparable Period

Q3 net income fell to $33.8 million from $117.4 million, primarily because of lower investment results, unfavorable fair-value changes on embedded derivatives and the absence of the prior-year gain on a reinsurance transaction.
Despite lower operating earnings, nine-month GAAP net income improved from a $32.5 million loss to $133.4 million profit because the 2014 period included the $272.6 million after-tax loss on the sale of Conseco Life Insurance Company and related unusual items.
Nine-month pre-tax operating earnings declined 14.3% to $274.6 million. Bankers Life declined to $248.4 million from $283.4 million, while Washington National declined to $79.2 million from $91.0 million. Colonial Penn remained near breakeven, with a nine-month operating loss of $1.1 million.
Bankers Life premium collections increased 0.8% for the nine months, including stronger fixed-index annuity collections, but long-term-care collections declined 3.8% as the block ran off. Washington National collections increased 3.8%, and Colonial Penn collections increased 7.1%.
Bankers Life’s long-term-care benefit ratio increased to 139.9% for the nine months from 129.0%; its interest-adjusted benefit ratio increased to 83.8% from 77.0%. Washington National’s supplemental-health interest-adjusted benefit ratio increased to 60.3% from 54.6%.
Accumulated other comprehensive income declined to $510.4 million from $825.3 million, primarily due to lower unrealized investment values.
The company repurchased 17.8 million shares for $311.2 million during the first nine months and declared $39.0 million of dividends. Quarterly dividends were increased to $0.07 per share from $0.06.

Outlook, Commentary, Risks and Unusual Items

Management expected Colonial Penn to generate $3 million to $6 million of 2015 earnings before investment gains or losses and taxes.
Management expected Bankers Life Medicare supplement benefit ratios to be in the 70% range and long-term-care interest-adjusted benefit ratios in the 84% range during the fourth quarter of 2015. Washington National supplemental-health interest-adjusted benefit ratios were expected to be approximately 58%.
Management attributed adverse health trends to unfavorable prior-period claim development, including longer and more expensive cancer-treatment patterns. It also stated that refinements to long-term-care reserve calculations affected the timing of reserve increases but not total statutory insurance liabilities.
Nine-month net realized investment losses were $20.8 million versus gains of $39.8 million in 2014. The 2015 amount included $21.6 million of other-than-temporary impairment losses, including energy-sector writedowns, VIE commercial-bank-loan writedowns and a legacy private-company writedown, partly offset by an $11.3 million gain on dissolution of a VIE.
The fixed-maturity portfolio had a fair value of $20.1 billion and gross unrealized losses of $261.7 million. Energy securities totaled $1.7 billion, including $107.2 million of unrealized losses; management warned that prolonged low oil prices could lead to downgrades and further declines.
Management identified low interest rates, investment performance, insurance claims and morbidity, long-term-care assumptions, premium-rate approvals, regulatory actions, litigation, tax-asset recoverability, reinsurance performance, debt covenants, ratings and liquidity as material risks.
The company had $2.8 billion of federal net operating losses and a $246.0 million valuation allowance against deferred tax assets. Future taxable income assumptions are significant; weaker results could require additional valuation allowances and tax expense.
The company stated that existing holding-company liquidity and expected operating cash flows should be sufficient for debt service and other obligations, but cautioned that regulatory, market and operating conditions could impair liquidity. No material change in market risk management was reported.
Pending accounting standards included revenue recognition, VIE consolidation, debt-issuance-cost presentation and insurance disclosure requirements. The company was assessing the impact; it expected the debt-issuance-cost standard to have no material effect.

Investor Verification Checklist

Verify the sustainability of operating earnings after excluding investment gains and losses, derivative fair-value changes, debt-refinancing costs and other unusual items.
Monitor long-term-care and supplemental-health claims trends, reserve development, benefit ratios and the effect of future premium-rate approvals.
Assess exposure to energy, below-investment-grade, VIE and other structured investments, including potential future impairment losses.
Reconcile corporate debt, FHLB borrowings, VIE borrowings and available revolving-credit capacity with holding-company liquidity and expected subsidiary dividends.
Evaluate the sensitivity of book value, capital and earnings to interest rates, unrealized investment values and fixed-index annuity derivative valuations.
Review the recoverability of deferred tax assets, the IRS position concerning the CSHI loss, and the potential effect of future ownership changes under Section 382.
Confirm the status and potential exposure of pending litigation, regulatory examinations and unclaimed-property investigations.