CNO Financial Group, Inc. 2014 Form 10-K Summary
Business context and reporting period
CNO is a U.S. insurance holding company serving middle-income pre-retirees and retirees through Bankers Life, Washington National and Colonial Penn. Products include health insurance, long-term-care insurance, annuities and individual life insurance, distributed through career agents, independent producers and direct marketing. This Form 10-K covers the fiscal year ended December 31, 2014; fourth-quarter 2014 data are also presented.
Following the July 1, 2014 sale of Conseco Life Insurance Company (CLIC) and the 2013 reinsurance of certain long-term-care business, management eliminated the Other CNO Business segment and revised prior-period segment presentations.
Financial results and key metrics
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Total revenues | $4,144.7 million | $4,476.1 million | Down 7.4% |
| Income before taxes | $175.1 million | $304.8 million | Down 42.6% |
| Net income | $51.4 million | $478.0 million | Down 89.2% |
| Diluted earnings per share | $0.24 | $2.06 | Down $1.82 |
| Net operating income | $259.5 million | $248.4 million | Up 4.5% |
| Operating earnings before taxes | $400.6 million | $378.3 million | Up 5.9% |
| Net cash from operating activities | $121.8 million | $720.4 million | Down $598.6 million |
- Annual premium collections were $3.43 billion, compared with $3.45 billion in 2013. Collections excluding CLIC increased to $3.36 billion from $3.31 billion.
- Bankers Life operating earnings rose to $386.9 million from $310.5 million, supported by growth in the in-force block, higher life and annuity collections, and lower benefits and amortization.
- Washington National operating earnings declined to $111.2 million from $140.6 million as supplemental-health benefit ratios and operating expenses increased and Medicare supplement business continued to run off.
- Colonial Penn reported operating earnings of $0.8 million versus a $12.5 million operating loss, reflecting premium growth and lower operating expenses.
- Long-term-care benefit ratios at Bankers Life remained unfavorable at 129.7%, versus 129.3% in 2013 and 117.6% in 2012. The interest-adjusted benefit ratio was 77.2%, compared with 80.6% in 2013.
- Total assets were $31.2 billion, shareholders’ equity was $4.7 billion, and total insurance-product liabilities were $22.3 billion at year-end.
- Total investments were $24.9 billion, including $20.6 billion of available-for-sale fixed maturities. The fixed-maturity portfolio had a $2.23 billion net unrealized gain; 12% of fixed maturities were below investment grade.
- Net investment income declined to $1.43 billion from $1.66 billion, while net realized investment gains increased modestly to $36.7 million from $33.4 million. Investment impairment losses were $27.3 million.
- Direct corporate debt was $794.4 million carrying value, with aggregate principal indebtedness of $797.1 million and approximately $115 million of expected 2015 debt service. Holding-company unrestricted cash and cash equivalents were $88.2 million, supplemented by fixed-income investments of $110.1 million and equity and other invested assets of $146.3 million.
- Insurance subsidiaries’ estimated consolidated RBC ratio was 434%, versus a 250% debt-covenant minimum. The debt-to-total-capitalization ratio was 17.2%, versus a 27.5% maximum, and interest coverage was 15.75x versus a 2.50x minimum.
Fourth-quarter 2014 results
| Metric | Q4 2014 | Q4 2013 |
|---|---|---|
| Revenues | $1,000.0 million | $1,158.2 million |
| Income before taxes | $75.9 million | $41.1 million |
| Net income | $83.9 million | $106.0 million |
| Diluted EPS | $0.41 | $0.47 |
Fourth-quarter results included an $8.0 million income-tax benefit. The company’s annual actuarial review lowered new-money-rate assumptions and produced $3.4 million of future-loss-reserve adjustments, a $9 million reserve increase for Washington National payout annuities, and an $11 million reduction in amortization expense on certain annuity and interest-sensitive life products.
Material changes, outlook and unusual items
- CLIC was sold for net cash proceeds of approximately $224.9 million. The transaction produced a $269.7 million pretax loss and a $289.1 million net loss after tax and valuation-allowance effects. The sale reduced revenue, assets and liabilities but also generated transition and support-service fees from Wilton Re.
- Bankers Life recaptured a block of life insurance business from Wilton Re for $28.0 million and recognized a $26.1 million pretax reinsurance gain, or $16.9 million after tax.
- Operating cash flow was substantially reduced by a $590.3 million payment to transfer certain long-term-care business to Beechwood Re. CNO remains primarily liable to policyholders if the reinsurer fails, and Beechwood is unrated and relies on collateral trusts.
- Management expects Wilton Re service agreements to provide $30 million through June 30, 2015, $20 million through June 30, 2016, and approximately $0.2 million annually for certain services through June 30, 2019. Failure to reduce overhead as these fees decline could pressure earnings.
- Management expects 2015 Medicare supplement benefit ratios at Bankers Life to be in the 70% range, Bankers Life long-term-care interest-adjusted benefit ratios near 81%, and Washington National supplemental-health interest-adjusted benefit ratios near 54%.
- Colonial Penn expects slightly positive 2015 earnings before investment gains and taxes, but anticipates a first-quarter loss of approximately $7 million due to seasonal advertising spending.
- Management expected to repurchase approximately $250 million to $325 million of common stock during 2015, subject to market and business conditions. Remaining repurchase authorization was $420.9 million at year-end.
- On February 10, 2015, CNO announced a Cognizant technology partnership expected to generate approximately $10 million of annual run-rate savings, with an estimated $6 million of transition charges during the first two quarters of 2015 and the transfer of approximately 640 IT positions.
Principal risks and contingencies
- Persistently low interest rates could compress investment spreads, increase reserve and acquisition-cost charges, and reduce profitability. A 50-basis-point decline in investment earnings rates for products other than interest-sensitive life and annuities was estimated to produce an approximately $175 million pretax charge.
- Long-term-care claims, persistency, mortality, morbidity and rate-approval outcomes remain significant sources of reserve and earnings risk. The company’s 2014 review reduced projected long-term-care margins by $150 million to approximately $100 million.
- CNO depends on dividends, surplus-debenture interest and service payments from regulated insurance subsidiaries. Because immediate insurance subsidiaries had negative earned surplus, future dividends may require regulatory approval.
- Reinsurance credit exposure is material: reinsurance receivables were $3.0 billion and ceded life insurance in force was $3.7 billion. CNO remains liable to policyholders if reinsurers default.
- Debt agreements restrict dividends, share repurchases, additional debt, asset sales and other activities. A covenant default could accelerate debt, and management states the holding company would not have sufficient liquidity to repay accelerated obligations.
- The company had approximately $3.0 billion of federal NOLs and $799.8 million of net deferred tax assets after a $246.0 million valuation allowance. An ownership change under Section 382, weaker future taxable income or an adverse IRS determination could reduce their value.
- Investment, litigation, regulatory, cybersecurity, outsourcing, competition, financial-strength-rating and policy-surrender risks could materially affect earnings, capital and liquidity.
Investor verification points
- Reconcile GAAP net income with non-GAAP net operating income and operating earnings, particularly the CLIC sale loss, tax valuation-allowance changes, investment gains and embedded-derivative effects.
- Review the sustainability of long-term-care assumptions, rate increases, future-loss reserves and the approximately $100 million projected long-term-care margin.
- Verify holding-company cash generation, regulatory approvals for extraordinary dividends and the timing of 2015 debt service and share repurchases.
- Assess credit, collateral and concentration exposure to Beechwood Re, other reinsurers, below-investment-grade securities, structured securities and consolidated VIEs.
- Evaluate the sensitivity of earnings and capital to interest rates, investment spreads, surrender rates, policy persistency and reserve changes.
- Confirm the implementation costs and savings from the Cognizant agreement and whether ongoing overhead reductions offset declining Wilton Re service fees.