CNO

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

Business Context and Reporting Period

This Quarterly Report on Form 10-Q covers the period ended September 30, 2005. The registrant, Conseco, Inc. (CNO), is a holding company for a group of insurance companies operating throughout the United States. The company focuses on supplemental health insurance, annuities, and individual life insurance, primarily serving senior and middle-income markets. CNO emerged from bankruptcy reorganization effective September 10, 2003. Operations are managed through two primary segments: Bankers Life (career agents and direct marketing) and Conseco Insurance Group (independent producers), along with an Other Business in Run-off segment.

Key Financial Metrics (Nine Months Ended Sept 30, 2005)

Material Changes vs. Prior Period

• Profitability: Net income increased 18.9% year-over-year, driven by higher net investment income and improved operating results in the Bankers Life segment.
• Investment Portfolio: Net realized investment gains were $3.1 million in 2005, compared to $27.5 million in 2004. This decrease was due to lower net gains from sales of fixed maturities and writedowns of $4.1 million for other-than-temporary impairments in 2005.
• Liquidity: Unrestricted cash and cash equivalents decreased significantly from $776.6 million to $189.0 million. This reduction was primarily due to the use of proceeds from a $330 million convertible debenture offering to repay term loans under the previous Credit Facility.
• Debt Structure: In August 2005, the company issued $330 million of 3.50% Convertible Debentures and entered into a new $447 million secured credit agreement (Amended Credit Facility), replacing the previous facility. A $3.7 million loss on extinguishment of debt was recognized.
• Segment Performance:
  • Bankers Life: Income before taxes increased to $187.5 million (from $175.7 million) due to higher premium collections in life insurance and annuities.
  • Conseco Insurance Group: Income before taxes decreased slightly to $199.1 million (from $202.8 million) due to lower premium collections in Medicare supplement products.
  • Other Business in Run-off: Income before taxes increased to $63.5 million (from $49.8 million), though the benefit ratio for long-term care products remained high at 97.2%.

Guidance, Outlook, Risks, and Contingencies

• Outlook: Management expects to increase annuity sales efforts in the Conseco Insurance Group segment for the remainder of 2005. The company is aggressively seeking rate increases on long-term care policies to address high benefit ratios.
• Rating Outlook: A.M. Best and S&P revised their outlooks on primary insurance subsidiaries to "Positive" in August 2005. Moody's placed ratings on review for upgrade in July 2005. Current ratings remain below investment grade (e.g., A.M. Best "B++", S&P "BB+", Moody's "Ba1").
• Key Risks:
  • Long-Term Care (LTC) Profitability: The LTC block in the "Other Business in Run-off" segment has a benefit ratio of 97.2% for the nine months ended Sept 30, 2005. Failure to obtain regulatory approval for rate increases could materially adversely affect results.
  • Interest Rate Risk: A 10% increase in interest rates could reduce the fair value of actively managed fixed maturity investments by approximately $725 million.
  • Litigation: The company faces numerous class actions, including the "Cost of Insurance" litigation involving ~86,500 policies and the "Russell" ERISA settlement ($10 million). The company estimates a maximum loss of $1.5 million for the securities litigation against former officers.
  • Director & Officer Loans: The company is pursuing collection of D&O loans totaling $481.3 million. Only ~$38 million is estimated to be collectible. A liability of $17.3 million is recorded for payments to former TOPrS holders.
• Unusual Items: A $3.7 million loss on extinguishment of debt was recorded in Q3 2005. Net realized investment losses included $4.1 million in writedowns for other-than-temporary impairments.

Investor Verification Checklist

• Long-Term Care Rate Approvals: Verify the status of pending rate increase applications for the "Other Business in Run-off" segment, as profitability is highly sensitive to these approvals.
• Litigation Reserves: Review the adequacy of reserves for the "Cost of Insurance" class action and the potential recovery of the $10 million Russell settlement from the fiduciary insurer (RLI).
• Debt Covenants: Confirm continued compliance with the Amended Credit Facility covenants, specifically the debt-to-total capitalization ratio (17% at Sept 30, 2005) and interest coverage ratio.
• Investment Impairments: Monitor the $163.6 million in gross unrealized losses on fixed maturities to assess the risk of future other-than-temporary impairment charges.
• Cash Flow Sustainability: Assess the impact of the significant drop in unrestricted cash ($587.6 million decrease) on the holding company's ability to service debt without relying on dividends from insurance subsidiaries.