CNO Financial Group, Inc. — 2023 First-Quarter Form 10-Q Summary
Business context and reporting period
CNO Financial Group is a holding company for U.S. insurance businesses offering health insurance, annuities, individual life insurance and related financial services. It primarily serves middle-income pre-retirees and retirees through exclusive agents, independent producers and direct marketing. The filing covers the unaudited three months ended March 31, 2023, with prior-year amounts recast for adoption of ASU 2018-12, the long-duration insurance accounting standard.
Key financial metrics
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Total revenues | $1,006.0 million | $842.9 million | +$163.1 million |
| Income before taxes | $(1.0) million | $240.3 million | Down $241.3 million |
| Net income | $(0.8) million | $183.4 million | Down $184.2 million |
| Diluted EPS | $(0.01) | $1.52 | Down $1.53 |
| Net operating income | $58.6 million | $64.5 million | Down $5.9 million |
| Operating earnings per diluted share | $0.51 | $0.54 | Down $0.03 |
| Net cash from operating activities | $81.9 million | $56.4 million | +$25.5 million |
| Total assets | $34.015 billion | $33.133 billion at Dec. 31, 2022 | +$881.9 million |
| Shareholders’ equity | $2.032 billion | $1.769 billion at Dec. 31, 2022 | +$263.0 million |
Insurance policy income was $625.5 million, essentially flat with $625.0 million in the prior-year quarter. General-account net investment income increased to $292.2 million from $277.5 million. Net investment income from policyholder and other special-purpose portfolios was $50.8 million versus a $69.3 million loss in Q1 2022. Total investment losses were $14.6 million compared with $32.7 million in the prior-year quarter.
Benefits and expenses increased to $1.007 billion from $602.6 million. The primary unusual drivers were a $65.1 million unfavorable effect from changes in the fair value of embedded derivative liabilities and market risk benefits, compared with a $165.4 million favorable effect in Q1 2022, and higher interest expense of $54.7 million versus $23.8 million.
Total insurance product margin increased to $221.2 million from $207.2 million. Annuity margin was $57.3 million, health margin was $116.5 million and life margin was $47.4 million. Fee income increased to $15.5 million from $9.9 million, while investment income not allocated to product lines declined to $15.5 million from $27.0 million.
Comprehensive income was $292.1 million compared with a comprehensive loss of $751.8 million in Q1 2022, primarily reflecting a $292.9 million after-tax improvement in other comprehensive income from investment and insurance liability remeasurement effects.
Financial condition, debt and liquidity
- Unrestricted cash and cash equivalents were $425.0 million at March 31, 2023; cash including amounts held by variable interest entities was $522.1 million.
- Holding-company liquidity was $157.5 million, above the $150 million minimum target. Management reported $22 million of holding-company free cash flow for the quarter.
- Direct corporate obligations were $1.139 billion, consisting primarily of $500 million of 5.250% senior notes due 2025, $500 million of 5.250% senior notes due 2029 and $150 million of 5.125% subordinated debentures due 2060.
- No amounts were outstanding under the $250 million revolving credit agreement. There were no scheduled repayments of direct corporate obligations until May 2025.
- FHLB investment borrowings were $1.840 billion, collateralized by investments with an estimated fair value of $2.4 billion. Investment borrowing increased from $1.640 billion at year-end 2022, and related interest expense rose materially because of higher variable rates.
- Corporate debt-to-total-capital was 35.9% on a GAAP basis and 23.6% excluding accumulated other comprehensive loss; management’s targeted range for the latter measure is 25% to 28%.
- Estimated consolidated statutory RBC ratio was 380%, above the company’s 375% target and 350% risk-appetite minimum, but down from 384% at December 31, 2022.
Material changes versus the prior comparable period
- GAAP earnings declined sharply because Q1 2022 benefited from a $165.4 million favorable fair-value change in embedded derivatives and market risk benefits, while Q1 2023 recorded a $65.1 million unfavorable change.
- Net operating income declined 9.1% despite a 6.8% increase in insurance product margin, primarily because allocated and unallocated expenses rose 10% and investment income not allocated to product lines declined.
- Life margin increased $11.4 million, supported by block growth and favorable mortality. Health margin increased modestly, with stronger supplemental health and long-term care results offsetting lower Medicare supplement margin.
- Medicare supplement insurance policy income declined 6.2%, reflecting lower recent sales partly offset by premium rate increases. Management also noted a shift toward Medicare Advantage sales through third-party products.
- Fixed indexed annuity premium collections declined 8.8% to $323.3 million, while fixed interest annuity premium collections increased 298% to $46.1 million, reflecting consumer preference for products offering higher credited rates in the prevailing interest-rate environment.
- Operating cash flow increased to $81.9 million from $56.4 million, while investing cash outflows decreased to $406.7 million from $1.010 billion. Financing cash inflows declined to $202.0 million from $816.2 million.
- The company repurchased 0.6 million shares for $15.1 million during the quarter and paid $16.4 million of declared common dividends. In May 2023, the board authorized an additional $500 million of repurchase capacity and increased the quarterly dividend to $0.15 per share from $0.14.
Guidance, outlook, risks and unusual items
Management maintained its 2023 outlook for operating earnings per diluted share of $2.80 to $3.00, excluding significant items, and holding-company cash flow of $170 million to $200 million, excluding the potential effect of a proposed reinsurance transaction.
CNO is seeking regulatory approval to form a wholly owned Bermuda captive reinsurer. The proposed structure would cede part of the in-force fixed indexed annuity business and all new fixed indexed annuity business written after inception. If approved, management expects to initiate a treaty in the third quarter of 2023 and estimates additional holding-company excess cash flow of $150 million to $200 million at inception.
Management expects higher interest rates to benefit operating results over time, but results remain sensitive to interest rates, equity markets, credit conditions, investment valuations, policyholder behavior, mortality, morbidity, health-care costs, lapse and surrender activity, and the adequacy of insurance reserves.
- Fixed maturity investments had an estimated fair value of $21.107 billion and gross unrealized losses of $2.495 billion at March 31, 2023. Management stated that it did not intend to sell the securities with unrealized losses and believed issuers would continue to meet their obligations; future realized losses remain possible.
- Approximately 96.8% of the fixed maturity portfolio by estimated fair value was investment grade; 3.2% was below investment grade. Consolidated VIE investments included approximately $1.018 billion of predominantly below-investment-grade corporate loans and related securities.
- The company’s $987.9 million net deferred tax asset was considered realizable based on projected future taxable income. Failure to achieve those projections could require a valuation allowance and reduce earnings and equity.
- Insurance subsidiaries’ ability to remit dividends is subject to regulatory approval. Several subsidiaries have significant negative earned surplus, increasing reliance on regulatory approval for future distributions.
- Pending litigation and regulatory examinations include matters related to Beechwood Re, Platinum Partners and policyholder claims. Management does not currently believe existing matters will have a material adverse effect after recorded provisions, but notes that outcomes and potential losses are difficult to predict.
- The company adopted ASU 2018-12 effective January 1, 2023. The adoption materially changed insurance liability, deferred acquisition cost, market risk benefit and accumulated other comprehensive income presentation, so reported comparisons should be evaluated using the recast amounts.
Most important facts for an investor to verify
- Reconcile the $58.6 million of net operating income to the $(0.8) million GAAP net loss and assess the sustainability of the underlying insurance margins.
- Monitor the fair-value sensitivity of fixed indexed annuity embedded derivatives and market risk benefits, which produced a $65.1 million unfavorable pre-tax effect in Q1 2023.
- Evaluate investment portfolio credit quality, unrealized losses, structured securities exposure and the below-investment-grade VIE portfolio.
- Confirm approval, timing, economics and capital effects of the proposed Bermuda captive reinsurance transaction.
- Assess liquidity dependence on insurance-subsidiary dividends, including regulatory approvals, RBC levels and subsidiary earned-surplus constraints.
- Review the company’s ability to achieve its $2.80 to $3.00 operating EPS guidance amid higher interest expense and elevated expenses.
- Track the recoverability of the $987.9 million deferred tax asset and the status of IRS, regulatory and litigation matters.