CNO Financial Group, Inc. — 2021 First-Quarter Form 10-Q
Reporting period: Three months ended March 31, 2021. CNO is an insurance holding company serving middle-income pre-retiree and retired Americans through annuity, health, life, investment and fee-based businesses.
Financial Overview
| Metric | Q1 2021 | Q1 2020 | Change |
|---|---|---|---|
| Total revenues | $1,006.0 million | $717.2 million | Up $288.8 million |
| Income before taxes | $190.0 million | $(71.0) million | Turned profitable |
| GAAP net income (loss) | $147.4 million | $(21.2) million | Turned profitable |
| Diluted EPS | $1.08 | $(0.15) | Improved $1.23 |
| Net operating income | $75.2 million | $84.3 million | Down $9.1 million |
| Operating earnings before taxes | $96.9 million | $105.5 million | Down $8.6 million |
| Net cash from operating activities | $89.4 million | $125.7 million | Down $36.3 million |
Reported earnings benefited materially from non-operating items, particularly an $82.1 million favorable change in fixed-index annuity embedded derivative liabilities, compared with a $66.7 million unfavorable change in the prior-year period. The prior-year period also included substantial investment losses and a $34.0 million CARES Act tax benefit.
Margins and Segment Results
- Total insurance product margin increased to $209.7 million from $190.7 million.
- Annuity margin declined to $57.9 million from $59.5 million, primarily due to lower margins in fixed-interest and other annuities, partly offset by growth in fixed-index annuities.
- Health margin rose to $124.7 million from $86.9 million. Management attributed approximately $40 million of favorable COVID-19 impact to deferred medical care, including approximately $25 million in long-term care and $9 million in Medicare supplement.
- Life margin declined to $27.1 million from $44.3 million. COVID-19-related mortality adversely affected life margin by approximately $19 million, including approximately $12 million in traditional life and $7 million in interest-sensitive life.
- Fee income declined modestly on an operating basis to $7.3 million from $7.8 million, despite higher gross fee revenue and expenses following the DirectPath acquisition.
Financial Position, Liquidity and Capital
- Total assets were $34.66 billion at March 31, 2021, compared with $35.34 billion at December 31, 2020.
- Shareholders’ equity declined to $4.86 billion from $5.48 billion, primarily because of a $668.0 million after-tax decline in accumulated other comprehensive income from unrealized investment losses. Book value per common share declined to $36.75 from $40.54; book value excluding accumulated other comprehensive income increased to $25.27 from $24.38.
- Unrestricted cash was $662.9 million, while cash including amounts held by variable interest entities totaled $738.9 million at quarter-end. Holding companies held $324.1 million of unrestricted cash and target minimum holding-company liquidity is $150 million.
- Operating cash flow was $89.4 million. Investing activities used $334.0 million, principally because investment purchases exceeded sales and maturities. Financing activities used $8.4 million.
- Direct corporate obligations were $1.14 billion, consisting principally of $500 million of 5.250% senior notes due 2025, $500 million of 5.250% senior notes due 2029 and $150 million of subordinated debentures due 2060. No amounts were outstanding under the $250 million revolving credit facility, and no scheduled corporate debt maturities occur before May 2025.
- FHLB investment borrowings totaled $1.64 billion and were collateralized by investments with an estimated fair value of $2.0 billion. Borrowings related to variable interest entities were $1.15 billion.
- Estimated consolidated statutory risk-based capital was 407%, versus 411% at year-end 2020; management’s long-term target range is 375% to 400%. The debt-to-total-capital ratio was 19.0% on a GAAP basis and 25.4% excluding accumulated other comprehensive income.
Material Changes and Unusual Items
- The company acquired DirectPath in February 2021 for approximately $50 million, funded with holding-company cash. Approximately $2.5 million of transaction expenses were recognized in the quarter, and the business is included in the fee income segment.
- CNO repurchased 4.1 million shares for $100.0 million during the quarter and had $169.3 million of remaining authorization at March 31. In May 2021, the board authorized an additional $500.0 million of repurchases.
- Common dividends declared totaled $16.2 million, or $0.12 per share. In May 2021, the quarterly dividend was increased to $0.13 per share.
- Net realized investment losses were $2.8 million, substantially improved from $115.5 million of losses in Q1 2020. The 2021 period included a $9.6 million favorable change in credit-loss allowances.
- Comprehensive loss was $520.6 million, driven by $668.0 million of after-tax other comprehensive loss from unrealized investment depreciation, despite GAAP net income of $147.4 million.
- Accumulated other comprehensive income declined to $1.52 billion from $2.19 billion, primarily reflecting lower fair values of fixed-maturity investments as interest rates increased.
Outlook, Risks and Contingencies
Management did not provide conventional full-year earnings guidance in the filing. Its stated outlook assumes investment income allocated to product lines will be approximately flat in 2021, fee income will be modestly favorable, and total expenses will be comparable with 2020 excluding legal and regulatory matters, asset impairments and DirectPath transaction expenses.
- Management expects COVID-19-related health-care deferrals to normalize, potentially increasing future health claims. It expects COVID-19 to have a modest net favorable effect on insurance product margin for the remainder of 2021 but a modest net unfavorable effect in 2022.
- Worksite life and health sales declined 30% year over year in Q1 2021, while consolidated health and life sales increased 4%. Consumer life sales increased 34%, consumer health sales declined 18%, and annuity collected premiums increased 11%.
- Key risks include COVID-19 effects, low interest rates, investment credit deterioration, mortality and morbidity, policy persistency, the adequacy of reserves, reinsurance counterparty risk, regulatory restrictions on subsidiary dividends, litigation, cybersecurity and the recoverability of deferred tax assets.
- The company has $1.5 billion of federal non-life net operating losses, including $945 million expiring in 2023. Management concluded that its deferred tax assets are more likely than not to be realized, but a shortfall in future taxable income could require a valuation allowance and reduce equity.
- Pending litigation includes actions involving Wilmington Trust, KPMG and Platinum-related reinsurance transactions. Management does not believe currently identified matters are probable of materially affecting consolidated results, but stated that adverse outcomes could exceed recorded liabilities.
- The company expects to adopt the revised long-duration insurance contract accounting standard on January 1, 2023 and has not yet determined its impact.
Investor Verification Items
- Reconcile GAAP net income of $147.4 million with net operating income of $75.2 million and assess the sustainability of the $82.1 million embedded-derivative benefit.
- Determine how quickly deferred health-care utilization and COVID-19 mortality effects normalize, particularly in long-term care, Medicare supplement and life products.
- Monitor investment portfolio credit quality, interest-rate sensitivity, unrealized losses and the 5.1% below-investment-grade portion of fixed maturities based on NAIC designations.
- Track statutory RBC, holding-company liquidity, subsidiary dividend approvals and the ability to fund debt service, dividends and share repurchases.
- Assess the effect of DirectPath integration, legal and regulatory accruals, and the pending long-duration contract accounting change.