CNO Financial Group, Inc. — Form 10-Q Summary
Business context and reporting period
CNO Financial Group is a U.S. insurance holding company serving senior and middle-income customers through Bankers Life, Washington National, Colonial Penn, Other CNO Business and corporate operations. Products include health insurance, annuities, individual life insurance and related products distributed through career agents, independent producers and direct marketing. This unaudited Form 10-Q covers the three and six months ended June 30, 2011, compared with the corresponding 2010 periods.
Key financial metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Total revenues | $1,032.0 million vs. $953.2 million | $2,081.2 million vs. $1,955.6 million |
| Income before taxes | $92.2 million vs. $51.8 million | $175.8 million vs. $104.9 million |
| Net income | $59.5 million vs. $33.1 million | $113.4 million vs. $67.0 million |
| Basic EPS | $0.24 vs. $0.13 | $0.45 vs. $0.27 |
| Diluted EPS | $0.21 vs. $0.12 | $0.39 vs. $0.25 |
| Operating income, non-GAAP | $57.5 million vs. $44.9 million | $109.4 million vs. $83.1 million |
| Cash flow from operations | Not separately provided | $360.8 million vs. $346.0 million |
Six-month total revenue increased approximately 6.4%, while net income increased approximately 69%. The filing does not present a single consolidated operating margin; income before taxes as a percentage of revenue was approximately 8.4% in the first six months of 2011 versus 5.4% in 2010.
Financial position, debt and liquidity
- Total assets were $32.4 billion at June 30, 2011, compared with $31.9 billion at December 31, 2010.
- Shareholders’ equity increased to $4.56 billion from $4.33 billion, supported by $113.4 million of net income and $134.4 million of other comprehensive income, partly offset by $16.2 million of share repurchases.
- Unrestricted cash and cash equivalents were $580.2 million; holding-company and other non-insurance subsidiaries held $131 million of unrestricted cash and $103 million of investments.
- Direct corporate notes payable were $934.5 million, down from $998.5 million. Total capital was $5.50 billion, and corporate debt represented 17.0% of total capital on a GAAP basis and 18.7% under the credit agreement definition.
- Investment borrowings were $1.31 billion, primarily collateralized Federal Home Loan Bank borrowings backed by investments with a fair value of approximately $1.6 billion. Borrowings related to variable-interest entities were $317.3 million.
- The company generated $360.8 million of operating cash flow, used $290.0 million in investing activities and $62.5 million in financing activities, ending with an $8.3 million increase in cash during the first six months.
- The insurance subsidiaries’ consolidated risk-based capital ratio was 351%, compared with a 300% management target and applicable credit agreement thresholds. Management stated that existing liquidity, operating cash flow and anticipated insurance-subsidiary dividends should meet holding-company obligations, but noted that regulatory approvals and business conditions could restrict such payments.
Material changes versus the prior comparable period
- Bankers Life was the primary earnings driver. Six-month segment income before realized investment gains increased to $148.6 million from $117.2 million, helped by higher investment income, life sales and favorable effects from long-term-care rate actions.
- Washington National’s six-month segment income before realized investment gains declined to $47.9 million from $48.7 million. Supplemental health growth was offset by weaker Medicare supplement sales, higher lapses and benefit pressure.
- Colonial Penn’s six-month segment income before realized investment gains increased slightly to $13.0 million from $12.9 million.
- Other CNO Business improved to $11.9 million from $6.9 million before realized investment gains, although it consists primarily of products no longer actively marketed.
- Net realized investment results improved to an $8.0 million gain from a $21.6 million loss. Other-than-temporary impairment losses recognized in earnings declined to $23.4 million from $48.2 million.
- Bankers Life’s six-month amortization expense increased to $171.6 million from $137.6 million, including approximately $23 million of additional amortization from higher-than-anticipated Medicare supplement lapses in the first quarter.
- Bankers Life premium collections declined 1.3% for the first six months, while Washington National collections increased 1.3% and Colonial Penn collections increased 3.7%.
- During the second quarter, the company sold the trading portfolio previously used to offset earnings volatility from fixed-index annuity embedded derivatives. Management expects greater future earnings volatility as a result.
Guidance, outlook, commentary and unusual items
- No formal quantitative earnings guidance is provided in the filing.
- Management expected approximately $37 million of additional long-term-care rate increases at Bankers Life after all state approvals; approximately $15.6 million had been approved by June 30, 2011.
- The fixed-maturity portfolio had a fair value of $21.6 billion, including $1.79 billion of below-investment-grade securities, or 8.5% of amortized cost. Gross unrealized losses were $229.0 million, compared with $336.9 million at December 31, 2010.
- The company recorded $23.4 million of investment impairments in the first six months, including an $11.5 million impairment related to a guaranteed investment contract and $8.6 million related to commercial mortgage loans. The remaining guaranteed investment contract had a $104.1 million book value and a 2029 maturity if not commuted earlier.
- Deferred tax assets were subject to a $1.1 billion valuation allowance. Management concluded that approximately $0.7 billion of deferred tax assets were more likely than not recoverable. Future taxable income, IRS positions and ownership changes could affect this conclusion.
- The company repurchased 2.2 million shares for $16.2 million under a new authorization of up to $100 million. The Senior Secured Credit Agreement was amended to reduce borrowing costs and modify restricted-payment, investment and non-investment-grade investment provisions.
- Long-term-care claims remain a significant risk. The six-month benefit ratio was 114.2% at Bankers Life and 221.0% in Other CNO Business; the corresponding interest-adjusted ratios were 71.2% and 127.6%.
- Material risks include low interest rates, investment losses and impairments, insurance claims and reserve estimation, regulatory approval of rate increases and dividends, debt covenant compliance, liquidity, financial-strength ratings, tax-asset recoverability, litigation and regulatory actions.
- Subsequent to quarter-end, CEO C. James Prieur announced retirement effective September 30, 2011. CFO Edward J. Bonach was appointed CEO effective October 1, 2011, and Scott R. Perry was appointed chief operating officer.
Most important facts for investors to verify
- Whether long-term-care rate increases are approved and produce the expected improvement in claims profitability and persistency.
- The effect of selling the fixed-index annuity trading portfolio on future earnings volatility and derivative accounting results.
- Investment portfolio credit quality, particularly below-investment-grade, structured securities, commercial mortgage loans and the remaining guaranteed investment contract.
- Whether statutory capital, risk-based capital and regulatory approvals support continuing dividends from insurance subsidiaries to the holding company.
- Compliance with debt covenants and the company’s ability to refinance or service approximately $951.8 million of scheduled direct corporate principal payments.
- Realization of deferred tax assets and the potential impact of IRS challenges or a future Section 382 ownership change.
- Developments in pending class actions, cost-of-insurance disputes, regulatory proceedings and related settlements.