CNO Financial Group, Inc. — 2010 Form 10-K Summary
Business context and reporting period
CNO Financial Group, formerly Conseco, Inc., is a U.S. insurance holding company serving primarily senior and middle-income customers through Bankers Life, Washington National, Colonial Penn, Other CNO Business and corporate operations. Products include supplemental health, Medicare supplement, long-term care, annuities and individual life insurance. This Form 10-K covers the fiscal year ended December 31, 2010; the filing is annual rather than a standalone fourth-quarter report.
Beginning July 1, 2010, management changed its operating segment presentation. The company had $31.9 billion of assets, $4.3 billion of shareholders’ equity and approximately 3,680 employees at year-end.
Key financial metrics
| Metric | 2010 | 2009 | Change |
|---|---|---|---|
| Total revenues | $4,083.9 million | $4,341.4 million | Down 5.9% |
| Income before taxes and discontinued operations | $293.5 million | $173.6 million | Up $119.9 million |
| Net income | $284.6 million | $85.7 million | Up $198.9 million |
| Diluted EPS | $0.99 | $0.45 | Up $0.54 |
| Net investment income | $1,366.9 million | $1,292.7 million | Up 5.7% |
| Net realized investment gains (losses) | $30.2 million | $(60.5) million | Improved $90.7 million |
| Net cash from operating activities | $734.0 million | $611.7 million | Up $122.3 million |
| Total assets | $31,899.6 million | $30,343.8 million | Up 5.1% |
| Shareholders’ equity | $4,325.3 million | $3,532.4 million | Up 22.5% |
Premium collections were $3,590.1 million, down from $4,114.8 million in 2009. Health collections were $1,963.1 million, annuity collections were $1,021.9 million and life collections were $605.1 million.
Operating EBIT, a non-GAAP measure excluding corporate interest, realized investment gains and losses, debt extinguishment effects, taxes and discontinued operations, was $360.9 million versus $337.0 million in 2009. Net operating income was $181.9 million versus $164.6 million.
The investment portfolio totaled $23.8 billion, including $20.6 billion of available-for-sale fixed maturities. The average cost-basis yield on fixed maturities was 5.9%, compared with an average credited or accrued rate on insurance liabilities of 4.5%. Insurance-product liabilities totaled $24.5 billion.
Direct corporate debt principal totaled $1,018.0 million at year-end, consisting primarily of the $375.0 million senior secured term loan, $275.0 million of 9.0% senior secured notes, $293.0 million of 7.0% convertible debentures and the $75.0 million Senior Health Note. Direct corporate obligations required approximately $122 million of cash service in 2011, including principal and interest. Holding-company unrestricted cash was approximately $161 million.
Statutory capital and surplus was $1,525.1 million, or $1,596.4 million including the asset valuation reserve. The consolidated insurance-subsidiary RBC ratio was 332%, and the company’s debt-to-total-capitalization ratio under its credit agreement was 19.99%.
Material changes versus prior comparable period
- Net income increased substantially, aided by a $95.0 million reduction in the deferred-tax-asset valuation allowance, improved realized investment results and lower benefits and expenses.
- Revenue declined primarily because of lower premium collections, the wind-down of PFFS business, lower Bankers Life health collections and the effect of prior reinsurance transactions.
- Bankers Life EBIT increased to $284.1 million from $278.0 million, while Washington National EBIT declined to $104.6 million from $110.9 million and Colonial Penn EBIT declined to $26.5 million from $29.4 million.
- Other CNO Business improved to an EBIT loss of $11.5 million from a loss of $43.6 million, but remained unprofitable. It recorded approximately $13 million of additional amortization related mainly to lower projected future investment yields and a $6 million write-off of present value of future profits related to a long-term care block.
- Bankers Life premium collections fell 14% to $2,575.2 million. Washington National collections fell 2.6% to $581.1 million, while Colonial Penn collections were broadly stable at $194.1 million.
- The company refinanced its previous senior credit agreement in December 2010 with a $375 million senior secured term loan and $275 million of 9.0% senior secured notes. It also repurchased all remaining 3.5% debentures and increased 7.0% debentures outstanding to $293 million.
- Net unrealized investment gains improved materially, contributing to accumulated other comprehensive income of $238.3 million at year-end versus a $264.3 million accumulated loss in 2009.
Outlook, commentary, risks and unusual items
Management’s principal 2011 goals are to increase earnings per share, grow sales profitably in the three primary operating segments, generate targeted investment income despite low interest rates, achieve expense efficiencies, manage long-term care profitability and improve or dispose of underperforming blocks.
Management stated that available holding-company cash, operating cash flows and other transactions were expected to support debt service and corporate obligations, but acknowledged that liquidity depends on regulatory approvals, subsidiary earnings, capital markets, competition and general economic conditions. No assurance was provided that sufficient liquidity will be available in all circumstances.
- Long-term care remains a major risk. The Bankers Life long-term care benefit ratio was 113.7% in 2010, while the Other CNO Business long-term care benefit ratio was 210.8%. Rate increases require regulatory approval and may increase lapses or cause adverse selection.
- Low interest rates may compress investment spreads, reduce investment income and require additional amortization or reserve adjustments. Asset and liability durations were approximately 8.8 years and 8.7 years, respectively.
- The company recognized $149.8 million of other-than-temporary impairment losses through net income in 2010, including a $70.6 million impairment on a guaranteed investment contract, $40.8 million on commercial mortgage loans and $23.6 million on mortgage-backed and asset-backed securities.
- Debt agreements restrict dividends, share repurchases, additional borrowing, asset sales and other activities. Covenant breaches could accelerate repayment and materially impair liquidity. The Senior Health Note also prohibits common-stock cash dividends while outstanding; the company did not pay or declare dividends.
- Insurance subsidiaries’ ability to upstream cash is subject to state regulation. The company expected approximately $215 million of extraordinary dividends and $160 million of capital contributions in 2011, subject to regulatory approval.
- Financial-strength ratings improved in 2010, but remained below investment-grade levels: primary subsidiaries were rated B+ by A.M. Best, BB by S&P and Ba1 by Moody’s; Conseco Life was rated B- by A.M. Best.
- The company disclosed litigation, regulatory examinations and class actions involving sales practices, cost-of-insurance charges, annuity suitability, long-term-care benefits and non-guaranteed policy elements. Outcomes could exceed recorded liabilities.
- Management reported that a previously identified material weakness in actuarial reporting controls had been remediated as of December 31, 2010. The independent auditor concluded that internal control over financial reporting was effective.
- Net income included a favorable $95.0 million valuation-allowance adjustment and a $5.5 million reduction from out-of-period adjustments. These items should be distinguished from recurring operating performance.
Most important facts for investors to verify
- Whether long-term care rate approvals, claims experience and persistency support the company’s reserve assumptions and future profitability.
- Whether insurance subsidiaries can generate the projected extraordinary dividends and whether regulators approve those payments.
- Compliance with debt covenants, including the 30% debt-to-total-capitalization limit, RBC requirements and statutory capital minimums.
- The sustainability of the $95 million deferred-tax valuation-allowance release and the realizability of the remaining $850.2 million of net deferred tax assets.
- The quality, valuation and impairment risk of the $23.8 billion investment portfolio, including below-investment-grade and structured securities.
- The effect of low interest rates, policy surrenders, investment defaults and reinsurer credit risk on liquidity and earnings.
- The status and potential financial exposure of pending litigation and regulatory proceedings, particularly the class actions involving cost-of-insurance, annuity sales practices and long-term-care benefits.