CNO

CNO Financial Group, Inc. (Conseco, Inc.) - Q1 2008 10-Q Summary

Business Context and Reporting Period

This is a Quarterly Report (Form 10-Q) for the period ended March 31, 2008. The registrant is Conseco, Inc. (CNO), a holding company for a group of insurance companies operating in the United States. The company focuses on supplemental health insurance, annuities, and individual life insurance, primarily serving senior and middle-income markets through career agents, independent producers, and direct marketing. The company is currently in the process of remediating a material weakness in internal controls over financial reporting identified in 2006 and 2007, which led to the restatement of prior financial periods.

Key Financial Metrics

Investment Portfolio: Total investments were $23.15 billion. The portfolio includes $20.16 billion in actively managed fixed maturities. Net realized investment losses for the quarter were $43.6 million, driven by $41.3 million in writedowns for other-than-temporary declines in fair value.

Material Changes vs. Prior Period

• Net Loss Increase: The net loss widened to $5.8 million from $0.5 million in Q1 2007. This was primarily due to increased net realized investment losses ($43.6 million vs. $34.9 million) and higher insurance policy benefits.
• Segment Performance:
  • Bankers Life: Income before taxes dropped to $12.3 million from $41.0 million, largely due to a $16.8 million net realized investment loss and higher benefit ratios in long-term care (111.6% vs. 102.7%).
  • Colonial Penn: Income before taxes decreased slightly to $3.1 million from $4.4 million, though premium collections rose 54%.
  • Conseco Insurance Group: Income before taxes improved to $14.5 million from $10.9 million, despite a 25% drop in premium collections due to reduced annuity sales and a major coinsurance transaction in late 2007.
  • Other Business in Run-off: Loss before taxes improved significantly to a $0.7 million profit from a $26.3 million loss, aided by a $22 million reserve adjustment in the prior year that is not recurring.
• Equity Decline: Shareholders' equity decreased by approximately $296 million from year-end 2007, driven by the net loss and a $292.3 million decrease in accumulated other comprehensive loss due to unrealized depreciation on investments.

Guidance, Outlook, Risks, and Unusual Items

• Investment Volatility: Management notes continued volatility in credit markets, leading to higher risk premiums and potential for additional impairments in the fixed maturity portfolio. Net unrealized investment losses increased by $0.5 billion in the quarter.
• Long-Term Care (LTC) Challenges: The company faces significant headwinds in its LTC blocks (Bankers Life and Run-off). Persistency is higher than assumed, and claims are increasing. The company is aggressively seeking rate increases; approximately 44% of requested increases in Bankers Life and 74% in Run-off have been approved as of March 31, 2008. Failure to obtain necessary rate increases could require write-offs of acquisition costs.
• Internal Controls: A material weakness in internal controls over the actuarial reporting process remains unremediated as of March 31, 2008. Management aims to remediate this by the end of 2008. Disclosure controls and procedures were deemed ineffective.
• Legal Proceedings: Significant litigation includes the "Cost of Insurance" class action (settled in 2007, with implementation ongoing), agent misclassification lawsuits, and annuity marketing practices suits. The company also faces regulatory examinations regarding LTC claims and sales practices, resulting in a potential $2.3 million fine and $10 million in additional penalties if benchmarks are not met.
• Tax Risks: The company holds approximately $5.0 billion in Net Operating Loss (NOL) carryforwards. Utilization is limited by Section 382 of the Internal Revenue Code to approximately $142 million annually (or $587 million for 2008 including carryforwards). An additional ownership change could further restrict the use of these NOLs.
• Variable Interest Entity (VIE): The company consolidated a VIE (Fall Creek CLO Ltd.) which experienced threshold ratio issues. The company committed up to $25 million in additional capital and contributed $5 million in Q1 2008.

Investor Verification Checklist

• Investment Impairments: Verify the extent of "other-than-temporary" impairments and the methodology used to assess recoverability of the $1.19 billion in gross unrealized losses on fixed maturities.
• LTC Rate Increase Approvals: Monitor the status of pending regulatory approvals for premium rate increases in the Bankers Life and Run-off segments, as profitability is heavily dependent on these adjustments.
• Internal Control Remediation: Track progress on the remediation of the material weakness in actuarial reporting to ensure future financial statements are reliable.
• Section 382 Limitations: Assess the risk of an "ownership change" that could further limit the utilization of the company's significant NOL carryforwards.
• Litigation Exposure: Review updates on pending class actions regarding agent misclassification and annuity marketing, as outcomes could result in material liabilities.
• Reinsurance Dependence: Evaluate the impact of the Coventry quota-share agreements on revenue stability and the risks associated with the recapture of modified coinsurance agreements.