CNO FINANCIAL GROUP, INC. In this section, we review the consolidated financial condition of CNO atJune 30, 2020 , and its consolidated results of operations for the six months endedJune 30, 2020 and 2019, and, where appropriate, factors that may affect future financial performance. Please read this discussion in conjunction with the accompanying consolidated financial statements and notes. Results for interim periods are not necessarily indicative of the results that may be expected for a full year, especially when considering the risks and uncertainties associated with the COVID-19 pandemic and the impact it may have on our business, results of operations and financial condition. For additional forward-looking information and risks related to the impact of the pandemic refer to Liquidity and Capital Resources - Potential Impacts of COVID-19 Pandemic included in Management's Discussion and Analysis of Financial Condition and Results of Operations and Item 1A - Risk Factors. In addition, the results for the quarterly period endedJune 30, 2020 , were impacted by: (i) our actuarial unlocking exercise to reduce future expected new money rates and lower the option budgets on our fixed index products; and (ii) increase our accrual for the Global Resolution Agreement. We are closely monitoring developments relating to COVID-19 and assessing its impact on our business, policyholders, agents and associates. Depending on the duration and severity of the pandemic, we foresee the potential for some adverse impacts related to, among other things, near-term sales results, insurance product margin, net investment income, invested assets, regulatory capital, liabilities for insurance products, deferred acquisition costs, the present value of future profits, and income tax assets, although the full extent to which COVID-19 impacts financial results remains uncertain. Operationally, we implemented our business continuity plans and took other precautions, such as employee business travel restrictions and remote work arrangements which, to date, have enabled us to support the health and wellness of our agents and associates, while maintaining our critical business processes, customer service levels, relationships with key vendors, financial reporting systems, internal controls over financial reporting and disclosure controls and procedures. In addition, we implemented additional cybersecurity precautions as a result of our remote working environment. We also introduced financial support programs for our exclusive agents who have seen their businesses disrupted, and their livelihoods challenged, and we deployed enhanced technology tools and training for such agents to allow them to serve consumers through virtual consultations and digital insurance applications. While we have implemented risk management and contingency plans and taken other precautions with respect to the COVID-19 pandemic, such measures may not adequately protect our business from the full impacts of the pandemic. Currently, most of our employees are working remotely with only a few operationally critical employees working at certain of our facilities for business continuity purposes. An extended period of remote work arrangements could strain our business continuity plans, introduce additional operational risk, including but not limited to cybersecurity risks, and impair our ability to effectively manage our business. In addition, the pandemic and its impact on the economy and financial markets could materially adversely affect our business, results of operations, investment portfolio or financial condition. We will continue reviewing accounting estimates, asset valuations and various financial scenarios for capital and liquidity; however, in light of evolving health, economic, governmental, social, and other factors, the potential impact of COVID-19 and actions taken in response to it on our business, results of operations, investment portfolio and financial condition remains uncertain.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Our statements, trend analyses and other information contained in this report and elsewhere (such as in filings by CNO with theSEC , press releases, presentations by CNO or its management or oral statements) relative to markets for CNO's products and trends in CNO's operations or financial results, as well as other statements, contain forward-looking statements within the meaning of the federal securities laws and the Private Securities Litigation Reform Act of 1995. Forward-looking statements typically are identified by the use of terms such as "anticipate," "believe," "plan," "estimate," "expect," "project," "intend," "may," "will," "would," "contemplate," "possible," "attempt," "seek," "should," "could," "goal," "target," "on track," "comfortable with," "optimistic," "guidance," "outlook" and similar words, although some forward-looking statements are expressed differently. You should consider statements that contain these words carefully because they describe our expectations, plans, strategies and goals and our beliefs concerning future business conditions, our results of operations, financial position, and our business outlook or they state other "forward-looking" information based on currently available 55 --------------------------------------------------------------------------------CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES ___________________ information. The "Risk Factors" section of our 2019 Annual Report on Form 10-K and the changes set forth in the Risk Factors section of this Form 10-Q provide examples of risks, uncertainties and events that could cause our actual results to differ materially from the expectations expressed in our forward-looking statements. Assumptions and other important factors that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, among other things:
• the ongoing COVID-19 pandemic and the resulting financial market, economic
and other impacts could adversely affect our business, results of
operations, financial condition and liquidity;
• changes in or sustained low interest rates causing reductions ininvestment income, the margins of our fixed annuity and life insurance
businesses, and sales of, and demand for, our products;
• expectations of lower future investment earnings may cause us toaccelerate amortization, write down the balance of insurance acquisition
costs or establish additional liabilities for insurance products;
• general economic, market and political conditions and uncertainties,
including the performance and fluctuations of the financial markets which
may affect the value of our investments as well as our ability to raise
capital or refinance existing indebtedness and the cost of doing so;
• the ultimate outcome of lawsuits filed against us and other legal and
regulatory proceedings to which we are subject;
• our ability to make anticipated changes to certain non-guaranteed elements
of our life insurance products;
• our ability to obtain adequate and timely rate increases on our health
products, including our long-term care business;
• the receipt of any required regulatory approvals for dividend and surplus
debenture interest payments from our insurance subsidiaries;
• mortality, morbidity, the increased cost and usage of health careservices, persistency, the adequacy of our previous reserve estimates,
changes in the health care market and other factors which may affect the
profitability of our insurance products;
• changes in our assumptions related to deferred acquisition costs or the
present value of future profits;
• the recoverability of our deferred tax assets and the effect of potential
ownership changes and tax rate changes on their value;
• our assumption that the positions we take on our tax return filings will
not be successfully challenged by the Internal Revenue Service;
• changes in accounting principles and the interpretation thereof;
• our ability to continue to satisfy the financial ratio and balance
requirements and other covenants of our debt agreements;
• our ability to achieve anticipated expense reductions and levels ofoperational efficiencies including improvements in claims adjudication and
continued automation and rationalization of operating systems;
• performance and valuation of our investments, including the impact of
realized losses (including other-than-temporary impairment charges);
• our ability to identify products and markets in which we can compete
effectively against competitors with greater market share, higher ratings,
greater financial resources and stronger brand recognition;
• our ability to generate sufficient liquidity to meet our debt service
obligations and other cash needs;
• changes in capital deployment opportunities;
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
___________________• our ability to maintain effective controls over financial reporting;
• our ability to continue to recruit and retain productive agents and
distribution partners;
• customer response to new products, distribution channels and marketing
initiatives;
• our ability to maintain the financial strength ratings of CNO and ourinsurance company subsidiaries as well as the impact of our ratings on our
business, our ability to access capital, and the cost of capital;
• regulatory changes or actions, including: those relating to regulation of
the financial affairs of our insurance companies, such as the calculation
of risk-based capital and minimum capital requirements, and payment of
dividends and surplus debenture interest to us; regulation of the sale,underwriting and pricing of products; and health care regulation affecting
health insurance products;
• changes in the Federal income tax laws and regulations which may affect or
eliminate the relative tax advantages of some of our products or affect
the value of our deferred tax assets;
• availability and effectiveness of reinsurance arrangements, as well as the
impact of any defaults or failure of reinsurers to perform;
• the performance of third party service providers and potential
difficulties arising from outsourcing arrangements;
• the growth rate of sales, collected premiums, annuity deposits and assets;
• interruption in telecommunication, information technology or other
operational systems or failure to maintain the security, confidentiality
or privacy of sensitive data on such systems;
• events of terrorism, cyber attacks, natural disasters or othercatastrophic events, including losses from a disease pandemic or potential
adverse impacts from global warming;
• ineffectiveness of risk management policies and procedures in identifying,
monitoring and managing risks; and
• the risk factors or uncertainties listed from time to time in our filings
with the SEC .
Other factors and assumptions not identified above are also relevant to the forward-looking statements, and if they prove incorrect, could also cause actual results to differ materially from those projected.
All written or oral forward-looking statements attributable to us are expressly qualified in their entirety by the foregoing cautionary statement. Our forward-looking statements speak only as of the date made. We assume no obligation to update or to publicly announce the results of any revisions to any of the forward-looking statements to reflect actual results, future events or developments, changes in assumptions or changes in other factors affecting the forward-looking statements.
The reporting of risk-based capital ("RBC") measures is not intended for the purpose of ranking any insurance company or for use in connection with any marketing, advertising or promotional activities.
OVERVIEW
We are a holding company for a group of insurance companies operating throughoutthe United States that develop, market and administer health insurance, annuity, individual life insurance and other insurance products. We focus on serving the senior and middle-income markets, which we believe are attractive, underserved, high growth markets. We sell our products through three distribution channels: career agents, independent producers (some of whom sell one or more of our product lines exclusively) and direct marketing. 57 --------------------------------------------------------------------------------CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES ___________________ Prior to 2020, the Company managed its business through the following operating segments: Bankers Life, Washington National and Colonial Penn, which were defined on the basis of product distribution; long-term care in run-off; and corporate operations, comprised of holding company activities and certain noninsurance company businesses. InJanuary 2020 , we announced a new operating model that changes how we view our operating segments. Instead of the operating business segments described above, we view our operations as four insurance product lines (annuity, health, life and long-term care) and the investment and fee revenue segments. The new structure creates a leaner, more integrated, customer-centric organization that better positions us for long-term success and shareholder value creation. Our new segments are aligned based on their common characteristics, comparability of profit margins and the way management makes operating decisions and assesses the performance of the business. We began reporting under the new segment structure in the first quarter of 2020. Prior period results have been reclassified to conform to the new reporting structure. Our insurance product line segments (including annuity, health, life and long-term care) include marketing, underwriting and administration of the policies our insurance subsidiaries sell. Under our new operating model, the business written in each of the four product categories through all of our insurance subsidiaries is aggregated allowing management and investors to assess the performance of each product category. When analyzing profitability of these segments, we use insurance product margin as the measure of profitability, which is: (i) insurance policy income; and (ii) net investment income allocated to the insurance product lines; less (i) insurance policy benefits and interest credited to policyholders; and (ii) amortization, non-deferred commissions and advertising expense. Net investment income is allocated to the product lines using the book yield of investments backing the block of business, which is applied to the average insurance liabilities, net of insurance intangibles, for the block in each period. Income from insurance products is the sum of the insurance margins of the annuity, health, life and long-term care product lines, less expenses allocated to the insurance lines. It excludes the income from our fee income business, investment income not allocated to product lines, net expenses not allocated to product lines (primarily holding company expenses) and income taxes. Management believes insurance product margin and income from insurance products help provide a better understanding of the business and a more meaningful analysis of the results of our insurance product lines.
Under our new structure, we market our insurance products through the Consumer and Worksite Divisions that reflect the customers served by the Company.
The Consumer Division serves individual consumers, engaging with them on the phone, online, face-to-face with agents, or through a combination of sales channels. This structure unifies consumer capabilities into a single division and integrates the strength of our agent sales forces and industry-leading direct-to-consumer business with proven experience in advertising, web/digital and call center support. The Worksite Division focuses on worksite and group sales for businesses, associations, and other membership groups, interacting with customers at their place of employment. By creating a dedicated Worksite Division, we bring a sharper focus to this high-growth business while further capitalizing on the strength of our recent acquisition of WBD. The individual results for the Worksite Division are currently not significant pursuant to accounting standards. Sales in the Worksite Division have been particularly adversely impacted by the COVID-19 pandemic given the challenges of interacting with customers at their place of employment. We plan to analyze the profitability of the insurance products of the Consumer and Worksite Divisions separately when the Worksite Division becomes significant.
We also centralized certain functional areas previously housed in the three business segments, including marketing, business unit finance, sales training and support, and agent recruiting, among others. All policy, contract, and certificate terms, conditions, and benefits remain unchanged.
The investment segment involves the management of our capital resources,
including investments and the management of corporate debt and liquidity. Our
measure of profitability of this segment is the total net investment income not
allocated to the insurance products. Investment income not allocated to product
lines represents net investment income less: (i) equity returns credited to
policyholder account balances; (ii) the investment income allocated to our
product lines; (iii) interest expense on notes payable and investment
borrowings; and (iv) certain expenses related to benefit plans that are offset
by special-purpose investment income. Investment income not allocated to product
lines includes investment income on investments in excess of average insurance
liabilities, investments held by our holding companies, the spread we earn from
the FHLB investment
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
___________________
borrowing program and variable components of investment income (including call
and prepayment income, adjustments to returns on structured securities due to
cash flow changes, income (loss) from COLI and variations in income (loss) from
alternative investments), net of interest expense on corporate debt.
Our fee and other revenue segment includes the earnings generated from sales of
third-party insurance products, services provided by WBD (our wholly owned
on-line benefit administration firm) and the operations of our broker-dealer and
registered investment advisor.
Expenses not allocated to product lines include the expenses of our corporate operations, excluding interest expense on debt.
The following summarizes our earnings for the three and six months ending
Three months ended Six months ended
June 30, June 30,
2020 2019 2020 2019
Insurance product margin
Annuity margin $ 123.8 $ 57.2 $ 183.3 $ 113.4
Health margin 82.3 78.3 155.9 157.2
Life margin 36.1 51.7 80.4 94.8
Long-term care margin 13.2 11.9 26.5 23.4
Total insurance product margin 255.4 199.1 446.1 388.8
Allocated expenses (128.1 ) (135.2 ) (264.7 ) (271.1 )
Income from insurance products 127.3 63.9 181.4 117.7
Fee income 5.2 4.4 13.0 8.8
Investment income not allocated to product
lines 8.2 48.3 65.6 91.6
Expenses not allocated to product lines (38.5 ) (19.9 ) (52.3 ) (38.0 )
Operating earnings before taxes 102.2 96.7 207.7 180.1
Income tax expense on operating income (22.8 ) (20.3 ) (44.0 ) (37.9 )
Net operating income (a) 79.4 76.4 163.7 142.2
Net realized investment gains (losses) from
sales, impairments and change in allowance for
credit losses (net of related amortization) 12.3 (1.7 ) (51.4 ) (2.4 )
Net change in market value of investments
recognized in earnings 31.2 6.8 (17.2 ) 23.4
Fair value changes related to agent deferred
compensation plan (13.2 ) (11.6 ) (13.2 ) (16.9 )
Fair value changes in embedded derivative
liabilities (net of related amortization) (27.1 ) (35.9 ) (93.8 ) (65.5 )
Loss on extinguishment of debt - (7.3 ) - (7.3 )
Other - .7 2.3 1.9
Net non-operating loss before taxes 3.2 (49.0 ) (173.3 ) (66.8 )
Income tax benefit on non-operating loss .6 (10.2 ) (36.4 ) (14.0 )
Valuation allowance for deferred tax assets and
other tax items - - (34.0 ) -
Net non-operating loss 2.6 (38.8 ) (102.9 ) (52.8 )
Net income $ 82.0 $ 37.6 $ 60.8 $ 89.4
Per diluted share
Net operating income $ .55 $ .48 $ 1.13 $ .89
Net non-operating loss .02 (.24 ) (.71 ) (.33 )
Net income $ .57 $ .24 $ .42 $ .56
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
_______________________________
(a) Management believes that an analysis of net operating income provides a
clearer comparison of the operating results of the Company from period to
period because it excludes: (i) net realized investment gains (losses)
from sales, impairments and change in allowance for credit losses, net of
related amortization and taxes; (ii) net change in market value of
investments recognized in earnings, net of taxes; (iii) fair value changes
due to fluctuations in the interest rates used to discount embedded
derivative liabilities related to our fixed index annuities, net of
related amortization and taxes; (iv) fair value changes related to theagent deferred compensation plan, net of taxes; (v) loss on extinguishment
of debt, net of taxes; and (vi) other non-operating items consisting
primarily of earnings attributable to VIEs. The table above reconciles the
non-GAAP measures to the corresponding GAAP measure.
In addition, management uses these non-GAAP financial measures in its budgeting process, financial analysis of segment performance and in assessing the allocation of resources. We believe these non-GAAP financial measures enhance an investor's understanding of our financial performance and allows them to make more informed judgments about the Company as a whole. These measures also highlight operating trends that might not otherwise be apparent. However, net operating income is not a measurement of financial performance under GAAP and should not be considered as an alternative to cash flow from operating activities, as a measure of liquidity, or as an alternative to net income as measures of our operating performance or any other measures of performance derived in accordance with GAAP. In addition, net operating income should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. Net operating income has limitations as an analytical tool, and you should not consider such measure either in isolation or as a substitute for analyzing our results as reported under GAAP. Our definition and calculation of net operating income are not necessarily comparable to other similarly titled measures used by other companies due to different methods of calculation.
CRITICAL ACCOUNTING POLICIES
Refer to "Critical Accounting Policies" in our 2019 Annual Report on Form 10-K
for information on our other accounting policies that we consider critical in
preparing our consolidated financial statements.
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
___________________CHANGES IN ACTUARIAL ASSUMPTIONS IN THE SECOND QUARTER OF 2020
We conducted our annual comprehensive review of actuarial assumptions in the fourth quarter of 2019. However, we update our assumptions, as necessary, to the extent current conditions or circumstances warrant changes that could be significant to our operating results. Given our expectation that interest rates will remain low for the long-term, we performed an actuarial unlocking exercise in the second quarter of 2020 to reflect our assumption that average new money rates will remain flat at 4 percent for the long-term. This change and the related impacts to persistency assumptions had a$45.6 million unfavorable impact on pre-tax earnings. As part of the actuarial unlocking exercise, we also changed our assumptions related to the future option costs we incur in providing benefits on fixed index annuities which had a favorable impact on pre-tax earnings of$91.5 million . These future option costs represent the estimated cost we will incur to purchase a series of annual forward options over the duration of the policy that back the potential return based on a percentage of the amount of increase in the value of the appropriate index. When interest rates decrease, we are permitted (subject to policy minimums) to decrease this benefit, lowering the option costs. The impact of these changes in assumptions is summarized below (dollars in millions): Line of business Fixed index Fixed interest Interest- annuities annuities sensitive life Total Favorable (unfavorable) Impacts of an average new money rate assumption of 4 percent Insurance policy benefits$ (5.0 ) $ -$ (7.4 ) $ (12.4 ) Amortization of insurance intangibles (25.6 ) (9.4 ) 1.8 (33.2 ) Subtotal (30.6 ) (9.4 ) (5.6 ) (45.6 ) Impacts of changes in future option costs Insurance policy benefits 104.8 - - 104.8 Amortization of insurance intangibles (13.3 ) - - (13.3 ) Subtotal 91.5 - - 91.5 Impact on pre-tax income$ 60.9 $ (9.4
)
As noted above, the magnitude of the offsetting impacts of the change in new money rate and the change in future option costs had significantly different impacts on our results in the second quarter of 2020. These results are consistent with the different accounting requirements for insurance intangibles and the embedded derivatives related to the future option budgets for our fixed index annuity products. Insurance intangibles related to interest-sensitive products are amortized in relation to estimated gross profits using the interest rate credited to the underlying policies. When actual profits or our current best estimates of future profits are different than our previous estimates, we adjust the cumulative amortization of insurance acquisition costs to maintain amortization expense as a constant percentage of gross profits over the entire life of the policies. Due to this accounting requirement, only a portion of the reduced estimated gross profits due to the change in new money rate assumptions is recognized in earnings in the period of unlocking. The adjustment to gross profits is spread on a retrospective basis over the life of the related blocks of business. The unlocking adjustment in the second quarter of 2020 is a "catch-up" adjustment recognized through earnings to reflect the inception date to current date income adjustments, as if our current assumptions were used to determine amortization from each policy's inception date. For example, the changes in new money rate and persistency assumptions had the effect of reducing estimated gross profits by approximately$280 million . This impact compares to the net unfavorable unlocking adjustments of$45.6 million . In contrast, the options attributable to the policyholder for the estimated life of the contract is treated as an embedded derivative. We are required to record the embedded derivatives related to our fixed index annuity products at estimated fair 61 --------------------------------------------------------------------------------CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES ___________________ value. The value of the embedded derivatives is determined based on the present value of estimated future option costs discounted using a risk-free rate adjusted for our non-performance risk and a risk charge. This rate is currently very low at .85%. Due to this accounting requirement, a significant percentage of the change in gross profits attributable to the change in option budgets is reflected in our current earnings as an unlocking adjustment. For example, the change in expected future option budgets had the effect of increasing estimated gross profits by approximately$105 million . This impact compares to the net favorable unlocking adjustments of$91.5 million . Changes in future new money rate and persistency assumptions can also result in a charge related to our life, health and annuity with life contingency products. However, assumptions related to these products are locked in when the policies are issued and a charge is only taken when the present value of future cash flows, in combination with the related liability for insurance products, is less than the unamortized insurance intangible balance. In such case, the charge would be made to amortization expense at the time assumption changes result in a deficiency. If the deficiency exceeds the balance of insurance intangibles, a premium deficiency reserve is established for the excess. The recoverability test referred to above is conducted based on lines of business consistent with the manner we group them in our segment reporting. Even after the changes in assumptions for new money rates, the loss recognition margins on our traditional life, long-term care, payout annuities, Medicare supplement and supplemental health products are positive. Although, no loss recognition is required in the second quarter of 2020, the future margins for these blocks would be reduced by approximately$160 million due to the impact of these changes in assumptions. This actuarial unlocking exercise does not replace our comprehensive annual review of all assumptions for our insurance products, which we plan to complete in the fourth quarter of this year. Additional adjustments may be identified based on the results of the comprehensive annual review. 62 --------------------------------------------------------------------------------CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES ___________________
RESULTS OF OPERATIONS
The following tables and narratives summarize the operating results of our segments (dollars in millions):
Three months ended Six months ended
June 30, June 30,
2020 2019 2020 2019
Insurance product margin
Annuity:
Insurance policy income $ 4.5 $ 4.2 $ 10.1 $ 10.8
Net investment income 116.6 114.8 234.0 230.6
Insurance policy benefits 107.7 (5.1 ) 102.2 (13.0 )
Interest credited (43.6 ) (41.6 ) (85.6 ) (84.8 )
Amortization and non-deferred commissions (61.4 ) (15.1 ) (77.4 ) (30.2 )
Annuity margin 123.8 57.2 183.3 113.4
Health:
Insurance policy income 360.1 358.1 722.2 716.3
Net investment income 36.1 35.8 72.2 72.0
Insurance policy benefits (274.7 ) (272.7 ) (544.3 ) (537.6 )
Amortization and non-deferred commissions (39.2 ) (42.9 ) (94.2 ) (93.5 )
Health margin 82.3 78.3 155.9 157.2
Life:
Insurance policy income 194.3 189.0 388.4 376.2
Net investment income 34.7 34.8 69.0 69.3
Insurance policy benefits (147.8 ) (126.2 ) (279.7 ) (257.0 )
Interest credited (10.9 ) (10.6 ) (21.2 ) (20.8 )
Amortization and non-deferred commissions (18.0 ) (20.3 ) (39.9 ) (41.2 )
Advertising expense (16.2 ) (15.0 ) (36.2 ) (31.7 )
Life margin 36.1 51.7 80.4 94.8
Long-term care:
Insurance policy income 66.4 67.0 133.3 134.3
Net investment income 34.0 34.0 68.3 67.3
Insurance policy benefits (84.3 ) (85.7 ) (168.5 ) (171.2 )
Amortization and non-deferred commissions (2.9 ) (3.4 ) (6.6 ) (7.0 )
Long-term care margin 13.2 11.9 26.5 23.4
Total insurance product margin 255.4 199.1 446.1 388.8
Allocated expenses:
Branch office expenses (15.1 ) (16.3 ) (34.0 ) (38.6 )
Other allocated expenses (113.0 ) (118.9 ) (230.7 ) (232.5 )
Income from insurance products 127.3 63.9 181.4 117.7
Fee income 5.2 4.4 13.0 8.8
Investment income not allocated to product
lines 8.2 48.3 65.6 91.6
Expenses not allocated to product lines (38.5 ) (19.9 ) (52.3 ) (38.0 )
Operating earnings before taxes 102.2 96.7 207.7 180.1
Income tax expense on operating income (22.8 ) (20.3 ) (44.0 ) (37.9 )
Net operating income $ 79.4 $ 76.4 $ 163.7 $ 142.2
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
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CNO is the top tier holding company for a group of insurance companies operating
throughout the United States that develop, market and administer health
insurance, annuity, individual life insurance and other insurance products. We
view our operations by segments, which consist of insurance product lines. These
products are distributed by our two divisions. The Consumer Division serves
individual consumers, engaging with them on the phone, online, face-to-face with
agents, or through a combination of sales channels. The Worksite Division
focuses on worksite and group sales for businesses, associations, and other
membership groups, interacting with customers at their place of employment.
Insurance product margin is management's measure of the profitability of its
annuity, health, life and long-term care product lines' performance and consists
of premiums plus allocated investment income less insurance policy benefits,
interest credited, commissions, advertising expense and amortization of
acquisition costs. Income from insurance products is the sum of the insurance
margins of the annuity, health, life and long-term care product lines, less
expenses allocated to the insurance lines. It excludes the income from our fee
income business, investment income not allocated to product lines, net expenses
not allocated to product lines (primarily holding company expenses) and income
taxes. Management believes insurance product margin and income from insurance
products help provide a better understanding of the business and a more
meaningful analysis of the results of our insurance product lines.
Investment income is allocated to the product lines using the book yield of
investments backing the block of business, which is applied to the average
insurance liabilities, net of insurance intangibles, for the block in each
period. Investment income not allocated to product lines represents net
investment income less the investment income allocated to our product lines and
includes investment income on investments in excess of average insurance
liabilities, investments held by our holding companies, the spread we earn from
the FHLB investment borrowing program and variable components of investment
income (including call and prepayment income, adjustments to returns on
structured securities due to cash flow changes, income (loss) from COLI and
variations in income (loss) from alternative investments), net of interest
expense on corporate debt.
Management believes that an analysis of Net income applicable to common stock
before: (i) net realized investment gains (losses) from sales, impairments and
change in allowance for credit losses, net of related amortization and taxes;
(ii) net change in market value of investments recognized in earnings, net of
taxes; (iii) fair value changes due to fluctuations in the interest rates used
to discount embedded derivative liabilities related to our fixed index
annuities, net of related amortization and taxes; (iv) fair value changes
related to the agent deferred compensation plan, net of taxes; (v) loss on
extinguishment of debt, net of taxes; (vi) changes in the valuation allowance
for deferred tax assets and other tax items; and (vii) other non-operating items
consisting primarily of earnings attributable to VIEs, net of taxes ("Net
operating income," a non-GAAP financial measure) is important to evaluate the
financial performance of the company, and is a key measure commonly used in the
life insurance industry. Management uses this measure to evaluate performance
because the items excluded from net operating income can be affected by events
that are unrelated to the company's underlying fundamentals.
Summary of Operating Results: Net operating income was $79.4 million in the
second quarter of 2020, up from $76.4 million in the second quarter of 2019, and
was $163.7 million in the first six months of 2020, up from $142.2 million in
the first six months of 2019.
Insurance product margin for the three and six months ended
The higher fee income in the 2020 periods primarily reflects changes in assumptions used to estimate revenues on the sales of third-party products, net of related distribution expenses.
Investment income not allocated to product lines was lower in the 2020 periods as discussed in additional detail below.
Expenses not allocated to product lines were higher in the 2020 periods due to a$23.5 million increase (recognized in the second quarter of 2020) in our liability for claims and interest pursuant to the Global Resolution Agreement as the third-party auditor has provided information that we have processed and verified allowing us to more accurately estimate the ultimate liability pursuant to the agreement. See the note to the consolidated financial statements entitled "Litigation and Other Legal Proceedings - Regulatory Examinations and Fines" for further information about the Global Resolution Agreement. 64 --------------------------------------------------------------------------------CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES ___________________
Margin from Annuity Products (dollars in millions):
Three months ended Six months ended
June 30, June 30,
2020 2019 2020 2019
Annuity margin:
Fixed index annuities
Insurance policy income $ 2.6 $ 2.8 $ 5.9 $ 5.9
Net investment income 82.9 76.0 165.0 151.3
Insurance policy benefits 104.1 (.5 ) 103.1 -
Interest credited (28.3 ) (24.7 ) (54.5 ) (50.4 )
Amortization and non-deferred commissions (49.6 ) (12.1 ) (63.4 ) (24.2 )
Margin from fixed index annuities $ 111.7 $ 41.5 $ 156.1 $ 82.6
Average net insurance liabilities $ 7,056.3 $ 6,388.9 $ 6,988.9 $ 6,291.3
Margin/average net insurance liabilities 6.33 % 2.60 % 4.47 % 2.63 %
Fixed interest annuities
Insurance policy income $ .1 $ .4 $ .4 $ .9
Net investment income 26.8 31.2 54.9 64.0
Insurance policy benefits - (.1 ) (.1 ) (.2 )
Interest credited (14.4 ) (16.0 ) (29.3 ) (32.4 )
Amortization and non-deferred commissions (11.7 ) (3.0 ) (13.8 ) (6.0 )
Margin from fixed interest annuities $ .8 $ 12.5 $ 12.1 $ 26.3
Average net insurance liabilities $ 2,088.2 $ 2,337.9 $ 2,117.2 $ 2,377.6
Margin/average net insurance liabilities .15 % 2.14 % 1.14 % 2.21 %
Other annuities
Insurance policy income 1.8 1.0 3.8 4.0
Net investment income 6.9 7.6 14.1 15.3
Insurance policy benefits 3.6 (4.5 ) (.8 ) (12.8 )
Interest credited (.9 ) (.9 ) (1.8 ) (2.0 )
Amortization and non-deferred commissions (.1 ) - (.2 ) -
Margin from other annuities $ 11.3 $ 3.2 $ 15.1 $ 4.5
Average net insurance liabilities $ 533.5 $ 574.4 $ 542.5 $ 575.1
Margin/average net insurance liabilities 8.47 % 2.23 % 5.57 % 1.56 %
Total annuity margin $ 123.8 $ 57.2 $ 183.3 $ 113.4
Average net insurance liabilities $ 9,678.0 $ 9,301.2 $ 9,648.6 $ 9,244.0
Margin/average net insurance liabilities 5.12 % 2.46 % 3.80 % 2.45 %
Margin from fixed index annuities was $111.7 million in the second quarter of
2020, compared to $41.5 million in 2019, and was $156.1 million in the first six
months of 2020, compared to $82.6 million in 2019. The increase in margin is
primarily due to: (i) the favorable impact of actuarial assumption changes
previously discussed; and (ii) growth in the block. Average net insurance
liabilities (total insurance liabilities less: (i) amounts related to reinsured
business; (ii) deferred acquisition costs; (iii) present value of future
profits; and (iv) the value of unexpired options credited to insurance
liabilities) were $7,056.3 million and $6,388.9 million in the second quarters
of 2020 and 2019, respectively, and were $6,988.9 million and $6,291.3 million
in the first six months of 2020 and 2019, respectively, driven by deposits and
reinvested returns in excess of withdrawals in periods subsequent to the second
quarter of 2019. The increase in net insurance liabilities results in higher net
investment income allocated, however, the earned yield was 4.70 percent in the
second quarter of 2020 down from 4.76 percent in 2019, and was 4.72 percent in
the first six months of 2020 down from 4.81 percent in 2019, reflecting lower
market yields.
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Net investment income and interest credited exclude the change in market values
of the underlying options supporting the fixed index annuity products and
corresponding offsetting amount credited to policyholder account balances. Such
amounts were $44.9 million and $20.2 million in the second quarters of 2020 and
2019, respectively, and were $(75.0) million and $58.1 million in the first six
months of 2020 and 2019, respectively.
Margin from fixed interest annuities was $.8 million in the second quarter of
2020, compared to $12.5 million in 2019, and was $12.1 million in the first six
months of 2020, compared to $26.3 million in 2019. The decrease in margin is
primarily due to: (i) the unfavorable impact of actuarial assumption changes
previously discussed; and (ii) a reduction in the size of the block. Average net
insurance liabilities were $2,088.2 million in the second quarter of 2020
compared to $2,337.9 million in 2019 and were $2,117.2 million in the first six
months of 2020 compared to $2,377.6 million in 2019, driven by withdrawals in
excess of deposits and reinvested returns. The decrease in net insurance
liabilities results in lower net investment income allocated. The earned yield
decreased to 5.13 percent in the second quarter of 2020 from 5.34 percent in
2019 and to 5.19 percent in the first six months of 2020 from 5.38 percent in
2019, reflecting lower market yields.
Margin from other annuities in the 2020 periods reflects favorable mortality
compared to the same periods in the prior year. Annuitant mortality related to
contracts with life contingencies resulted in a decrease in insurance
liabilities and insurance policy benefits of $9.8 million in the second quarter
of 2020.
Margin from
Three months ended Six months ended
June 30, June 30,
2020 2019 2020 2019
Health margin:
Supplemental health
Insurance policy income $ 169.8 $ 164.4 $ 339.6 $ 327.6
Net investment income 34.9 34.7 69.8 69.7
Insurance policy benefits (138.1 ) (128.9 ) (271.0 ) (252.0 )
Amortization and non-deferred commissions (26.2 ) (27.8 ) (55.8 ) (55.4 )
Margin from supplemental health $ 40.4 $ 42.4 $ 82.6 $ 89.9
Margin/insurance policy income 24 % 26 % 24 % 27 %
Medicare supplement
Insurance policy income $ 190.3 $ 193.7 $ 382.6 $ 388.7
Net investment income 1.2 1.1 2.4 2.3
Insurance policy benefits (136.6 ) (143.8 ) (273.3 ) (285.6 )
Amortization and non-deferred commissions (13.0 ) (15.1 ) (38.4 ) (38.1 )
Margin from Medicare supplement $ 41.9 $ 35.9 $ 73.3 $ 67.3
Margin/insurance policy income 22 % 19 % 19 % 17 %
Total health margin $ 82.3 $ 78.3 $ 155.9 $ 157.2
Margin/insurance policy income 23 % 22 % 22 % 22 %
Margin from supplemental health business was$40.4 million in the second quarter of 2020, down 4.7 percent from 2019, and was$82.6 million in the first six months of 2020, down 8.1 percent from 2019, driven primarily by a decrease in the margin as a percentage of insurance policy income to 24% in the second quarter of 2020 compared to 26% in the prior year period and 24% in first six months of 2020 compared to 27% in the prior year period. Insurance policy benefits in the 2019 periods reflected better claims experience than expected. Insurance policy income increased due to new sales in recent periods. Our margin on the supplemental health business in the second quarter of 2020 was unfavorably impacted by higher persistency resulting in a lower release of reserves, more than offsetting favorable claim experience. Such higher persistency primarily resulted from regulatory mandates and the Company's policy which delays the lapsation of policies due to the non-payment of premiums during the pandemic. 66
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Our supplemental health products (including specified disease, accident and
hospital indemnity products) generally provide fixed or limited benefits. For
example, payments under cancer insurance policies are generally made directly
to, or at the direction of, the policyholder following diagnosis of, or
treatment for, a covered type of cancer. Approximately three-fourths of our
supplemental health policies inforce (based on policy count) are sold with
return of premium or cash value riders. The return of premium rider generally
provides that after a policy has been inforce for a specified number of years or
upon the
policyholder reaching a specified age, we will pay to the policyholder, or a
beneficiary under the policy, the aggregate amount of all premiums paid under
the policy, without interest, less the aggregate amount of all claims incurred
under the policy. The cash value rider is similar to the return of premium
rider, but also provides for payment of a graded portion of the return of
premium benefit if the policy terminates before the return of premium benefit is
earned. Accordingly, the net cash flows from these products generally result in
the accumulation of amounts in the early years of a policy (reflected in our
earnings as reserve increases which is a component of insurance policy benefits)
which will be paid out as benefits in later policy years (reflected in our
earnings as reserve decreases which offset the recording of benefit payments).
As the policies age, insurance policy benefits will typically increase, but the
increase in benefits will be partially offset by investment income earned on the
accumulated assets.
Margin from Medicare supplement business was $41.9 million and $35.9 million in
the second quarters of 2020 and 2019, respectively, and was $73.3 million and
$67.3 million in the first six months of 2020 and 2019, respectively. The
increase in margin on the Medicare supplement business in the 2020 periods
reflects favorable claim experience. Such favorable claim experience in the
second quarter of 2020 may be attributable to policyholders deferring health
care during the pandemic which may lead to higher claim costs in future periods.
Insurance policy income was $190.3 million in the second quarter of 2020, down
1.8 percent from 2019, and was $382.6 million in the first six months of 2020,
down 1.6 percent from 2019, reflecting lower sales in recent periods partially
offset by premium rate increases.
Medicare supplement business consists of both individual and group policies.
Government regulations generally require we attain and maintain a ratio of total
benefits incurred to total premiums earned (excluding changes in policy benefits
reserves which is a component of Insurance policy benefits) of not less than 65
percent on individual products and not less than 75 percent on group products.
The ratio is determined after three years from the original issuance of the
policy and over the lifetime of the policy and measured in accordance with
statutory accounting principles. Since the insurance product liabilities we
establish for Medicare supplement business are subject to significant estimates,
the ultimate claim liability we incur for a particular period is likely to be
different than our initial estimate. Changes to our estimates are reflected in
Insurance policy benefits in the period the change is determined.
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
___________________Margin from Life Products (dollars in millions):
Three months ended Six months ended
June 30, June 30,
2020 2019 2020 2019
Life margin:
Interest-sensitive life
Insurance policy income $ 38.7 $ 37.3 $ 78.3 $ 73.5
Net investment income 11.7 11.7 23.4 23.3
Insurance policy benefits (23.2 ) (14.9 ) (38.9 ) (30.8 )
Interest credited (10.7 ) (10.4 ) (20.9 ) (20.4 )
Amortization and non-deferred commissions (4.8 ) (7.1 ) (12.2 ) (14.1 )
Margin from interest-sensitive life $ 11.7 $ 16.6 $ 29.7 $ 31.5
Average net insurance liabilities $ 913.5 $ 860.7 $ 906.8 $ 856.4
Interest margin $ 1.0 $ 1.3 $ 2.5 $ 2.9
Interest margin/average net insurance
liabilities .44 % .60 % .55 % .68 %
Underwriting margin $ 10.7 $ 15.3 $ 27.2 $ 28.6
Underwriting margin/insurance policy
income 28 % 41 % 35 % 39 %
Traditional life
Insurance policy income $ 155.6 $ 151.7 $ 310.1 $ 302.7
Net investment income 23.0 23.1 45.6 46.0
Insurance policy benefits (124.6 ) (111.3 ) (240.8 ) (226.2 )
Interest credited (.2 ) (.2 ) (.3 ) (.4 )
Amortization and non-deferred commissions (13.2 ) (13.2 ) (27.7 ) (27.1 )
Advertising expense (16.2 ) (15.0 ) (36.2 ) (31.7 )
Margin from traditional life $ 24.4 $ 35.1 $ 50.7 $ 63.3
Margin/insurance policy income 16 % 23 % 16 % 21 %
Margin excluding advertising
expense/insurance policy income 26 % 33 % 28 % 31 %
Total life margin $ 36.1 $ 51.7 $ 80.4 $ 94.8
Margin from interest-sensitive life business was $11.7 million in the second
quarter of 2020, down 30 percent from 2019, and was $29.7 million in the first
six months of 2020, down 5.7 percent from 2019. The decrease in margin is
primarily due to: (i) the unfavorable impact of actuarial assumptions previously
discussed; partially offset by (ii) growth in the block due to sales in recent
periods. In addition, we estimate that the impact from death claims related to
COVID-19 on the margin of this block of business was approximately $1 million in
the second quarter of 2020.
The interest margin was $1.0 million and $1.3 million in the second quarters of
2020 and 2019, respectively, and was $2.5 million and $2.9 million in the first
six months of 2020 and 2019, respectively. Net investment income in the 2020
periods is comparable to the 2019 periods. The increase in average net insurance
liabilities results in higher net investment income allocated, however, the
decrease in earned yield has resulted in net investment income being flat
compared to the prior year. The earned yield was 5.12 percent and 5.44 percent
in the second quarters of 2020 and 2019, respectively, and 5.16 percent and 5.44
percent in the first six months of 2020 and 2019, respectively. Interest
credited to policyholders may be changed annually but are subject to minimum
guaranteed rates and, as a result, the reduction in our earned rate was not
fully reflected in the rate credited to policyholders.
Net investment income and interest credited excludes the change in market values
of the underlying options supporting the fixed index life products and
corresponding offsetting amount credited to policyholder account balances. Such
amounts were $5.8 million and $2.9 million in the second quarters of 2020 and
2019, respectively, and were $(10.8) million and $8.6 million in the first six
months of 2020 and 2019, respectively.
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Margin from Traditional life business was $24.4 million in the second quarter of
2020, down 30 percent from 2019, and was $50.7 million in the first six months
of 2020, down 20 percent from 2019. Insurance policy income was $155.6 million
in the second quarter of 2020, up 2.6 percent from the 2019 period, and was
$310.1 million in the first six months of 2020, up 2.4 percent from the 2019
period, reflecting new sales and persistency in the block. Insurance policy
benefits were $124.6 million in the second quarter of 2020, up 12 percent from
the same period in 2019, and were $240.8 million in the first six months of
2020, up 6.5 percent from the 2019 period. We estimate that the impact from
death claims related to COVID-19 increased insurance policy benefits by
approximately $13 million in the second quarter of 2020.
Allocated net investment income in the 2020 periods was comparable to the 2019 periods, as the growth in the block was offset by lower average investment yields in the 2020 periods.
Advertising expense was$16.2 million in the second quarter of 2020, up$1.2 million from the comparable period in 2019, and was$36.2 million in the first six months of 2020, up$4.5 million from the comparable period in 2019. The demand and cost of television advertising can fluctuate from period to period. We are disciplined with our marketing expenditures and will increase or decrease our marketing spend depending on prices.
Margin from Long-term Care Products (dollars in millions):
Three months ended Six months ended
June 30, June 30,
2020 2019 2020 2019
Long-term care margin:
Insurance policy income $ 66.4 $ 67.0 $ 133.3 $ 134.3
Net investment income 34.0 34.0 68.3 67.3
Insurance policy benefits (84.3 ) (85.7 ) (168.5 ) (171.2 )
Amortization and non-deferred commissions (2.9 ) (3.4 ) (6.6 ) (7.0 )
Margin from long-term care $ 13.2 $ 11.9 $ 26.5 $ 23.4
Margin/insurance policy income 20 % 18 % 20 % 17 %
Margin from Long-term care products was$13.2 million in the second quarter of 2020, up 11 percent from 2019, and was$26.5 million in the first six months of 2020, up 13 percent from 2019. The margin as a percentage of insurance policy income increased to 20% in the second quarter of 2020 compared to 18% in the second quarter of 2019 and to 20% in the first six months of 2020 compared to 17% in the first six months of 2019. The margin in the 2020 periods benefited from reserve releases due to deaths that occurred as well as lower claims incurred attributable to policyholders deferring health care during the pandemic. 69 -------------------------------------------------------------------------------- CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES ___________________ Collected Premiums From Annuity and Interest-Sensitive Life Products (dollars in millions): Three months ended Six months ended June 30, June 30, 2020 2019 2020 2019 Collected premiums from annuity and interest-sensitive life products: Annuities$ 242.7 $ 341.2 $ 534.9 $ 656.9 Interest-sensitive life 51.3 51.9 104.4 99.4 Total collected premiums from annuity and interest-sensitive life products$ 294.0 $ 393.1
Collected premiums from annuity and interest-sensitive products decreased 25 percent in the second quarter of 2020, compared to the second quarter of 2019 and 15 percent in the first six months of 2020, compared to the first six months of 2019, primarily due to lower premium collections from fixed index products. We have proactively managed the participation rates on our fixed index products in order to balance sales growth and profitability in the current low interest rate environment.
Investment Income Not Allocated to Product Lines (dollars in millions):
Three months ended Six months ended
June 30, June 30,
2020 2019 2020 2019
Net investment income $ 318.8 $ 334.5 $ 488.4 $ 690.3
Allocated to product lines:
Annuity (116.6 ) (114.8 ) (234.0 ) (230.6 )
Health (36.1 ) (35.8 ) (72.2 ) (72.0 )
Life (34.7 ) (34.8 ) (69.0 ) (69.3 )
Long-term care (34.0 ) (34.0 ) (68.3 ) (67.3 )
Equity returns credited to policyholder
account balances (50.7 ) (23.1 ) 85.8 (66.7 )
Amounts allocated to product lines and
credited to policyholder account balances (272.1 ) (242.5 ) (357.7 ) (505.9 )
Amount related to variable interest
entities and other non-operating items (9.6 ) (16.0 ) (21.2 ) (35.2 )
Interest expense on debt (13.6 ) (12.6 ) (27.2 ) (24.7 )
Interest expense on investment borrowings (5.8 ) (12.3 ) (14.9 ) (24.7 )
Less amounts credited to deferred
compensation plans (offsetting investment
income) (9.5 ) (2.8 ) (1.8 ) (8.2 )
Total adjustments (38.5 ) (43.7 ) (65.1 ) (92.8 )
Investment income not allocated to product
lines $ 8.2 $ 48.3 $ 65.6 $ 91.6
The above table reconciles net investment income to investment income not
allocated to product lines. Such amount will fluctuate from period to period
based on the level of prepayment income (including call premiums); the
performance of our alternative investments (which are typically reported a
quarter in arrears); and the earnings related to the investments underlying our
COLI. The decrease in investment income not allocated to product lines in the
2020 periods can be attributed to lower variable investment income including
income (loss) on alternative investments and prepayment and call income.
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___________________Net Non-Operating Income (Loss) (dollars in millions):
The following summarizes our net non-operating income (loss) for the three and
six months ending
Three months ended Six months ended
June 30, June 30,
2020 2019 2020 2019
Net realized investment gains (losses)
losses from sales, impairments and change
in allowance for credit losses (net of
related amortization) $ 12.3 $ (1.7 ) $ (51.4 ) $ (2.4 )
Net change in market value of investments
recognized in earnings 31.2 6.8 (17.2 ) 23.4
Fair value changes related to agent
deferred compensation plan (13.2 ) (11.6 ) (13.2 ) (16.9 )
Fair value changes in embedded derivative
liabilities (net of related amortization) (27.1 ) (35.9 ) (93.8 ) (65.5 )
Loss on extinguishment of debt - (7.3 ) - (7.3 )
Other - .7 2.3 1.9
Net non-operating income (loss) before
taxes $ 3.2 $ (49.0 ) $ (173.3 ) $ (66.8 )
Net realized investment gains (losses), net of related amortization, in the
three and six months ended June 30, 2020 , were $12.3 million and $(51.4)
million , respectively, including an (increase) decrease in the allowance for
credit losses and other-than-temporary impairment losses of $15.9 million and
$(39.5) million , respectively, which were recorded in earnings. The increase in
the allowance for credit losses in the first six months of 2020 reflects the
market volatility and other impacts of the COVID-19 pandemic. We anticipate
continued volatility and the potential for additional increases to the allowance
for credit losses in future periods. Net realized investment losses in the first
six months of 2019 were $2.4 million (net of related amortization) including
other-than-temporary impairment losses of $2.2 million which were recorded in
earnings.
During the first six months of 2020 and 2019, we recognized an increase
(decrease) in earnings of
During the first six months of 2020 and 2019, we recognized a decrease in earnings of$13.2 million and$16.9 million , respectively, for the mark-to-market change in the agent deferred compensation plan liability which was impacted by changes in the underlying actuarial assumptions used to value the liability. We recognize the mark-to-market change in the estimated value of this liability through earnings as assumptions change. During the first six months of 2020 and 2019, we recognized a decrease in earnings of$93.8 million and$65.5 million , respectively, resulting from changes in the estimated fair value of embedded derivative liabilities related to our fixed index annuities, net of related amortization. Such amounts include the impacts of changes in market interest rates used to determine the derivative's estimated fair value. AtJune 30, 2020 , the weighted average discount rate used to value this liability was .85 percent compared to 1.88 percent atDecember 31, 2019 . The discount rate is based on risk-free rates (U.S. Treasury rates for similar durations) adjusted for non-performance risk and risk margins for non-capital market inputs. The significant decrease inU.S. Treasury rates in the first six months of 2020 was the primary factor in the change in estimated fair value of the embedded derivative liabilities. Loss on extinguishment of debt in the 2019 periods of$7.3 million consisted of: (i) a premium of$6.1 million due to the redemption of the 4.500% Senior Notes dueMay 2020 (the "2020 Notes"); and (ii)$1.2 million related to the write-off of unamortized issuance costs due to the redemption of the 2020 Notes. 71 --------------------------------------------------------------------------------CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES ___________________
LIQUIDITY AND CAPITAL RESOURCES
Potential Impacts of COVID-19 Pandemic
We expect the potential impact of the pandemic on our results will be largely driven by three things which are already impacting our business, but the duration and severity of which are currently unknown:
• the impact of social distancing on our sales volumes;
• changes in mortality, morbidity, and persistency (or lapse rates)
impacting insurance product margin; and
• the resulting economic recession driving: (i) lower net investment income
through lower interest rates; (ii) the impact of credit deterioration on
invested assets and capital; and (iii) potential impacts to reserves and
deferred acquisition costs resulting from lower interest rates.
Given the ongoing uncertainty related to how the COVID-19 pandemic will impact
our results and the continued economic impact it will have, we continue to model
a range of potential outcomes across these three dimensions. The purpose of our
modeling is not to predict certain outcomes, but to develop a range of potential
outcomes and manage capital and liquidity in the context of outcomes within the
range. We most recently updated our models for two scenarios in July 2020 . These
scenarios incorporate many assumptions and actual conditions in future periods
may differ materially from the assumptions used in modeling the two scenarios.
In the first scenario, we assumed 150,000 deaths from the virus in the United
States , with the economy recovering in the third quarter of 2020 and with muted
economic growth in the fourth quarter of 2020. In the second scenario, we
assumed 400,000 deaths from the virus in the United States , with more modest
economic growth in the third quarter of 2020 and with a second wave of economic
recession beginning in the fourth quarter of 2020.
With respect to the impact of the COVID-19 pandemic on sales volumes, we expect
our consolidated results in the second half of 2020 to continue to be
challenged, but with positive momentum during the period. In the second quarter
of 2020, our Consumer Division life, health and long-term care sales (new
annualized premiums) were down 10 percent and collected premiums from our
annuity products were down 29 percent from the same period in the prior year. To
the extent the economy continues to reopen and as our customers and agents
become more accustomed to virtual transactions, sales in the Consumer Division
are expected to improve.
The path to recovery within our Worksite Division is proving to be more
difficult. In the second quarter of 2020, our Worksite Division life and health
sales (new annualized premiums) were down 69 percent compared to the same period
in the prior year. We currently expect sales in the Worksite Division to remain
challenged through the third quarter of 2020 and begin to improve in the fourth
quarter in conjunction with open enrollment periods.
With respect to changes in mortality and morbidity, based on the modeling of the
two scenarios described above we estimate that COVID-19 related claims could
have a net adverse impact on our full year 2020 total insurance product margin
in the range of approximately $20 million to $52 million across the two
scenarios. In the second quarter of 2020, our margin on life insurance products
reflected an estimated $14 million adverse mortality impact related to COVID-19.
While higher mortality claims unfavorably impact our life product margins, we
anticipate that our health and long-term care margins will generally benefit
through a related release of reserves in the second half of 2020. Physical
distancing practices related to COVID-19 had a significant favorable impact on
paid claims in the second quarter of 2020 in our health and long-term care
businesses as consumers deferred medical and/or long-term care treatments. We
expect some portion of this trend to reverse in some subsequent quarter, as and
when physical distancing practices are relaxed.
We believe there is a possibility that high unemployment could translate to an
increase in lapse rates in future periods. If higher lapse rates do occur, we
expect that current period earnings would generally be favorably impacted but
earnings in future periods would be unfavorably impacted, as the base of our
inforce business would be lower.
Regarding our investment portfolio, we have evaluated a range of potential
impacts from the pandemic, including impacts on credit migration, default
levels, net investment income and capital. We used a range of assumptions which
are market-consistent, or in-line with downside assumptions from rating agencies
and consistent with past financial crises. Our
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
___________________evaluation focused in particular on COVID-19 impacted sectors such as real estate, airlines, retail, hospitality, and energy, among others.
With respect to the collective impact of the COVID-19 pandemic on earnings, we expect our operating earnings in the second half of 2020 to be lower than the prior year period. This is driven by the expectation of lower investment yields and due to the impact of COVID-19 claims on insurance product margins. We believe our earnings over the long-term will be impacted by lower interest rates consistent with the assumptions reflected in our actuarial unlocking exercise in the second quarter of 2020. Refer to "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Changes in Actuarial Assumptions in the Second Quarter of 2020" for further information related to changes in certain actuarial assumptions and their impact on our operating results in the second quarter of 2020.
With respect to capital, based on the modeling described above, even with the more adverse impacts of the second scenario, we believe we would be able to:
• maintain our target RBC levels, debt to capital ratios and minimum holding
company liquidity;
• maintain our quarterly dividend to shareholders; and
• have continued capacity for modest share repurchases.
The two modeling scenarios described above, and the resulting range of estimated outcomes, are hypothetical and have been provided to give a general sense of how certain aspects of our business could be affected by COVID-19, depending on the duration and severity of the pandemic and related governmental and social responses and the economic consequences of the pandemic. There are many modeling scenarios which could result in materially different projected outcomes from the two described above and, accordingly the modeling scenarios described above do not constitute an exclusive set of possible outcomes resulting from COVID-19 which could affect our business, results of operations, financial condition and liquidity. Similarly, given the unprecedented nature of the COVID-19 pandemic, the assumptions used in these modeling scenarios, and the related range of outcomes, are based on assumed facts which are inherently unpredictable and, accordingly, if the pandemic progresses and updated assumptions were to be applied to the modeling scenarios the outcome generated by the application of updated assumptions to these modeling scenarios may be materially different from those described above. For example, the actual number ofU.S. deaths and the related economic impacts from COVID-19 may differ materially from the assumptions used to generate the outcomes from the two scenarios. In this regard, we note that while the number of presumed COVID-19 related deaths at the time we modeled the financial impacts to us of COVID-19 was less than our low end assumptions of 150,000, as of the date of this filing the number of reported presumed deaths from the virus inthe United States exceeds 150,000. In addition, policies and actions taken bythe United States government have mitigated the impacts of COVID-19 on the financial markets, investment performance and valuations. There can be no assurance that these policies will continue. If the economic impact of COVID-19 is ultimately worse than contemplated by our modeled scenarios, the impact to our business, results of operations, financial condition and liquidity could be significantly different than described above. 73 -------------------------------------------------------------------------------- CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES ___________________ Our capital structure as ofJune 30, 2020 andDecember 31, 2019 was as follows (dollars in millions): June 30, 2020 December 31, 2019 Total capital: Corporate notes payable$ 989.7 $ 989.1 Shareholders' equity: Common stock 1.4 1.5 Additional paid-in capital 2,664.3 2,767.3 Accumulated other comprehensive income 1,520.2 1,372.5 Retained earnings 545.3 535.7 Total shareholders' equity 4,731.2 4,677.0 Total capital$ 5,720.9 $ 5,666.1 The following table summarizes certain financial ratios as of and for the six months endedJune 30, 2020 and as of and for the year endedDecember 31, 2019 : June 30, 2020 December 31, 2019 Book value per common share$ 33.38 $ 31.58
Book value per common share, excluding accumulated other comprehensive income (a)
22.66 22.32
Debt to total capital ratios:
Corporate debt to total capital 17.3 % 17.5 %
Corporate debt to total capital, excluding accumulated other comprehensive income (a)
23.6 % 23.0 %
_____________________
(a) This non-GAAP measure differs from the corresponding GAAP measure presented
immediately above, because accumulated other comprehensive income has been
excluded from the value of capital used to determine this
measure. Management believes this non-GAAP measure is useful because it
removes the volatility that arises from changes in accumulated other
comprehensive income. Such volatility is often caused by changes in the
estimated fair value of our investment portfolio resulting from changes in
general market interest rates rather than the business decisions made by
management. However, this measure does not replace the corresponding GAAP
measure.
Liquidity for Insurance Operations
Our insurance companies generally receive adequate cash flows from premium collections and investment income to meet their obligations. Life insurance, long-term care insurance and annuity liabilities are generally long-term in nature. Life and annuity policyholders may, however, withdraw funds or surrender their policies, subject to any applicable penalty provisions; there are generally no withdrawal or surrender benefits for long-term care insurance. We actively manage the relationship between the duration of our invested assets and the estimated duration of benefit payments arising from contract liabilities. Three of the Company's insurance subsidiaries (Bankers Life, Washington National and Colonial Penn) are members of the FHLB. As members of the FHLB, our insurance subsidiaries have the ability to borrow on a collateralized basis from the FHLB. We are required to hold certain minimum amounts of FHLB common stock as a condition of membership in the FHLB, and additional amounts based on the amount of the borrowings. AtJune 30, 2020 , the carrying value of the FHLB common stock was$71.0 million . As ofJune 30, 2020 , collateralized borrowings from the FHLB totaled$1.6 billion and the proceeds were used to purchase fixed maturity securities. The borrowings are classified as investment borrowings in the accompanying consolidated balance sheet. The borrowings are collateralized by investments with an estimated fair value of$2.1 billion atJune 30, 2020 , which are maintained in custodial accounts for the benefit of the FHLB. 74 --------------------------------------------------------------------------------CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES ___________________ State laws generally give state insurance regulatory agencies broad authority to protect policyholders in their jurisdictions. Regulators have used this authority in the past to restrict the ability of our insurance subsidiaries to pay any dividends or other amounts without prior approval. We cannot be assured that the regulators will not seek to assert greater supervision and control over our insurance subsidiaries' businesses and financial affairs. Our estimated consolidated statutory RBC ratio was 405 percent atJune 30, 2020 , compared to 408 percent atDecember 31, 2019 . The decrease is primarily due to a 29 percentage point decrease in investment valuation-related items which were substantially offset by statutory operating earnings and the impacts of a change in principle related to certain reserve calculations, net of dividends paid to the holding company. In the first six months of 2020, our estimated consolidated statutory operating earnings were$228 million and insurance company dividends of$130.3 million were paid to the holding company. Statutory operating income and capital and surplus were favorably impacted by$99 million and$53 million , respectively, related to certain provisions in the CARES Act. The favorable impact resulted from provisions that permitted the carryback of net operating losses that were created after 2017 and the temporary repeal of the 80% limitation on the utilization of NOLs created after 2017. Our insurance subsidiaries transfer exposure to certain risk to others through reinsurance arrangements. When we obtain reinsurance, we are still liable for those transferred risks in the event the reinsurer defaults on its obligations. The failure, insolvency, inability or unwillingness of one or more of the Company's reinsurers to perform in accordance with the terms of its reinsurance agreement could negatively impact our earnings or financial position and our consolidated statutory RBC ratio.
Financial Strength Ratings of our Insurance Subsidiaries
Financial strength ratings provided by Fitch Ratings ("Fitch"), A.M. Best
Company ("A.M. Best"), S&P and Moody's Investor Services, Inc. ("Moody's") are
the rating agency's opinions of the ability of our insurance subsidiaries to pay
policyholder claims and obligations when due.
On April 21, 2020 , Fitch affirmed its "A-" financial strength ratings of our
primary insurance subsidiaries. The outlook for these ratings remain stable. An
insurer rated "A", in Fitch's opinion, indicates a low expectation of ceased or
interrupted payments and indicates strong capacity to meet policyholder and
contract obligations. This capacity may, nonetheless, be more vulnerable to
changes in circumstances or in economic conditions than is the case for higher
ratings. Fitch ratings for the industry range from "AAA Exceptionally Strong " to
"C Distressed" and some companies are not rated. Pluses and minuses show the
relative standing within a category. Fitch has nineteen possible ratings. There
are six ratings above the "A-" rating of our primary insurance subsidiaries and
twelve ratings that are below that rating.
On January 29, 2020 , A.M. Best affirmed its "A-" financial strength ratings of
our primary insurance subsidiaries. The outlook for these ratings remain stable.
The "A-" rating is assigned to companies that have an excellent ability, in A.M.
Best's opinion, to meet their ongoing obligations to policyholders. A.M. Best
ratings for the industry currently range from "A++ (Superior)" to "F (In
Liquidation)" and some companies are not rated. An "A++" rating indicates a
superior ability to meet ongoing obligations to policyholders. A.M. Best has
sixteen possible ratings. There are three ratings above the "A-" rating of our
primary insurance subsidiaries and twelve ratings that are below that rating.
On June 21, 2019 , S&P upgraded the financial strength ratings of our primary
insurance subsidiaries to "A-" from
"BBB+" and the outlook for these ratings is stable. S&P financial strength
ratings range from "AAA" to "R" and some companies are not rated. An insurer
rated "A", in S&P's opinion, has strong financial security characteristics, but
is somewhat more likely to be affected by adverse business conditions than are
insurers with higher ratings. Pluses and minuses show the relative standing
within a category. S&P has twenty-one possible ratings. There are six ratings
above the "A-" rating of our primary insurance subsidiaries and fourteen ratings
that are below that rating.
On October 4, 2018 , Moody's upgraded the financial strength ratings of our
primary insurance subsidiaries to "A3" from "Baa1" and the outlook for these
ratings is stable. Moody's actions resulted from the Company's announcement that
Bankers Life had closed on its agreement to cede certain long-term care
policies. Moody's financial strength ratings range from "Aaa" to "C". These
ratings may be supplemented with numbers "1", "2", or "3" to show relative
standing within a category. In Moody's view, an insurer rated "A" offers good
financial security, however, certain elements may be present which suggests a
susceptibility to impairment sometime in the future. Moody's has twenty-one
possible ratings. There are six ratings above the "A3" rating of our primary
insurance subsidiaries and fourteen ratings that are below that rating.
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___________________
Rating agencies have increased the frequency and scope of their credit reviews
and requested additional information from the companies that they rate,
including us. They may also adjust upward the capital and other requirements
employed in the rating agency models for maintenance of certain ratings
levels. We cannot predict what actions rating agencies may take, or what actions
we may take in response. Accordingly, downgrades and outlook revisions related
to us or the life insurance industry may occur in the future at any time and
without notice by any rating agency. These could increase policy surrenders and
withdrawals, adversely affect relationships with our distribution channels,
reduce new sales, reduce our ability to borrow and increase our future borrowing
costs.
Liquidity of the Holding Companies
Availability and Sources and Uses of Holding Company Liquidity; Limitations on Ability of Insurance Subsidiaries to Make Dividend and Surplus Debenture Interest Payments to the Holding Companies; Limitations on Holding Company Activities
AtJune 30, 2020 , CNO,CDOC, Inc. ("CDOC", our wholly owned subsidiary and the immediate parent ofWashington National and Conseco Life Insurance Company of Texas ("CLTX")) and our other non-insurance subsidiaries held unrestricted cash and cash equivalents of$208.0 million . CNO and CDOC are holding companies with no business operations of their own; they depend on their operating subsidiaries for cash to make principal and interest payments on debt, and to pay administrative expenses and income taxes. CNO and CDOC receive cash from insurance subsidiaries, consisting of dividends and distributions, interest payments on surplus debentures and tax-sharing payments, as well as cash from non-insurance subsidiaries consisting of dividends, distributions, loans and advances. The principal non-insurance subsidiaries that provide cash to CNO and CDOC are 40|86Advisors, Inc. , which receives fees from the insurance subsidiaries for investment services, andCNO Services, LLC which receives fees from the insurance subsidiaries for providing administrative services. The agreements between our insurance subsidiaries andCNO Services, LLC and 40|86Advisors, Inc. , respectively, were previously approved by the domestic insurance regulator for each insurance company, and any payments thereunder do not require further regulatory approval.
The following summarizes the current ownership structure of CNO's primary subsidiaries:
[[Image Removed: orgchart2020.jpg]]
The ability of our insurance subsidiaries to pay dividends is subject to state
insurance department regulations and is based on the financial statements of our
insurance subsidiaries prepared in accordance with statutory accounting
practices prescribed or permitted by regulatory authorities, which differ from
GAAP. These regulations generally permit dividends to be paid from statutory
earned surplus of the insurance company without regulatory approval for any
12-month period in amounts equal to the greater of (or in some states, the
lesser of): (i) statutory net gain from operations or net income for the prior
year; or (ii) 10 percent of statutory capital and surplus as of the end of the
preceding year. However, as each of the immediate insurance subsidiaries of CDOC
has significant negative earned surplus, any dividend payments from the
insurance subsidiaries require the prior approval of the director or
commissioner of the applicable state insurance department. In the first six
months of 2020, our insurance subsidiaries paid dividends to CDOC totaling
$130.3 million . We expect to receive regulatory approval for future
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
___________________dividends from our subsidiaries, but there can be no assurance that such payments will be approved or that the financial condition of our insurance subsidiaries will not change, making future approvals less likely.
CDOC holds surplus debentures from CLTX with an aggregate principal amount of$749.6 million . Interest payments on those surplus debentures do not require additional approval provided the RBC ratio of CLTX exceeds 100 percent (but do require prior written notice to theTexas state insurance department). The estimated RBC ratio of CLTX was 352 percent atJune 30, 2020 . CDOC also holds a surplus debenture from Colonial Penn with a principal balance of$160.0 million . Interest payments on that surplus debenture require prior approval by thePennsylvania state insurance department. Dividends and other payments from our non-insurance subsidiaries, including 40|86Advisors, Inc. andCNO Services, LLC , to CNO or CDOC do not require approval by any regulatory authority or other third party. However, insurance regulators may prohibit payments by our insurance subsidiaries to parent companies if they determine that such payments could be adverse to our policyholders or contractholders. The insurance subsidiaries of CDOC receive funds to pay dividends primarily from: (i) the earnings of their direct businesses; (ii) tax sharing payments received from subsidiaries (if applicable); and (iii) with respect to CLTX, dividends received from subsidiaries. AtJune 30, 2020 , the subsidiaries of CLTX had earned surplus (deficit) as summarized below (dollars in millions): Subsidiaries of CLTX Earned surplus (deficit) Additional information Bankers Life $ 256.0 (a) Colonial Penn (354.8 ) (b) ____________________
(a) Bankers Life paid cash dividends of
six months of 2020. Bankers Life may pay dividends without regulatory
approval or prior notice for any 12-month period if such dividends are
less than the greater of: (i) statutory net income for the prior year; or
(ii) 10 percent of statutory capital and surplus as of the end of the
preceding year. Dividends in excess of these levels require 30 days prior
notice.
(b) The deficit is primarily due to transactions which occurred several years
ago, including a tax planning transaction and the fee paid to recapture a
block of business previously ceded to an unaffiliated insurer.
A significant deterioration in the financial condition, earnings or cash flow of the material subsidiaries of CNO or CDOC for any reason could hinder such subsidiaries' ability to pay cash dividends or other disbursements to CNO and/or CDOC, which, in turn, could limit CNO's ability to meet debt service requirements and satisfy other financial obligations. In addition, we may choose to retain capital in our insurance subsidiaries or to contribute additional capital to our insurance subsidiaries to maintain or strengthen their surplus or fund a long-term care reinsurance transaction, and these decisions could limit the amount available at our top tier insurance subsidiaries to pay dividends to the holding companies.
At
Free cash flow is a measure of holding company liquidity and is calculated as: (i) dividends, management fees and surplus debenture interest payments received from our subsidiaries; plus (ii) earnings on corporate investments; less (iii) interest expense, corporate expenses and net tax payments. In the first six months of 2020, we generated approximately$173 million of such free cash flow. The Company is committed to deploying 100 percent of its free cash flow into investments to accelerate profitable growth, common stock dividends and share repurchases. In lateJune 2020 , we resumed share repurchase activity after suspending such share repurchases inmid-March 2020 in light of the uncertainty related to the COVID-19 pandemic. We expect to have capacity to continue modest share repurchases in the second half of 2020. The amount and timing of future share repurchases (if any) will be based on business and market conditions and other factors including, but not limited to, available free cash flows, the current price of our common stock and investment opportunities. In the first six months of 2020, we repurchased 7.1 million shares of common stock for$113.0 million under our securities repurchase program. The Company had remaining repurchase authority of$419.3 million as ofJune 30, 2020 . 77 --------------------------------------------------------------------------------CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES ___________________
In the first six months of 2020, dividends declared on common stock totaled
OnApril 21, 2020 , Fitch affirmed its "BBB-" rating on our senior unsecured debt. The outlook for these ratings remain stable. In Fitch's view, an obligation rated "BBB" indicates that expectations of default risk are currently low. The capacity for payment of financial commitments is considered adequate but adverse business or economic conditions are more likely to impair this capacity. Pluses and minuses show the relative standing within a category. Fitch has a total of 21 possible ratings ranging from "AAA" to "D". There are nine ratings above CNO's "BBB-" rating and eleven ratings that are below its rating. OnJanuary 29, 2020 ,A.M. Best affirmed its "bbb-" issuer credit and senior unsecured debt ratings. The outlook for these ratings remain stable. InA.M. Best's view, a company rated "bbb-" has an adequate ability to meet the terms of its obligations; however, the issuer is more susceptible to changes in economic or other conditions. Pluses and minuses show the relative standing within a category.A.M. Best has a total of 22 possible ratings ranging from "aaa (Exceptional)" to "d (In default)". There are nine ratings above CNO's "bbb-" rating and twelve ratings that are below its rating. OnJune 21, 2019 , S&P upgraded our senior unsecured debt rating to "BBB-" from "BB+" and the outlook for these ratings is stable. In S&P's view, an obligation rated "BBB" exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation. Pluses and minuses show the relative standing within a category. S&P has a total of 22 possible ratings ranging from "AAA (Extremely Strong)" to "D (Payment Default)". There are nine ratings above CNO's "BBB-" rating and twelve ratings that are below its rating. OnOctober 4, 2018 , Moody's upgraded our senior unsecured debt rating to "Baa3" from "Ba1" and the outlook for these ratings is stable. Moody's actions resulted from the Company's announcement that Bankers Life had closed on its agreement to cede certain long-term care policies. In Moody's view, obligations rated "Baa" are subject to moderate credit risk and may possess certain speculative characteristics. A rating is supplemented with numerical modifiers "1", "2" or "3" to show the relative standing within a category. Moody's has a total of 21 possible ratings ranging from "Aaa" to "C". There are nine ratings above CNO's "Baa3" rating and eleven ratings that are below its rating. We believe that the existing cash available to the holding company, the cash flows to be generated from operations and other transactions will be sufficient to allow us to meet our debt service obligations, pay corporate expenses and satisfy other financial obligations. However, our cash flow is affected by a variety of factors, many of which are outside of our control, including insurance regulatory issues, competition, financial markets and other general business conditions. We cannot provide assurance that we will possess sufficient income and liquidity to meet all of our debt service requirements and other holding company obligations. 78 --------------------------------------------------------------------------------
CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES ___________________ INVESTMENTS
At
Gross Gross Estimated
Amortized unrealized unrealized Allowance for fair
cost gains losses credit losses value
Investment grade (a):
Corporate securities $ 10,908.4 $ 2,010.4 $ (33.1 ) $ (2.6 ) $ 12,883.1
United States Treasury securities
and obligations of United States
government corporations and agencies 151.3 79.0 - - 230.3
States and political subdivisions 2,161.5 316.3 (3.3 ) (.5 ) 2,474.0
Foreign governments 85.6 15.9 - - 101.5
Asset-backed securities 1,084.6 27.0 (18.2 ) (.3 ) 1,093.1
Agency residential mortgage-backed
securities 67.8 7.6 - - 75.4
Non-agency residential
mortgage-backed securities 907.9 38.4 (2.7 ) - 943.6
Commercial mortgage-backed
securities 1,810.8 59.0 (43.5 ) - 1,826.3
Collateralized loan obligations 457.6 - (15.1 ) - 442.5
Total investment grade fixed maturities, available for sale 17,635.5 2,553.6 (115.9 )
(3.4 ) 20,069.8
Below-investment grade (a) (b):
Corporate securities 742.8 24.0 (14.9 ) (7.4 ) 744.5
States and political subdivisions 12.9 - (3.5 ) - 9.4
Asset-backed securities 87.8 .2 (5.7 ) - 82.3
Non-agency residential
mortgage-backed securities 1,092.4 110.1 (7.9 ) - 1,194.6
Commercial mortgage-backed
securities 70.2 .5 (3.4 ) - 67.3
Total below-investment grade fixed
maturities, available for sale 2,006.1 134.8 (35.4 ) (7.4 ) 2,098.1
Total fixed maturities, available
for sale $ 19,641.6 $ 2,688.4 $ (151.3 ) $ (10.8 ) $ 22,167.9
_______________(a) Investment ratings are assigned the second lowest rating by Nationally
Recognized Statistical Rating Organizations ("NRSROs") (Moody's, S&P or
Fitch), or if not rated by such firms, the rating assigned by the National
"1" or "2" include fixed maturities generally rated investment grade
(rated "Baa3" or higher by Moody's or rated "BBB-" or higher by S&P and
Fitch). NAIC designations of "3" through "6" are referred to as
below-investment grade (which generally are rated "Ba1" or lower by
Moody's or rated "BB+" or lower by S&P and Fitch). References toinvestment grade or below-investment grade throughout our consolidated
financial statements are determined as described above.
(b) Certain structured securities rated below-investment grade by NRSROs maybe assigned a NAIC 1 or NAIC 2 designation based on the cost basis of the
security relative to estimated recoverable amounts as determined by the
NAIC. Refer to the table below for a summary of our fixed maturity
securities, available for sale, by NAIC designations.
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
___________________
The NAIC evaluates the fixed maturity investments of insurers for regulatory and
capital assessment purposes and assigns securities to one of six credit quality
categories called NAIC designations, which are used by insurers when preparing
their annual statements based on statutory accounting principles. The NAIC
designations are generally similar to the credit quality designations of the
NRSROs for marketable fixed maturity securities, except for certain structured
securities. However, certain structured securities rated below investment grade
by the NRSROs can be assigned NAIC 1 or NAIC 2 designations depending on the
cost basis of the holding relative to estimated recoverable amounts as
determined by the NAIC. The following summarizes the NAIC designations and NRSRO
equivalent ratings:
NAIC Designation NRSRO Equivalent Rating
1 AAA/AA/A
2 BBB
3 BB
4 B
5 CCC and lower
6 In or near default
A summary of our fixed maturity securities, available for sale, by NAIC
designations (or for fixed maturity securities held by non-regulated entities,
based on NRSRO ratings) as of June 30, 2020 is as follows (dollars in millions):
Percentage of
total
Estimated fair estimated fair
NAIC designation Amortized cost value value
1 $ 10,806.7 $ 12,240.1 55.2 %
2 7,934.0 9,037.0 40.8
Total NAIC 1 and 2
(investment grade) 18,740.7 21,277.1 96.0
3 660.3 656.4 3.0
4 218.1 212.2 .9
5 21.5 21.2 .1
6 1.0 1.0 -
Total NAIC 3, 4, 5
and 6
(below-investment
grade) 900.9 890.8 4.0
Total $ 19,641.6 $ 22,167.9 100.0 %
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
___________________The following table summarizes the carrying values and gross unrealized losses of our fixed maturity securities, available for sale, by category as ofJune 30, 2020 (dollars in millions): Percent of Percent of gross fixed Gross unrealized unrealized Carrying value maturities losses losses
States and political subdivisions
$ 6.8 4.6 %
Non-agency residential mortgage-backed
securities 2,138.2 9.7 10.6 7.0
Commercial mortgage-backed securities 1,893.6 8.5 46.9 31.0
Banks 1,582.8 7.1 5.8 3.8
Utilities 1,506.9 6.8 1.2 .8
Insurance 1,479.7 6.7 6.5 4.3
Healthcare/pharmaceuticals 1,307.6 5.9 1.8 1.2
Asset-backed securities 1,175.4 5.3 23.9 15.8
Food/beverage 945.5 4.3 .6 .4
Energy 774.9 3.5 14.1 9.3
Technology 727.5 3.3 .5 .3
Brokerage 725.8 3.3 1.2 .8
Telecom 576.1 2.6 - -
Transportation 533.5 2.4 .6 .4
Real estate/REITs 468.9 2.1 3.0 2.0
Cable/media 451.3 2.0 .4 .3
Collateralized loan obligations 442.5 2.0 15.1 9.9
Capital goods 431.1 1.9 .5 .3
Chemicals 375.0 1.7 1.2 .8
U.S. Treasury and Obligations 230.3 1.0 - -
Other 1,917.9 8.7 10.6 7.0
Total fixed maturities, available for sale
AtJune 30, 2020 , the amortized cost of the Company's below-investment grade fixed maturity securities, available for sale, was$2,006.1 million , or 10 percent of the Company's fixed maturity portfolio. The estimated fair value of the below-investment grade portfolio was$2,098.1 million , or 105 percent of the amortized cost. Below-investment grade corporate debt securities typically have different characteristics than investment grade corporate debt securities. Based on historical performance, probability of default by the borrower is significantly greater for below-investment grade corporate debt securities and in many cases severity of loss is relatively greater as such securities are generally unsecured and often subordinated to other indebtedness of the issuer. Also, issuers of below-investment grade corporate debt securities frequently have higher levels of debt relative to investment-grade issuers, hence, all other things being equal, are generally more sensitive to adverse economic conditions. The Company attempts to reduce the overall risk related to its investment in below-investment grade securities, as in all investments, through careful credit analysis, strict investment policy guidelines, and diversification by issuer and/or guarantor and by industry. 81 --------------------------------------------------------------------------------CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES ___________________
Net Realized and Unrealized Investment Losses
During the first six months of 2020, the$50.4 million of realized losses on sales of$402.4 million of fixed maturity securities, available for sale included: (i)$15.1 million related to various corporate securities; (ii)$25.0 million related to commercial mortgage-backed securities; and (iii)$10.3 million related to various other investments. Securities are generally sold at a loss following unforeseen issuer-specific events or conditions or shifts in perceived relative values. These reasons include but are not limited to: (i) changes in the investment environment, including changes in relative value among potential investment strategies; (ii) expectation that the market value could deteriorate; (iii) our desire to reduce our exposure to an asset class, an issuer or an industry; (iv) prospective or actual changes in credit quality; or (v) changes in expected portfolio cash flows. During the first six months of 2019, the$52.3 million of realized losses on sales of$877.4 million of fixed maturity securities, available for sale, included: (i)$45.2 million related to various corporate securities; and (ii)$7.1 million related to various other investments.
The following summarizes the investments sold at a loss during the first six months of 2020 which had been continuously in an unrealized loss position exceeding 20 percent of the amortized cost basis prior to the sale for the period indicated (dollars in millions):
At date of sale
Number
of issuers Amortized cost Fair value
Less than 6 months prior to sale 17 $ 49.1 $ 34.6
Greater than or equal to 6 months and
less than 12 months prior to sale 1 3.1 1.9
Total 18 $ 52.2 $ 36.5
Prior to January 1, 2020 , we regularly evaluated all of our investments with
unrealized losses for possible impairment. Our assessment of whether unrealized
losses were "other than temporary" required significant judgment. Factors
considered included: (i) the extent to which fair value was less than the cost
basis; (ii) the length of time that the fair value had been less than cost;
(iii) whether the unrealized loss was event driven, credit-driven or a result of
changes in market interest rates or risk premium; (iv) the near-term prospects
for specific events, developments or circumstances likely to affect the value of
the investment; (v) the investment's rating and whether the investment was
investment-grade and/or had been downgraded since its purchase; (vi) whether the
issuer was current on all payments in accordance with the contractual terms of
the investment and was expected to meet all of its obligations under the terms
of the investment; (vii) whether we intended to sell the investment or it was
more likely than not that circumstances would require us to sell the investment
before recovery occurs; (viii) the underlying current and prospective asset and
enterprise values of the issuer and the extent to which the recoverability of
the carrying value of our investment would be affected by changes in such
values; (ix) projections of, and unfavorable changes in, cash flows on
structured securities including mortgage-backed and asset-backed securities; (x)
our best estimate of the value of any collateral; and (xi) other objective and
subjective factors.
Future events may occur, or additional information may become available, which
may necessitate future realized losses in our portfolio. Significant losses
could have a material adverse effect on our consolidated financial statements in
future periods.
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___________________
The following table sets forth the amortized cost and estimated fair value of
those fixed maturities, available for sale, with unrealized losses at June 30,
2020 , by contractual maturity. Actual maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without penalties. Structured securities frequently include provisions
for periodic principal payments and permit periodic unscheduled payments.
Estimated
Amortized fair
cost value
(Dollars in millions)
Due in one year or less $ 2.4 $ 2.5
Due after one year through five years 152.7 149.4
Due after five years through ten years 319.7 305.3
Due after ten years 712.3 664.6
Subtotal 1,187.1 1,121.8
Structured securities 2,094.7 1,997.9
Total $ 3,281.8 $ 3,119.7
The following summarizes the investments in our portfolio rated below-investment
grade not deemed to have credit losses which have been continuously in an
unrealized loss position exceeding 20 percent of the cost basis for the period
indicated as of June 30, 2020 (dollars in millions):
Number Cost Unrealized Estimated
of issuers basis loss fair value
Less than 6 months 1 $ 12.5 $ (3.6 ) $ 8.9
Total $ 12.5 $ (3.6 ) $ 8.9
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___________________
The following table summarizes the gross unrealized losses of our fixed maturity
securities, available for sale, by category and ratings category as of June 30,
2020 (dollars in millions):
Investment grade Below-investment grade
Total gross
B+ and unrealized
AAA/AA/A BBB BB below losses
Commercial mortgage-backed
securities $ 39.5 $ 4.0 $ 3.4 $ - $ 46.9
Asset-backed securities 6.1 12.1 3.8 1.9 23.9
Collateralized loan
obligations 15.1 - - - 15.1
Energy - 5.4 8.7 - 14.1
Non-agency residential
mortgage-backed securities 1.3 1.4 5.3 2.6 10.6
States and political
subdivisions .3 3.0 3.5 - 6.8
Insurance .1 6.3 - .1 6.5
Banks .7 5.0 - .1 5.8
Real estate/REITs 1.4 1.5 .1 - 3.0
Aerospace/defense - 2.8 - .1 2.9
Retail - 2.2 .4 .1 2.7
Entertainment/hotels - - 2.3 .1 2.4
Healthcare/pharmaceuticals - 1.6 .1 .1 1.8
Brokerage .3 .8 .1 - 1.2
Chemicals - 1.0 .2 - 1.2
Autos - 1.1 - .1 1.2
Utilities - 1.2 - - 1.2
Other .6 1.1 1.2 1.1 4.0
Total fixed maturities,
available for sale $ 65.4 $ 50.5 $ 29.1 $ 6.3 $ 151.3
Our investment strategy is to maximize, over a sustained period and within
acceptable parameters of quality and risk, investment income and total
investment return through active strategic asset allocation and investment
management. Accordingly, we may sell securities at a gain or a loss to enhance
the projected total return of the portfolio as market opportunities change, to
reflect changing perceptions of risk, or to better match certain characteristics
of our investment portfolio with the corresponding characteristics of our
insurance liabilities.
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
___________________AtJune 30, 2020 , fixed maturity investments included structured securities with an estimated fair value of$5.7 billion (or 25.8 percent of all fixed maturity securities). The yield characteristics of structured securities generally differ in some respects from those of traditional corporate fixed-income securities or government securities. For example, interest and principal payments on structured securities may occur more frequently, often monthly. In many instances, we are subject to variability in the amount and timing of principal and interest payments. For example, in many cases, partial prepayments may occur at the option of the issuer and prepayment rates are influenced by a number of factors that cannot be predicted with certainty, including: the relative sensitivity of prepayments on the underlying assets backing the security to changes in interest rates and asset values; the availability of alternative financing; a variety of economic, geographic and other factors; the timing, pace and proceeds of liquidations of defaulted collateral; and various security-specific structural considerations (for example, the repayment priority of a given security in a securitization structure). In addition, the total amount of payments for non-agency structured securities may be affected by changes to cumulative default rates or loss severities of the related collateral. The amortized cost and estimated fair value of structured securities atJune 30, 2020 , summarized by type of security, were as follows (dollars in millions): Estimated fair value Percent Amortized of fixed Type cost Amount maturities Asset-backed securities$ 1,172.4 $ 1,175.4 5.3 % Agency residential mortgage-backed securities 67.8 75.4 .3
Non-agency residential mortgage-backed securities 2,000.3 2,138.2
9.7
Commercial mortgage-backed securities 1,881.0 1,893.6 8.5
Collateralized loan obligations 457.6 442.5 2.0
Total structured securities $ 5,579.1 $ 5,725.1 25.8 %
Residential mortgage-backed securities ("RMBS") include transactions
collateralized by agency-guaranteed and non-agency mortgage obligations.
Non-agency RMBS investments are primarily categorized by underlying borrower
credit quality: Prime, Alt-A, Non-Qualified Mortgage ("Non-QM"), and Subprime.
Prime borrowers typically default with the lowest frequency, Alt-A and Non-QM
default at higher rates, and Subprime borrowers default with the highest
frequency. In addition to borrower credit categories, RMBS investments include
Re-Performing Loan ("RPL") and Credit Risk Transfer ("CRT") transactions. RPL
transactions include borrowers with prior difficulty meeting the original
mortgage terms and were subsequently modified, resulting in a sustainable
payback arrangement. CRT securities are collateralized by Government-Sponsored
Enterprise ("GSE") conforming mortgages and Prime borrowers, but without an
agency guarantee against default losses.
Commercial mortgage-backed securities ("CMBS") are secured by commercial real
estate mortgages, generally income producing properties that are managed for
profit. Property types include multi-family dwellings including apartments,
retail centers, hotels, restaurants, hospitals, nursing homes, warehouses, and
office buildings. While most CMBS have call protection features whereby
underlying borrowers may not prepay their mortgages for stated periods of time
without incurring prepayment penalties, recoveries on defaulted collateral may
result in involuntary prepayments.
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
___________________INVESTMENTS IN VARIABLE INTEREST ENTITIES
The following table provides supplemental information about the revenues and
expenses of the VIEs which have been consolidated in accordance with
authoritative guidance, after giving effect to the elimination of our investment
in the VIEs and investment management fees earned by a subsidiary of the Company
(dollars in millions):
Three months ended Six months ended
June 30, June 30,
2020 2019 2020 2019
Revenues:
Net investment income - policyholder
and other special-purpose portfolios $ 13.0 $ 18.6 $ 28.3 $ 40.8
Fee revenue and other income 1.3 1.5 2.6 3.1
Total revenues 14.3 20.1 30.9 43.9
Expenses:
Interest expense 9.0 13.7 19.7 30.2
Other operating expenses .4 .8 .7 1.2
Total expenses 9.4 14.5 20.4 31.4
Income before net realized investment
gains (losses) and income taxes 4.9 5.6 10.5 12.5
Net realized investment gains (losses) 8.8 (6.3 )
(21.3 ) (14.5 )
Income (loss) before income taxes
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
___________________Supplemental Information on Investments Held by VIEs
The following table summarizes the carrying values of the investments held by
the VIEs by category as of
Percent of
Percent Gross gross
of fixed unrealized unrealized
Carrying value maturities losses losses
Healthcare/pharmaceuticals $ 143.7 12.6 % $ 7.6 12.8 %
Technology 126.6 11.1 4.9 8.1
Cable/media 117.8 10.3 5.3 8.9
Food/beverage 81.1 7.1 4.5 7.6
Capital goods 71.7 6.3 3.7 6.2
Consumer products 53.7 4.7 4.0 6.8
Aerospace/defense 51.2 4.5 2.8 4.6
Building materials 48.7 4.3 2.0 3.4
Brokerage 48.4 4.3 1.6 2.6
Paper 46.7 4.1 2.3 3.8
Chemicals 37.1 3.3 1.6 2.7
Transportation 32.1 2.8 1.9 3.2
Autos 31.5 2.8 2.0 3.3
Utilities 29.8 2.6 1.2 2.0
Retail 28.9 2.5 2.2 3.8
Insurance 28.4 2.5 1.0 1.7
Gaming 26.5 2.3 1.6 2.7
Business services 18.1 1.6 1.0 1.6
Metals and mining 12.1 1.1 .6 1.0
Entertainment/hotels 11.5 1.0 1.3 2.2
Other 91.8 8.2 6.6 11.0
Total $ 1,137.4 100.0 % $ 59.7 100.0 %
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CNO FINANCIAL GROUP, INC. AND SUBSIDIARIES
___________________
The following table sets forth the amortized cost and estimated fair value of
those investments held by the VIEs with unrealized losses at June 30, 2020 , by
contractual maturity. Actual maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without penalties.
Estimated
Amortized fair
cost value
(Dollars in millions)
Due in one year or less $ 1.0 $ .4 Due after one year through five years 753.7 691.6 Due after five years through ten years 429.0 404.6 Due after ten years
4.0 3.7
Total $ 1,187.7 $ 1,100.3 The following summarizes the investments sold at a loss during the first six months of 2020 which had been continuously in an unrealized loss position exceeding 20 percent of the amortized cost basis prior to the sale for the period indicated (dollars in millions):
At date of sale
Number
of issuers Amortized cost Fair value
Less than 6 months prior to sale 4$ 5.9 $ 4.0 4$ 5.9 $ 4.0 The following summarizes the investments in our portfolio rated below-investment grade not deemed to have credit losses which have been continuously in an unrealized loss position exceeding 20 percent of the cost basis for the period indicated as ofJune 30, 2020 (dollars in millions): Number Cost Unrealized Estimated of issuers basis loss fair value Less than 6 months 1$ 3.5 $ (.9 ) $ 2.6 $ 3.5 $ (.9 ) $ 2.6 NEW ACCOUNTING STANDARDS
See "Recently Issued Accounting Standards" in the notes to consolidated financial statements for a discussion of recently issued accounting standards.
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