CNO Financial Group Inc (CNO) 2005 Q3 法說會逐字稿

Thank you for holding and welcome to the Conseco teleconference. We will begin with an address of Lowell Short, Conseco's Senior Vice President of Investor Relations. [OPERATOR INSTRUCTIONS] Thank you for your attention and here is Lowell Short.

Good morning, everyone. Thank you for joining us for Conseco's third quarter earnings conference call. On the call with me this morning are Bill Kirsch, Conseco's Chief Executive Officer, Gene Bullis, Chief Financial Officer, Jim Hohmann, Chief Administrative Officer, Scott Perry, Chief Operating Officer of the Company's Bankers Life segment, Michael Dubes, President of the Company's Conseco Insurance Group segment, and several other executives.

Before I turn it over to the management team, just a couple of reminders We'll be referring in the call to information contained in this mornings's earnings release. You can obtain the release by visiting the Company news section of our website at conseco.com. We expect to file our Form 10-Q on Monday, November 7th. The 10 Q will also be available through the investors section of of our website. The forward-looking statements being made today are subject to a number of factors, which may cause actual results to be materially different than those contemplated by the forward-looking statements. Please refer to this morning's earnings release and to our latest forms 10-K and 10-Q for additional information concerning the forward-looking statements and related factors.

And now I'll turn the call over to our Chief Executive Officer, Bill Kirsch. Bill?

Thank you, Lowell. First, I would like to summarize financial highlights of our third quarter performance. Net operating income for this quarter was up 24% compared to Q3 '04 to $72 million. Operating income per share rose 22% to $0.44. Net income per diluted share, including $0.02 per share of realized investment losses rose 17% to $0.42. And EBIT, which also factors out realized gains and losses, rose 23% to $143 million, and we expect our actual federal tax rate to be less than 1%.

As the third quarter financial results clearly show, Conseco today is making substantial progress in building a more valuable business. Sales are up, expenses are down, and we continue to make substantial strategic investments to improve our distribution channels, operating platform, product development and delivery, in-force management and leadership team. We continue to make progress on each of our key initiatives, aimed at achieving our short-term goal of higher ratings and building a solid foundation for future growth.

Importantly, year-to-date operating earnings of $216.6 million are up nearly $75 million or 53% compared to the first nine months of 2004. Our steady performance continues to build financial strength. We ended this quarter with a book value per share of $20.65, up from $19.18 at year-end. Our balance sheet has no goodwill, low leverage with a debt to capital ratio of about 17%, and a high-quality investment portfolio, with about 97% of our fixed income investments rated investment grade. While we have not yet completed our stat financials, we expect our consolidated RBC at September 30th to be above 330%, demonstrating the high level of financial strength that protects our policyholders. In a few minutes, I'm going to ask Gene Bullis, our CFO, to give you the details behind our strong third quarter financial performance. But before I turn it over to Gene, I'd like to cover a few operational highlights of our quarter.

Our first key initiative is sales growth. Total sales for the nine months were up 8% compared to 2004, and total sales for the quarter rose by 9%. We are continuing to achieve measured sales growth in products where we can compete profitably today, and which will serve as the foundation for a family of future products. During the quarter, we capitalized on growth opportunities across our three distribution channels, including independent, captive and direct.

In the Conseco insurance independent agent channel, total sales for the nine months were up 9% compared to 2004, and sales for the quarter rose by a robust 34%. We are very pleased with the sales progress at CIG. It is the result of good planning and hard work commenced earlier in the year to improve agent and customer service and to design new products, which provide our agents with a competitive sales strategy to enhance their ability to serve customers. One important example of the many programs underway at CIG to recruit independent agents is our 'Expect Big Things' sales road show.

This recruiting road show, which began early in August in Indianapolis and wrapped up today in Omaha, took us to 28 cities in all parts of the country and put us in front of more than 1,600 independent agents. We are very pleased with the response we are experiencing on our road show. And thanks in part to this road show and in part to our other determined recruiting programs, CIG's new agent appointments, new applications and new business are running well ahead of last year.

In the Career channel at Bankers, sales grew 2% over Q3 '04 and sales for the nine months were up 7%. Growth came in our Med Supp line, which was up 14% versus Q3 '04. Life sales increased 38% over Q3 '04, continuing to reflect the purposeful rotation of our agent force to a more balanced mix between health, life and annuity products. Sales for the quarter for fixed annuities were affected adversely by rising CD rates, declining 11% from a year ago. And long-term care sales were down 14% with prior year's third quarter, reflecting the effect of our price increase.

Although long-term care sales were slow, we continue to be pleased with our agent's acceptance of our new LTC products and their determination to sell through the price increases. As of September 30, 2005, the Bankers agent force has increased to 4,650 from 4,200 a year earlier. During the fourth quarter 2005, Bankers will be introducing two annuity products, a new equity indexed annuity and a five-year fixed annuity, designed to compete against the CD market.

We are very excited about launching our new Medicare Part D prescription drug program on November 15th. Our PDP products and marketing plans have been well received by our Bankers branches across the country. The career channel did experience a disruption in business, due to the effects of both hurricane Katrina and Wilma. Hurricane Katrina directly affected the operations of four Gulf Coast branch offices. Our best estimate is that the disruption resulted in approximately one to two million less sales for the third quarter, and hurricane Wilma directly affected six Florida branch offices. We are working hard to minimize the impact on the fourth quarter. At Colonial Penn. total sales were up 21% over Q3 '04 and sales for the nine months rose 10%.

Our next key initiative is expense management. Consistent with our commitment to be a low-cost operator, we continue to aggressively eliminate nonstrategic costs. I'm very proud that all operating segments achieved their expense savings goal this quarter. As a result, we are on track to exceed our stated goal of 30 million. We plan to keep pushing hard for additional savings, as we simplify and streamline our business, and we expect further expense reductions in 2006. In addition to our success on sales and expenses, our initiatives to achieve technological excellence, implement the more efficient and effective operating platform, deliver excellent customer service, and adopt best practices in governance and compliance all contributed to our strong third quarter.

In technology, we are consolidating and simplifying data processing and management systems, in order to provide better and more cost-effective service to policyholders and distribution partners. We are continuing to make major investments in systems designed to simplify our operations and improve their cost and scalability. In operations at both CIG and Bankers, we are pleased with our efforts to improve service and reduce costs, while handling increasing volumes of business. In our effort to build a unified performance culture, we continue to upgrade and develop our talent. Since our last call, we continued strengthening our leadership team with the addition of Chris Nickele, our new EVP of product development. Chris is a first-rate insurance industry veteran who joins us from Lincoln Financial and is already making important contributions to our product development efforts.

In addition, we were fortunate to recruit Tim Powell as Director of Private Placements, a new position for 40|86. Tim previously served as Director of Domestic Private Placements at MetLife, where he managed a $12 billion portfolio. We have now added 21 new key executives to our leadership team since August, 2004, expanding both our expertise and growth prospects. Beyond these achievements, we are also making substantial progress on in-force management.

I will now invite Jim Hohmann, our Chief Administrative Officer, to discuss the highlights of the resolute actions we are taking on our in-force blocks. Jim?

Thanks, Bill. We are moving forward to rerate our in-force Medicare supplement business at both CIG and Bankers. And we are also in the process of implementing the Florida Insurance Department order, regarding our home health care policies in that state. Both Bankers Life and CIG have very efficient and proven rerate processes for Medicare supplement policies. For example, if you look at Bankers Life, in the past -- in years past, we have successfully implemented 90% of all rate increases with a 1-1 effective date.

This year, we are on a similar track, having already achieved approval in 60% of our states. In addition, after careful analysis, consideration and planning, we have decided to rerate much of the in-force comprehensive long-term care and nursing home business at Bankers. This increase will impact approximately 65% of the total LTC in-force block at Bankers. As has the entire LTC industry over the past several years, Bankers comprehensive LTC and nursing home in-force has experienced lower lapses in interest rate declines.

This decision to rerate our in-force results from the recognition of the full impact of the emerging lapse rates on future experience. Rate increase filings began in October and have been sent to approximately 90% of the state's for approval. To date, we have actually received approval in five states, including Illinois, our state of domicile. Bill.

Thank you, Jim. I want to thank the Bankers field force for supporting our decision to carefully manage Bankers in-force long-term care business. We have not made this decision lightly, and we have involved our field force in the process. Bankers agents understand these actions and are -- in that they are consistent with Bankers commitment to remain a strong and leading provider in this market. And now I will turn it over to our CFO, Gene Bullis, for comments on the financial results.

Thanks, Bill. As detailed in this morning's press release, net income applicable to common stock for the third quarter was $68.4 million or $0.42 per diluted common share. Excluding realized investment losses, net income was $72.1 million or $0.44 per share. Our book value per share at September 30th increased to $20.65 per share, excluding accumulated other comprehensive income under FAS 115. As you know, during the third quarter we amended and reduced our bank debt facility and issued $330 million of convertible debt. As a result, we have reduced our annual interest cost by about $17 million and increased our financial flexibility.

Turning to benefit ratios Bankers Med Supp benefit ratio declined .6% from 72.4% in the second quarter to 71.8% in the third quarter. We would expect fourth quarter benefit ratios to be in this range and then improve in 2006, as our rating actions on the in-force block take hold. Bankers long-term care benefit ratio was 93.9%, compared to 92.6% in Q2. As we disclosed, the Q2 ratio included a one-time reserve release of $6.4 million, and otherwise would have been 97%. The principle factor impacting this ratio persistency abated during the quarter.

CIG's Med Supp benefit ratio improved during the quarter, and earned premium was flat, reversing a declining trend, although I will caution expectations that Med Supp earned premium for CIG would be flat. As a matter of fact, we expect it to continue to decline gradually for the next few quarters and then start to increase, as the impact of NAP takes hold. Our specified disease loss ratio increased by 1.8% compared to Q2, which is inconsistent with our expectation of moderate improvement. The variance related, in part, to an old transport life cancer block that experienced unusual incidence of claim activity on lives with very old old initial incurral dates, suggesting an increase in recidivism on these lives. We have no reason to believe that this represents a trend, although we are continuing to monitor claim activity for this phenomenon.

Net investment income continues to benefit from prepayment activity, which contributed about $12 million of incremental yield this quarter. A significant portion of prepayments were attributable to investments allocated to FAS 97 products and, accordingly, resulted in offsetting increased amortization of $5 million. Excluding prepayments from both periods, our year-to-date 2005 earned yield increased to 5.65%, compared to 5.59% last year. We have experienced prepayment income consistently for the last several quarters, which reflects our asset allocation weighting towards mortgage-related investments. As rates rise, which we expect, prepayments will likely decline, but portfolio yield should increase.

Portfolio quality remains a chief driver and our portfolio reflects strong bias toward conservative assessment of risk reward in today's markets. At September 30th, the portfolio was 97% investment grade. Our gross unrealized losses on below investment grade securities, a leading indicator of potential impairments, was only $16 million. Pretax results for the quarter in our corporate segment included some unusual items, specifically $8 million of performance fee income, triggered by the liquidation of a 40|86 managed structured investment, $2.4 million of severance related to headcount reduction across the Company and $3.7 million loss on early debt extinguishment. Our statutory statements for the quarter will be filed on November 15th, and we expect continued solid results for stat, as well.

Based on our fourth -- our first nine months results and expectations for the fourth quarter, we currently expect full year earnings for 2005 will be in line with our earnings trend to date. Our priority continues to be the maximize long-term value by investing in future growth opportunities. Because we are managing our business to achieve annual, rather than quarterly targets, we do not provide quarterly earnings guidance. Our outlook, which excludes the impact of net realized investment gains and losses is based on numerous assumptions and factors, so please consult our cautionary forward-looking statements in today's release and in our other documents filed with the SEC. We expect to provide outlook for 2006 when we report results for the full year 2005.

With that, I'll turn it back to Bill Kirsch for some concluding comments.

Thank you, Gene. Looking forward, Conseco will strive to continue to execute effectively our key initiatives, as we invest in building a more efficient platform in order to reduce costs, grow sales and provide effective customer service. In the coming months, we will roll out new products to strengthen our value proposition for agents and leverage our strengths with existing needs in the marketplace, as we continue to position Conseco to provide value to middle America through our offerings in life, annuities, and supplemental health insurance products. We will continue building on our strengths and remain resolute in taking the tough actions necessary to increase our productivity and drive increases in sales and earnings in a manner which positions our ability to grow shareholder value over the long term.

And now, I'll turn it up to the operator for your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Jukka Lipponen of KBW.

Good morning. A couple of questions. First, with respect to the guidance, Bill, am I interpreting the changed language correctly in that you have consistently said that you would not provide specific quarterly guidance and so was that basically what was driving sort of the changed language?

Yes. We continue to stand by our conservative philosophy of not providing any guidance, but with three quarters of recorded earnings that have already been announced, we thought it would be prudent to provide an outlook for the full year and basically, to articulate that we believe it's reasonable to anticipate full-year earnings to reflect our current performance trends through the previous three recorded quarters.

On the tax rulings, can you give us an update where we are on those?

Yes, I'd be happy to. Let me offer a little perspective on that. In August of 2004 we had four substantial issues open with the IRS. Number one, it was open as to whether our loss was a capital loss or an ordinary loss. Second, we were open as to the amount of the loss. Third, we were open as to whether section 382 would apply to limit the loss. And fourth, we were open as to whether the IRS would confirm that the NOL was life versus nonlife.

Since August, 2004, we have made steady and consistent and positive progress with the IRS, and today we have resolved three of the four open issues. We have reached a closing agreement, as previously reported, with the IRS, which concluded that the CFC loss was ordinary and not capital. That was a huge agreement with the IRS. We confirmed that the amount of the NOL was $6.7 billion resulting in a $4.5 billion usable NOL on a going-forward basis. And recently the IRS national office confirmed their agreement that -- with us in our prior position that section 382 does not apply.

The remaining question that remains open with the IRS is whether our NOL,which has been confirmed, in dollar amount and in character as an ordinary loss not limited by 382, is life or nonlife. It's important to understand that, given the progress we have made to date, at a minimum we are able to use 35% of our life income and shelter it each year by even the nonlife NOL. So regardless of the outcome with the IRS, we can shelter 35% of our life income each year by our nonlife NOL. We are in continuous discussions with the IRS, but as you can imagine, in dealing with the IRS we cannot predict any timing or outcome. We have made excellent progress to date in working through our issues with the IRS. We have a very constructive working relationship with them. They respect our positions and we are focused on continuing to make steady progress to resolve our one remaining issue.

And then last question, on the Florida home health care block, how are the policyholder selections coming in between the three options?

That's another excellent question. I am going to invite Jim Hohmann to answer that question for us.

Okay. With regard to Florida order, recall that there are three options in the order, and the first option is one that would result in a 50% rate increase and no change in benefits. The second option would have a 25% rate increase, with certain reductions in benefit and some opportunity to have rate increase in future years. And the third option is the discontinuance of premiums, effectively a nonforfeiture type of option. The way the elections have come in on Conseco Senior Health, which is essentially complete at this point, is as follows. Roughly, if you look at overall all of the policies, roughly 50% have elected option one. A very small amount, less than 3% have elected option 2. About 30% have elected option 3. We're waiting response on about 7.5%, and almost 12% are actually on claim now.

What happens with those that are on claim is after they would come off claim, they would receive an election notice and they would be -- they would be asked to make an election, just like all the other policyholders. So if you were, for example, to exclude those that we're awaiting responses on and those that are on claim, and if you were to take the very small election of option 2 as just that, a very small election, they seem to be breaking out roughly 60/40 option one, option three.

Thank you very much.

Your next question comes from Andrew [Brill] of Goldman Sachs.

Just a few questions here. First off, what sort of loss improvement should we be thinking about from the rate increases on the long-term care side at Bankers? And just as a follow up to that, how quickly will we see that price impact -- impact the loss ratios?

We would not expect to see a significant impact on our GAAP results on benefit ratios on long-term care as a result of the price increase, largely because future rate increases were anticipated when we established active life reserves when we did Fresh Start. We should expect to see a relatively significant impact on statutory results.

Thank you. And just with regards to the 'Expect Big Things' tour, can you just talk to the number of additional new agents that you have contracted, as a result of that, and should we be thinking about material impact to sales in 4Q or in 2006 as a result of this?

It is developing effort to continue to appoint new agents. We have enjoyed a nice healthy boost in appointing new agents from our 'Expect Big Things' road show. It was very well attended in each of the cities that we visited. And the robust increase in sales in the third quarter reflects our current trend, which we expect to continue. So 'Expect Big Things' road show, you know, is one of many important steps we are taking to successfully reengage independent distribution.

So, you'd say 3Q had a fairly big impact from this tour?

I would say that 3Q is reflecting a number of purposeful initiatives that are underway and have been underway throughout the year, including new product launches, including improved customer service, and including other efforts to recruit agents in addition to the road show. So, our team at CIG is very skilled at developing quality and enduring relationships with independent agents and we're enjoying the benefits of that, and we expect to continue.

That's helpful. Just one more question, who decides opportunity from Medicare Part D? I mean, is it fair to believe we should expect a noticeable boost in Med Supp sales over the next few quarters, as people start to sign on ahead of the May '06 deadline?

Well, there's two things there. Number one, we do -- one of the things we're very proud of is the fact that we are continuing to be very effective in selling our Med Supp products across our distribution channels. At CIG, our Med Supp sales are up substantially and accelerating. At Bankers our Med Supp sales, as we discussed earlier, are growing, I think it was 14%. And we think that the PDP product will stand on its own, as does our Med Supp product and we believe we continue to offer a valuable proposition to our customers in the supplemental health lines. Our PDP product I think is a very good product and I think it it reflects our -- the strength of our distribution channels, which will be successful in selling nonproprietary products.

Thank you.

Thank you.

Your next question comes from Thomas Gallagher of Credit Suisse First Boston.

Good morning, this is Craig Siegenthaler As a follow up with the IRS tax issue question, we just want to make sure we got this right. Have you filed an appeal and when do you think it will be resolved? And, also, I'd like to follow with a third question following the answer.

On the tax question, we are in discussions with the IRS, We believe that, you know, the progress that we're making is steady and, while I don't want to be, you know, inscrutable, I think it's important to point out that our discussions with the IRS are confidential, and we really cannot -- we're not at liberty to discuss the details of that process.

Okay, thank you. Final question, describe what you're seeing in Bankers long-term care loss trends, and were there any reserve releases in the loss ratio in the third quarter?

There were no reserve releases in the third quarter, and the trend reflects a couple of ticks improvement in persistency.

Okay, thank you.

An improvement persis --

Less persistent.

Yes, that which is improvement for us.

Right.

[OPERATOR INSTRUCTIONS] Your next question comes from Mark Finkelstein of Cochran Caronia Securities.

Hi, good morning. A couple things here. I understand the answer to the long-term care rerates in terms of the GAAP loss ratio, but I'm kind of curious, with the rate increases, would you expect to see shock lapses, and how should we think about dak acceleration charges.

We have modeled some level of shock lapses in our expectations. So there will be some, which is already reflected in our expectations, so we don't see that as having a significant impact on our overall results. And it would be -- we would expect that those-- those shock lapses would be most likely to occur in relatively recent policy issues. In other words, the older books would be able to absorb this premium increase and we don't think we will see much in the way of shock lapses. Of course, if there is, active life reserve adjustments they would be minimal for new issues.

We have thoroughly evaluated that issue in connection with the rerate process and, you know, our assumptions in that are baked into the rerates that we have filed and are filing.

Okay, thank you. And then I don't recall this, if you can't disclose it yet that's okay, what percentage of the risk are you going to take on Part D?

Yes, we're not at liberty to disclose that in a confidential agreement, but suffice it to say we are very pleased with the position that we have in the PDP program. We think our partnership with Coventry gives us the opportunity to maximize this opportunity and at the same time do it in a way that minimizes our expenditures and positions us to be able to address our customer base with a very, very competitive product that will be very beneficial to the customers that purchase it.

We are expecting the PDP market to be a very competitive one. We think that as you look at the number of health insurers that are entering the arena to sell PDP it is basically everyone in the market will be participating and competing aggressively. And we think that our distribution channel, especially at Bankers, offers us a unique position to compete effectively for customers in this market. And we think the product that we've selected and that we will be selling, positions us and our agents very well to serve our customers.

Okay. Then I guess this might be a question for Scott at the Bankers channel. I guess it's also relevant to CIG, as well. I'm curious about what you're seeing, exactly, in loss trends on Med Supp. A couple of your competitors, not all of them, but have shown significantly higher claim frequency levels, which is kind of offset some seasonality in the product, and I'm curious if you're seeing some similar trends there? Then secondly, when you look to rate increases going into 2006, I guess what are you budgeting in terms of kind of rate increase above loss cost trend, to kind of get you back into the high 60s normalized loss ratio?

That's several questions. I would say we're not seeing a significant rise in claim frequency in our Med Supp book. It's not dramatically higher or lower. Things are pretty consistent. I think relative to our expected rate increases, they would be marginally in excess of claim cost reductions, because we've really tracked a little below the last two years in terms of claim loss trends. We tracked a little below the last two years, so this year we will be catching up moderately.

But I would not expect to see Bankers Med Supp benefit ratio on a blended basis to get below 70, just because we do have some group affinity coverage that's in that that has a 75% targeted loss ratio. I would expect to see it in that, you know, trend more toward 70 than the high 60s.

Okay, that's looking out into '06?

Yes.

Okay, perfect, thanks.

[OPERATOR INSTRUCTIONS] Your next question comes from Joe Obren of Ryder Fund.

Hi. You just answered my question, thank you.

We do have one follow-up question from Jukka Lipponen of KBW.

Actually two quick ones. First of all, the Bankers Life I think you gave agent count currently, and I think I missed that. Then secondly, the way you look at internally if rates rise and the prepay income declines, is your internal expectation that the increase in the investment income from having invested new monies higher rates would sort of fully offset that?

The count of agents at Bankers is 4,650, up from 4,200 a year earlier. And Gene, you want to get the second one?

Yes, I would say overtime it should offset it, recognizing that prepayment is lumpy and increases in portfolio yield is more gradual. I think that, relative to our expectations for aggregate earned yield over time, the two should reasonably offset.

Thank you.

At this time there are no further questions. Mr. Kirsch, are there any closing remarks.

I would like to thank everyone for joining us today. And we look forward to a very good close of the year, and hope everyone has a good day. Thank you very much, operator.

This concludes today's Conseco teleconference. You may now disconnect.