CNO Financial Group Inc (CNO) 2008 Q4 法說會逐字稿

Good afternoon. My name is Kayla, and I will be your conference operator today. At this time, I would like to welcome everyone to the final fourth-quarter 2008 earnings and update conference call. (Operator Instructions). Mr. Scott Galovic, you may begin your conference.

Thank you, operator. Good afternoon and thank you for joining us on Conseco's fourth-quarter 2008 earnings and update conference call. Today's presentation will include remarks from Jim Prieur, Conseco's CEO, and Ed Bonach, Chief Financial Officer. Following the presentation, we will also have several other business leaders available for the Q&A period.

During this call, we will be referring to information contained in this afternoon's press release. You can obtain the release by visiting the Company News section of our website at www.Conseco.com. During the conference call, we will be also be referring to a presentation that can be obtained and viewed from the Company's website. This presentation was filed in a Form 8-K earlier today.

The Form 10-K for 2008 was filed today and will be available together with the investor supplement through the Investors section of our website.

Let me remind you that 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 afternoon's press release for additional information concerning the forward-looking statements and related factors.

The presentation to which we will be referring contains a number of non-GAAP measures. These measures should not be considered as substitutes for the most directly comparable GAAP measures. The appendix to the presentation contains a reconciliation of the GAAP measures with the non-GAAP measures.

And now I will turn the call over to Conseco's CEO, Jim Prieur. Jim?

Thanks, Scott. Today's press release contains the final financial results for 2008. The only adjustment to the GAAP financial results released on March 2 was to reflect a $45 million increase in the deferred tax valuation allowance, which Ed will talk to in a little while.

As we indicated in early March, our delay in reporting fourth-quarter earnings and filing our 10-K was the result of a couple of items. In addition to needing more time to finalize the analysis and disclosure related to our investment portfolio in light of market conditions, our auditors had informed us that without additional information and analysis from the Company to satisfy their concerns regarding the Company's liquidity and debt covenant margins, their audit opinion would have included an explanatory paragraph regarding the Company's ability to continue as a going concern.

As we've previously stated, such concerns were primarily related to how additional realized losses in the Company's investment portfolio could impact our compliance with debt covenants.

On March 24 we announced that we were seeking to amend our existing $911.8 million senior secured credit agreement. This morning, we announced completion of the amendment. The amendment, which did not seek any additional borrowing or any changes in the repayment schedule, reflects changes in certain financial covenants and an increase in the interest rate payable by the Company.

In addition, we received regulatory approval for surplus debenture interest and dividend payments totaling $46.2 million. I am pleased to report that after a tremendous amount of time and effort spent over the last month, we have resolved the auditors' concerns regarding liquidity and debt covenant margins. The Form 10-K for 2008 has been filed today with an unqualified audit opinion.

To briefly review the fourth quarter, we are pleased that the fourth-quarter results again showed operating earnings in all of our operating segments. Total EBIT exceeded $78 million in Q4. Full-year earnings before interest and taxes of $291.3 million was up 58% over 2007.

In addition, overall new business volumes in the fourth quarter were up 16% over the fourth quarter of 2007, with sales at Bankers up 25% and Colonial Penn sales up 16%, while CIG sales were down 9% from the previous year.

Our final audited financial statements show compliance with all the covenants in our credit agreement as of December 31, 2008, including those related to insurance subsidiary capital, the combined risk-based capital ratio of the insurance subs, our debt to capital ratio and the interest coverage ratio.

Next up is our CFO, Ed Bonach, who will take us through our financial data. Ed?

Thanks, Jim. As Jim already mentioned, there was only one adjustment to the financial results released on March 2, which was to reflect a $45 million increase in the deferred tax valuation allowance. This increase represents the projected future tax benefit of net operating loss carryforwards that are expected to be lost as a result of the higher debt service.

Other than this increase in the deferred tax valuation allowance, there were no changes to the preliminary GAAP financial results. Our core segment earnings were solid. Our net operating income before valuation allowance for deferred tax assets of $48.7 million equated to $0.26 for the fourth quarter of 2008 compared to a net operating income before valuation allowance for deferred tax assets of $27.2 million in the fourth quarter of 2007 or $0.15 per share.

For the fourth quarter of 2008, the net loss applicable to common stock was $451.8 million, which includes $88 million of net realized investment losses, $45 million related to an increase in the valuation allowance for deferred tax assets, and $367.5 million of losses on discontinued operations. The loss from discontinued operations is related to the transfer of Senior Health and its long-term care business to an independent trust. These items equate to a net loss of $2.45 per share, including $0.48 per share of net realized investment losses, $0.24 per share related to the valuation allowance for deferred tax assets, and $1.99 per share of losses related to discontinued operations.

Investment losses recognized in the fourth quarter of 2008 were not reduced by a tax benefit due to the establishment of a deferred tax valuation allowance, which is consistent with prior periods' accounting treatments, as it is unlikely that the tax benefits related to investment losses will be utilized to offset future taxable income.

Turning to slide seven, as we said earlier, the Company had operating income in the three insurance segments with a small loss recorded in the corporate segment. Year-over-year results show improvement with total segment EBITDA increasing to $78.1 million in Q4 of '08 compared to $64.8 million a year earlier.

In our Bankers Life segment, pretax operating earnings were $40 million in the fourth quarter of 2008 compared to $58.3 million in Q4 of '07. Results for the fourth quarter of 2008 were affected primarily by a lower-than-expected margin in PFFS and PDP, along with Medicare supplement.

Additionally, two of our risk and capital management transactions in the fourth quarter would reinsure approximately 70% of the Bankers LTC new business sold in 2008 and reinsurance related to Bankers Medicare supplement in-force block, which reduced earnings by about $3 million. Earnings were also negatively impacted by approximately $2 million related to the FAS 133 impact on equity indexed annuity products. In addition, we recorded a $3 million negative return on our COLI investment.

For Colonial Penn, the pretax operating earnings were $6.7 million in the fourth quarter of 2008 compared to a pretax operating loss of $200,000 in the fourth quarter of 2007. Results for the fourth quarter of 2007 were primarily affected by $8.4 million of expenses related to the test marketing of Medicare Advantage products through this distribution channel, which we have now subsequently terminated.

In our Conseco Insurance Group segment, or CIG, pretax operating earnings were $31.5 million in the fourth quarter of 2008 compared to $9.6 million in the fourth quarter of 2007. Results for the fourth quarter of 2008 were improved primarily due to improved specified disease margins of approximately $7 million and a $12 million reduction in specified disease return of premium reserves from a correction related to the remediation of our material control weakness. These were partially offset by approximately $5 million of lower margins on the remaining closed block LTC business that was folded back into the CIG segment after the Senior Health separation.

The corporate segment showed better results in Q4 2008, primarily as a result of reduced expenses. The gain on extinguishment of debt relates to our repurchase of $37 million in face value of convertible debentures for $16 million, which resulted in a gain of $21 million in the fourth quarter. Net realized investment losses were $88 million, which is better than what we have seen throughout the industry and the market as a percentage of assets. This included approximately $45 million of write-downs for securities we determined were subject to other than temporary impairment.

Based on our valuation of the recovery of deferred tax assets, we determined the need to increase the valuation allowance by $395 million in the fourth quarter of 2008. $319.1 million of the increase related to discontinued operations, $30.9 million related to tax benefits associated with investment losses that will not be utilized to offset future taxable income, and $45 million related to the projected additional future expense following the amendment to our credit facility.

As reported in our preliminary release, GAAP accounting requires the transfer of the stock of Senior Health to be reported as a discontinued operation in financial statements prepared after November 12, 2008. As a result, all Senior Health business previously included in our other business and runoff segment is now reported as discontinued operations.

Non-Senior Health LTC business, as well as a small amount of health business, which were both previously part of the runoff segment, have been collapsed back into CIG results for reporting purposes. Discontinued operations had a loss of $367.5 million in the fourth quarter of 2008 compared to a loss of $6.9 million in the fourth quarter of 2007. As part of the separation, Conseco recorded GAAP accounting charges totaling approximately $1 billion, comprised of Senior Health equity, an additional valuation allowance for deferred tax assets, the capital contribution of Senior Health and the results of its operations. Conseco recorded $496 million of these charges in the quarter ended June 30, 2008, $157 million in the quarter ended September 30, 2008, and $368 million at the close of the transaction in the fourth quarter. The Company recognized no deferred tax assets on such losses as it is unlikely that such tax benefits will be utilized to offset future taxable income. This completes the recording of charges resulting from the separation of Senior Health from Conseco.

Slide eight details our corporate debt obligations as of December 31, 2008. The Company's credit facility consists of a $55 million revolving credit facility and $857 million term loan. The revolver matures in June of this year and the term limit matures in 2013.

We have a $125 million note due to Senior Health, which is payable over five years in equal installments, with the first installment due in November of this year. And we also have $293 million of outstanding senior unsecured convertible debentures that are puttable on September 30, 2010.

As Jim mentioned earlier, this morning we announced completion of the amendment to the credit facility. The amendment, which did not seek any additional borrowing or changes in the repayment schedule, reflects changes in certain financial covenants and an increase in the interest rate payable by the Company.

Slide nine details out the primary financial covenant changes as a result of the amendment. As you will note, the amendment provides for relief on the financial covenants for the period of March 31, 2009 through June 30, 2010, at which time they will revert back to the levels applicable prior to the amendment.

The financial covenant modifications are as follows -- an increase in the maximum debt to capitalization ratio to 32.5% returning to 30%; a reset of the minimum interest coverage ratio to 1.5 times returning to 2 times; a reduction in the minimum statutory capital to $1.1 billion returning to $1.27 billion; and a reduction in the minimum RBC ratio to 200% returning to 250%.

Note that we have also detailed out our pro forma margin for adverse development from December 31, 2008 levels on each of these covenants.

Turning now to slide 10, interest on the senior credit facility will increase from LIBOR plus 200 basis points to LIBOR plus 400 basis points with a LIBOR floor of 2.5%, which currently equates to a total of 6.5%, plus an additional 1% annual payment in kind interest. The total interest rate increased from approximately 2.6% before the amendment to 7.5%, with 6.5% reflecting the immediate cash impact. Our 8-K and 10-K disclosures provide detail on the other modifications of the terms of the credit facility.

Our final audited financial statements showed compliance with all covenants in our credit agreement as of December 31, 2008. As we talked about in our preliminary call, we did complete several strategic moves to bolster our capital position, and we will continue to look at additional opportunities during 2009.

Our 2009 liquidity projection has been updated to reflect the additional debt servicing costs following the amendment to our credit facility, along with other refinement. As you can see on slide 11, our projected December 31, 2009 cash balance at the holding company is $66.4 million, a reduction of $9 million from the previous projection.

Our liquidity at the holding company is impacted primarily by the strength of our insurance subsidiaries. Subsequent to the transfer of Senior Health and its long-term care business to an independent trust, our insurance companies currently are expected to generate approximately $200 million of statutory operating profits annually, excluding extraordinary items. This is in excess of the capital needs to support ongoing growth.

The statutory dividend capacity of the insurance subsidiaries is in the range of $50 million to $125 million annually based on statutory net income of $200 million per year, reflecting, again, our core earnings power. The dividend and surplus debenture interest payments applied for in February totaling $46.2 million has been approved.

In addition to dividend from the insurance companies, the holding company also generates cash from interest payments on surplus notes, fees for investment and administrative services provided to the insurance company.

And with that, I'll turn it back to Jim Prieur. Jim?

Thanks, Ed. As a final note, I would like to again stress some of the key differences between Conseco and the rest of the insurance industry, which become increasingly evident at this time of market and economic stress.

First, our sales are continuing to grow. Second, our products are simple and straightforward and entail less risk than products that are designed for higher net worth customers. And third, our market demographics are significantly different from most insurers since we are dealing with the senior middle-market consumer.

During the fourth quarter, we made a number of moves which strengthened capital. Some of those had an immediate impact, and others will have an impact in future quarters. An example of that would be exiting the Coventry reinsurance deal and continuing to reinsure a portion of the Bankers LTC new business. Those moves do reduce future income, but are necessary to manage capital prudently.

We are keenly aware of where our debt covenants are, and future moves to improve our capital position such as reinsurance will have the same sort of negative effect on current income that the moves in the fourth quarter had. The goal of achieving an 11% operating return on equity is still our long-term goal, but it will be deferred as we manage through this uncertain economy.

The Company has got a strong franchise in the consumer senior middle market with more than 4 million policyholders. It sells straight-forward policies to an underserved market, a market segment that is growing faster than the overall market. We don't have a lot of stock market exposure, which others in the industry have, nor do we have any likely run on the bank risks that some of our more highly rated competitors have. So we will be continuing to work on sales growth, continuing to make the business more efficient and continuing to work on projects to improve our capital position going forward.

And with that, now we will open it up for your questions. Operator?

(Operator Instructions). Sir, do you have any comments while we are compiling the roster?

No.

Randy Binner, FBR Capital.

I just wanted to ask a few questions, if I could, about the repurchase of converts. Maybe a good starting point is with -- on slide nine, could you just confirm that the thinnest margin on the debt covenants is the $265 million with the statutory capital? Is that the right way to look at it?

On one hand, it is. But if you look at the RBC ratio, there is $145 million on risk-based capital. So there are different pressure points depending on if you are looking at required capital or actual capital.

So it is actually $145 million?

Yes. But it is required capital, which is -- you multiply it by 2, in essence, to get to the risk-based capital ratio.

Okay. Maybe I will follow-up with you on that one. So moving on to converts, I am just trying to understand the dynamic, obviously, with more buffer, the idea of continuing to buy back the convert might be interesting. So could you review quickly in the fourth quarter you had a $21 million gain, I think, on the sale of some converts?

On the repurchase of converts.

I'm sorry, on the repurchase. And how much -- what was the face value of those?

$37 million. So it is about $0.40 on the dollar.

Okay. And so --

$0.60 on the dollar of a gain.

And that gain goes right to statutory capital?

No. This is only at the Company, so it is GAAP only.

Okay, there you go. So if we were thinking of a way to minimize that obligation, that is all sitting at the holdco, so it is not something that would impact the statutory capital buffer that we look at on slide nine?

That is correct.

Okay.

The only covenant on slide nine impacted would be the interest coverage ratio and I guess the debt to cap as well.

Right. Fair enough. Okay. Thanks. Let me drop back in the queue.

(Operator Instructions).

We might be going back to Randy.

Paul Sarron, Fox-Pitt.

You completed some reinsurance deals in 2008 that freed up capital. Have you been in talks to do any more deals? Do you think that you have capacity on the existing blocks of business to do more in-force deals?

Answering your second question first, yes, we certainly do have capacity. Reinsurance is a normal part of our business for both risk management and capital management. Certainly, as we have indicated in the past with the long-term care business, we felt that we were overweighted. That is why we did reinsurance of the Bankers new business, and I should mention that it's also 50% of the Bankers long-term-care new business going forward for 2009, and the future is also being reinsured. But we will continue to explore and utilize reinsurance to manage both risk and capital.

Okay. When I try to project out what your liquidity might look like in 2010, even with pretty optimistic assumptions, I still get shortfalls compared to the $256 million of converts that become credible. What kind of sources of capital do you see that would let you settle that?

There's a variety of sources. Certainly reinsurance is a source of capital, a potential source. Earnings from the operations is another source. We do have the ability to seek to issue debt, be it unsecured, but that is another source as well as equity is another source. Of course, with debt and equity, we are very mindful of the times that we are in and the prices associated with that or the potential dilution. So those are also kept in mind as we evaluate those sources of capital.

Another thing, obviously, to point out is that the convertible debentures are trading in the 20s.

You mean versus par?

Versus par. And therefore, it's not very likely that they would receive par anytime soon.

That's a good point. Do you really think that you would be able to issue debt in this market? Unsecured debt?

Well, in terms of comparing it to a $20 unsecured piece of paper, I mean I think that is what you -- that is where the comparison has to be made.

Okay. Thanks. I will come back if I have anything else.

Patrick Meegan, Hotchkis and Wiley.

My question is, can you walk us from the $18.35 book value per share at year end down to the book value or I guess the economic value upon which the 11% ROE goal should be calculated, just so I understand what all the moving pieces are?

The main item that should be removed would be the AOCL and the NOL or deferred tax asset.

Okay. And then what is the NOL value?

That's what I'm trying to find here while we are talking. Net of the allowance, it is roughly $600 million. So that is about $3.25 a share.

Okay. So the NOL is $3.25 a share.

The AOCL as of year-end is $1.77 billion. So that is about --

$9.58 a share. I'm going to say $9.60.

Right, almost $10 a share.

Okay. And then so that is the base upon which management -- I mean, I think your competition goals are based on your achievement of the 11% ROE off of that base number.

That is correct. And then numerator of the earnings are, however, fully taxed.

Okay.

I mean that has been our goal for awhile, and I guess we signaled earlier in March that that would not be a goal that we were within sight of hitting in 2009.

No, I understand. But you get paid on -- well, let me ask you -- the calculation is based on -- allows for the deduction of accumulated comprehensive income?

Yes.

And then do you get paid on the operating number or the net number?

Well, with respect to the --

The numerator or --?

With respect to the long-term incentive payment, there was an 11% goal. That was only a piece of the compensation for the management. And, of course, that goal is what the goal is, and therefore, what we are saying is we are not going to hit that goal. Therefore, we are not going to get that part of the payment.

There was another piece of the goal which related to total shareholder return in comparison with a bunch of other insurance companies. And, of course, that all depends upon where the market ends at the end of the year, and so those were both in the long-term incentive payments.

The other part the management gets paid for, there's a short-term incentive comp which is tied to net income and the value of new business and some other metrics. So there are multiple metrics involved, not just the 11% ROE. Clearly, if we hit the 11% operating ROE, we would have been doing pretty well on all the other goals as well, and that doesn't look likely now.

Well, I think I would like to thank everyone for attending the conference call. This was just really a brief conference call to bring everyone up-to-date on where we stood with the 10-K and where we stood with the amendment to the loan agreement. And once again, thank you very much for your participation.

Conseco is a company that is focused on the senior middle-market in America. This is the fastest growing market segment in that business. We have a unique sales machine dedicated to this market, whether it is through agents, directors or brokers, and we are committed to growing this business successfully in the future.

Thank you very much.

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.