CNO Financial Group, Inc. (CNO) Earnings Call Transcript & Summary

We will jump right into it here. Thank you, everybody, for being here, and a special thank you to Gary Bhojwani, CEO of CNO Financial; Paul McDonough, CFO of CNO Financial. Very much appreciated your attendance.

And so I'm kicking off a lot of these conversations with a broad strategy update type of question. And so I want to do the same with you all. Could you run through some of the key initiatives for your firm and some of the things you're most focused on as we think through the medium term?

Yes. So when I try and explain CFO -- or CNO Financial and what it is we focus on, there's really a handful of things I would point to that I think make us unique and really form critical parts of our strategy. The first is that we focus almost exclusively on the middle market. And different people have different definitions of this, but the vast majority of our clients have a net worth of well below $100,000. So our focus is the middle market in the United States. I think the second thing that's a key part of our strategy and really makes us unique is the emphasis on distribution and specifically what we do with distribution. We got very lucky on the timing of one critical issue. Right before the pandemic in January of 2020, we decided to combine our Consumer businesses. We had historically had our Bankers Life business which is our captive market -- captive career agent distribution and Colonial Penn, which is a direct-to-consumer business, totally separate, separate leadership and so on. And we brought those together in January of 2020, so right before the pandemic. And as just -- we'll talk about this later, but as one proof point to what that's done, literally now, a full 1/3 of the life insurance sales by our captive agents have emanated from leads that started out on the Colonial Penn side or the direct-to-consumer side. So bringing that business together and really combining the 2, I think, is a very unique thing, and it's a key part of our strategy in terms of how we approach the consumer. And when I talk about distribution, though, I think also the emphasis on that captive agent and what we refer to as the last mile. We're not trying to be the lowest-cost provider. We're really focusing on the middle market, and the bulk of our clients are people that want someone to come sit at their kitchen table and talk to them about these products. So when I say emphasis on distribution, it's the combination of that last mile along with the integration of the direct-to-consumer. And those things, I think, make us very unique. The third thing I would point to is the breadth of products. We're not trying to be a life company or an annuity company or a med sub company. We're not trying to be a product company per se. Whatever it is, within reason, that that middle market consumer needs, we want to provide that. And so what that's led us to, most of our products are manufactured, which is to say we take the balance sheet risk, but we actually have quite a few products, Med Advantage is a good example, where we strictly distribute it. And we take the view that if it's in our wheelhouse, if it's in our expertise to talk about and the middle-market consumer wants it, if they can benefit from it, we want to figure out how to deliver it even if it means we don't manufacture it. So it's really those 3 things I would point to: middle market, the way we approach distribution; and then the way we surround that middle-market consumer with a breadth of products and how those products interrelate with one another.

Got it. That's very helpful.

Are you going to talk a little bit about Worksite?

Sorry. Oh yes. Sorry, Paul, made a good point. Everything I just said applies to the single largest portion of our business, which is our Consumer business. It represents about 80% of CNO Financial. There's also a Worksite business, which represents 20% of our business, and where we've made a handful of investments in recent years, 2 acquisitions in particular, where we can sell insurance products. We have a technology platform for the employers that we work with and we have an advice and advocacy business. And so we've brought all of those together under a unified brand, Optavise, and are really pushing into that. So I guess that's one other aspect that is critical to CNO and understanding what makes CNO difference is this balance between Consumer and Worksite.

Got it. Next, I wanted to touch on your agent distribution. Can you talk about the outlook for agent recruiting and maybe some of the initiatives that you have on that front?

Sure. So we've had a few different approaches over the years. If you look back at the company, call it 8 to 10 years ago, really, the philosophy was to appoint as many agents as possible, kind of create the biggest army possible. And over the years, we moved away from that. And in the last 3 to 5 years, in particular, we really were emphasizing productivity and yield. And productivity is obvious. I think everyone understands that. But by yield, historically, these numbers aren't precise, but they're not too far off, we would appoint roughly 5,000 to 10,000 agents a year and 3 to 4 years later, less than 300 of those agents are still with us. That's a really expensive model to keep going. So what we wanted to do over the last 3 to 5 years was change that dynamic materially. And instead of appointing 5,000 or 10,000 agents a year, appoint 3,000 to 5,000 a year. But instead of having 300 of them still around a couple of years later, having 600 of them around. So really driving that yield up. And we've had a lot of success over the last couple of years on both fronts, on the yield and the productivity. Historically, in this business, because it's a commission-only business, higher unemployment causes more people to be willing to try a career like this. So when the economy starts to soften a little bit, we get a benefit from that in terms of our agent ranks. And what we've done over the last few years to try and enhance the yield, we've implemented, I think, better and more refined referral programs. So there's some prequalification, if you will, that goes in before the agent gets appointed. We've implemented a better set of support mechanisms, financial and otherwise, training, around the agents to try and improve that yield. And then probably the biggest thing and the thing that's taken the most time is creating the business in a way where there's a true career path for these agents. So as an example, in 2016, we started a broker-dealer. So we have a credible career path now for these folks that come in as insurance agents selling a product where they can ultimately graduate to becoming financial advisers and they can see what the benefit is, not only from a financial perspective, but just in terms of growing their own expertise and so on. So we've done a number of those things relative to the yield, the productivity, the career path. We've had very good success in the last few quarters. We're getting back to pre-pandemic levels in terms of our recruitment and our productivity and we feel really good about the numbers we're seeing. And by the way, we're seeing those trends on both the Consumer and the Worksite side. We've seen some really good success on both sides in terms of recruiting new agents and getting them productive.

Got it. Maybe turning over to the competitive environment across your health and life products, are you seeing any trends shift one way or the other there? How price sensitive are your customers?

Yes. We're -- so first of all, we benefited, I think, during the pandemic, there was a heightened awareness and interest from consumers in the life and health products. So we certainly benefited from that. We're, of course, not immune to competitive forces. There's a lot of competitors out there, but there are very few competitors that are focusing on the middle-market consumer. So by definition, our clients just don't have as many folks knocking on their door trying to pitch them on these products. So we're somewhat insulated from that standpoint. And then when you layer into it on both our Consumer and Worksite, we have a substantial portion of our business produced by captive agents, that's kind of another degree of insulation for us. So are we seeing competitive pressures? Of course. But the clients that we're going after aren't being called on by most of the other folks. And almost -- not almost, but by definition, the business model is such that we're not trying to appeal to the consumer that wants the lowest price. There's plenty of other resources for them. We're trying to appeal to that middle-market consumer that wants someone to come into their kitchen table and sit with them and explain these products and provide an overall perspective, that's been the model. So those things all come together to somewhat insulate us.

Yes. Understood. Just around 4Q, enrollment in the end of the year tends to be an important time for the sales process. Any color you might be able to provide on how that year-end is going?

Yes. So for the folks that aren't familiar, the annual enrollment period for Medicare is from October, I think, 15th until December 7. So we're literally in the last week of it. The interesting thing or maybe not so interesting, maybe it's common sense, there's really a big push in this last week, something like 20% of the business gets sold in the last week, a lot of procrastinators out there. And so we're right in the thick of it. It's difficult for me to say too much because we don't have the numbers yet, but I can tell you that we like what we're seeing so far.

Got it. Okay. So next, I'll turn to annuities. I was hoping you could discuss -- you already touched on the competitive environment a bit for your products. And so maybe you can extrapolate on like the ways that you're able to avoid this competitive environment, particularly with the emergence of private equity-backed insurers and so forth in some of these products like fixed and mixed annuities?

Yes. The vast majority of the private equity-backed annuity issues are working through independent distribution. And there's a very different structure in terms of incentives and commissions and so on in terms of how independent distribution works and how captive distribution works. We frown upon and in most instances, flat out, disallow our captive agents from moving a consumer from annuity A to annuity B, particularly if they're not out of the surrender period. So we have an extra layer of control that you don't find in some other distribution models. And sometimes that hurts us, right, because we're not putting up new sales numbers the same way because we're not allowing replacements. We think that that's a better way to go for our business model. I've been on both sides of these issues. I've spent many years working with a company that ran independent distribution, so I'm familiar with the model, each one has its own merits. But in our case, we have a different approach. We believe there too, there's a certain amount of insulation that we have. And I would again point to the fact that if you look at many of the annuity writers, their average annuity sale is far larger than ours. Our average annuity is about $100,000. I'd be willing to bet most of these other folks working with independent distribution is probably closer to $0.25 million. So again, a very different type of consumer, very different needs and very different distribution structure, control and incentives.

So you touched on this a bit here, just in terms of liquidity risk and what we've seen with higher interest rates and some of the turnover that we've seen throughout the industry. How do you manage that duration risk? And it sounds like there's some built-in protection as well.

Yes. To a large extent, that issue is really existent only in our annuity business. Roughly 80% of our annuity book is still within the surrender period. And then you layer into it the captive distribution, the extra control that we have, all these other things. Do we see surrenders tick up slightly during periods of higher interest rates? Yes, we do. But it's within expectations and within the models that we have priced for. So we don't see it as a point of concern. It's a reality, and I think we have -- relative to some others, we have relatively low exposure.

Makes sense.

And then on the duration risk side of it, Alex, there's sort of 2 dynamics that mitigate that risk. The first is the fact that fairly healthy net inflows result in a growing book, so we're able to kind of rebalance as needed pretty quickly. And then the second thing is, if you think about the breadth of our product portfolio and the breadth of durations across that product portfolio, there's sort of a natural hedge in terms of those durations.

Got it. Okay. So I want to shift gears a little over to Worksite benefits. I thought maybe you could drill into the growth strategy a bit more there for us. And maybe also take us a bit deeper into the strategy to expand your footprint geographically?

Sure. So the Worksite business, let me first say, in general, we're very bullish on it. And we're bullish on it for a few simple reasons. Number one, there's not that many other alternatives for consumers to get some of these needs met that a supplemental health policy, as an example, will provide. Particularly when you're talking about a middle-market consumer. The government can't afford to provide some of these things and most employers can't either. So we think there's an opportunity here in the worksite space where these products will continue to grow. So when you think broadly about worksite, it's important to try and identify what aspects of it you're going after. Historically, we've been focused on the insurance products, which we manufacture. And that continues for us in the worksite space. But what we've added to that in recent years, we've always had the insurance manufacturer and the captive distribution, those 2 things remain. We've added to that. Now we're distributing more products just like on the Consumer side that we don't manufacture if it makes sense. We also acquired a benefits technology company, a technology platform. And then we acquired a small enrollment and advocacy company. So we've brought all of these things together under the brand Optavise, and we're now able to go to our worksite clients with a more consolidated offering. Now in full disclosure, I've been very pleased with the recovery post-pandemic of the insurance sales. We have now met or exceeded our pre-pandemic levels of insurance sales. The fee side of the business, some of the other things I talked about, the services and the technology, have been slower to recover, and we really are turning our attention to that here in 2024 to get that fee side of the business growing again at the same rate the insurance side is. But we have anecdotal evidence. I don't have the numbers to back it up yet, but we have anecdotal evidence in talking to our employer clients that this type of a consolidated offering is a differentiated capacity that they really want. So we're very excited about providing that.

You mentioned the acquisitions you've done in the worksite space. I thought maybe you could elaborate on that. What it's specifically enabled you to do within that business? And yes, how the integration process has gone as well?

Yes. Both of the businesses were acquired really with an eye towards giving this consolidated offering, to be able to go to our Worksite clients and say we can do more than just your insurance. So the technology platform, many of you may be familiar with the company called Workday, big company where your benefits are administered. It's a platform that an employer can go to. We bought a company called Web Benefits, a much smaller version of that, that type of an offering. The other business we bought, DirectPath, they provide education and enrollment assistance. Big employers out there really want to outsource that. They want somebody that their employees can call that feels like it's their company, that feels like it's ABC manufacturer that answers the phone and can talk to the employee about their benefits and give them the counsel and the advice and so on. So we brought those assets together. One of them we bought I guess, in hindsight, on the one hand, it was right around the time of the pandemic. So that made all this much harder. The flip side is we were able to reflect that in the price. But it's been slower coming than we would like. And we expect 2024 to really start to see a turn and have these businesses come together. And again, it's all about giving that consolidated offering to employers.

Got it. Next, on Bermuda, I wanted to maybe first have you just remind us of what's been done, particularly for some of those they may not know the details as much. And there's a capital release piece of it, but what does it also do for just ongoing sales of annuities and growing the business?

Sure. So we've set up a Bermuda captive. We shared on our third quarter earnings call that the company was licensed, that it was approved. What we've done since then is we closed on the initial treaty, closed just last Thursday. And that initial treaty cedes roughly $6.2 billion of roughly $9 billion of fixed indexed annuity in-force book to Bermuda in a ModCo Structure and then going forward -- and that's as of 10/01, a 10/01 effective date. And then going forward, we'll cede 100% of the new business. We have some optionality around dialing that back if we so choose, but the expectation is that we cede 100%. So that's the starting point. We'll explore other products we may choose to cede to the Bermuda platform. We would have to get pre-approval for that, but that's something that we'll explore. As we talked about on the third quarter call, that initial treaty frees up about $150 million of capital that will sit at the holdco as excess capital. We haven't really changed the way we think about how we deploy that excess capital, but it gives us optionality. So we could choose, for instance, on the new business to get more competitive on pricing. There's not a huge need or sort of compelling reason for us to do that just because of where we compete. As Gary talked about, in the middle market, and through captive distribution, both of those things cause us to be less sort of price focused. So that's basically what we've done and where we're headed and how we think about the capital efficiency that, that structure allows us to participate in. The real sort of catalyst for us deciding to do this was to get ourselves in a level playing field with the many companies that did this before us.

That makes sense. You mentioned that you haven't changed anything about the way you think about deploying capital. Certainly, you do have more flexibility. Can you give us a taste of if you decided to go after opportunities, what some of those may be?

So if you think about how we've deployed it in the past, most of our excess capital on the margin has been deployed through share repurchase, so returning excess capital to shareholders through share repurchase. We have done some acquisitions. Gary talked about the 2 acquisitions in the worksite space. That's likely the size of a transaction that we might consider. We do have a corp dev team that's constantly looking for opportunities for us to create value by augmenting our organic growth with inorganic growth through acquisitions. I will say that with our stock and our peer group stock trading at sort of mid-70s as a percent of book value, share repurchase is a very compelling use of excess capital and any acquisition has to sort of compete with that.

Makes sense. Next on the Life business, could you describe the performance of the in-force and how things are shaping up from an endemic state standpoint coming out of the pandemic. We've seen some peers have some pressure from old age mortality hiccups and that kind of thing. Is there anything like that, that you're seeing in your book?

Yes, I wouldn't say that we've experienced any hiccups. The book continues to perform well and reasonably stable in terms of the insurance product margin that it generates. We do -- we have seen and we've included in our actuarial assumptions, a tick up in mortality as compared to pre-COVID as COVID has transitioned into more of an endemic state and we expect that will persist for the foreseeable future.

So next on long-term care. There were some fireworks in 3Q from mainly one peer. Can you talk about the performance of your block? What you're seeing in frequency trends coming away from the pandemic? And maybe any other nuances that we should keep in mind about CNO's exposure to long-term care that may be differentiated?

Sure. So I'd say that the block has performed very well, certainly through COVID just because of the decrease in utilization of health care broadly. That's come back a bit, but it's still performing better than pre-COVID when it was already performing well in terms of target returns. One thing I would really emphasize is that the profile of our book in the wake of the long-term care reinsurance transaction that we completed in the fall of 2018 is very different than virtually all of our peers, certainly, those that experienced some pressure during the third quarter. And the ways that it is different are primarily in the amount of inflation benefits and sort of the amount of benefits in terms of the benefit period. So let me just share some data to put that in perspective. With our new sales, 99% of what we sell has a benefit period of 2 years or less. And 90% of what we sell has a benefit period of a year or less. And less than 10% of everything we sell has any sort of inflation rider. So we offer it to but there's not much uptake on it. The in-force book, less than 25% has inflation benefits, less than 3% has lifetime benefits and the 97-plus percent that does not have lifetime benefits has an average benefit period of 1.5 years. So that profile makes us very different than most of our peers. And it's the profile of a business that we like. We like the economics. It's a product that serves a very important need for our target market at an affordable price. So we expect to continue to sell it. We actually just launched a new product this fall, that's done very well. I guess the last 3 things I'd share in terms of the profile of the book is that the attained age of our book is about 75 years. That's very different. Since 2008, we've ceded 25% of the new business to a reinsurance company, highly rated, highly regarded, tells us they'd be happy to take more of it if we would agree to that. We prefer to keep it because we like the business. So all in, an important part of our product set and a business that's performed well.

Next on the topic, cash flow sort of increased in popularity in terms of metrics that investors look at with life insurance companies. Is there anything around the Bermuda deal that impacts cash conversion? And any thoughts you'd provide around your valuation and how you all internally think about the capital generation of the business?

Sure. So on the margin, the Bermuda structure is more capital efficient and therefore, all else equal, should generate better free cash flow. And our business historically has generated very healthy free cash flow sort of in absolute terms, as a percentage of operating income, as a ratio and relative to our peers. And I think that the fundamental sort of dynamics of our business will always generate healthy levels of free cash flow, and that will translate to some amount of capital return including some amount of share repurchase. Having said that, as critically important as the cash flow dynamics of the business are, I think it's a little shortsighted to focus too much on the ratio sort of in isolation. Because for us, it's pretty easy to think about scenarios where we might take decisions that I think would enhance the long-term value creation of the business but would reduce the free cash flow in the near-term. So I'll give you 2 examples. The first is if we took more risk on our assets. Since early 2019, we've had a very distinct up in quality bias. But that wasn't the strategic decision. That wasn't we're going to do that from now and forever more. It was really more of a tactical decision reflecting where we were seeing relative value as we put money to work. That could easily change. And if and when it does, we wouldn't hesitate to take more risk, that would consume more capital. I think that the decision to do that would be that there's more relative value there and it's going to enhance value over the long-term, generate more income on a risk-adjusted basis, but in the near-term, would reduce free cash flow. And the other thing that I hope happens and we, as a management team, will help try to make this happen, is to accelerate organic growth. Gary talked a lot about recruiting and retaining agents and productivity of our agents. That should translate to increased top line growth. If we accelerate that, we should get more operating leverage. It should allow us to translate more of the sales growth to earnings growth, would certainly enhance value, but would erode free cash flow in the near term, all else equal. So I just offer that context as we talk about what free cash flow conversion should we think about.

Yes, it's a tough topic. I appreciate that. On the investment portfolio, you mentioned it in passing there, and I know there was an up in quality trade for a while. But maybe you could just unpack what kind of credit performance are you seeing across your book right now? And are there any of those types of allocation decisions or shifts that you may be pursuing?

Sure. So the up in quality has positioned us well relative to any sort of recessionary economic conditions that may eventually happen. We've been predicting, it seems like, for the last 2 years, and there seems to be more of a narrative around a soft landing. But if there were more recessionary economic conditions, and that would translate to some amount of credit migration, we're well positioned. Certainly, relative to where we would have been, if we hadn't opted this up in quality, I think relative to many of our peers. Having said that, we've got some exposure to commercial mortgage loans and to CMBS. We like how we're positioned there. It's performed well so far. I think this commercial real estate story has some legs on it. It will take some time for sort of the repricing of that asset class to play through. But I think we're well positioned, and we've been sharing some data on our -- on those assets in our earnings call deck the last few quarters which I think give credence to this position that I'm taking that we're well positioned. We soared pretty well through the regional banking crisis in the early part of this year; actually saw that as an opportunity to buy some securities. Spreads had gapped out. Our alts have performed sort of in line with the benchmark. So great through most of '20 and '21 and half of '22 and then not so great for the second half of last year and the first half of this year. But sequentially improving. Third quarter generated a return of about 4.5%. So not where we'd like it to be or expect it to be on average in the long term, which should be closer to 9%, 9.5%, but moving in the right direction.

I'm jumping around here a bit, but I want to go back to the topic of distribution. I do want to ask you about the Department of Labor rule that came out. I mean I think it's less of a surprise to some around certainly than getting hit with it in 2016. But maybe you could still help us think through some of the things that are in that regulation and how it can impact your business and I guess, particularly the distribution of annuities.

Yes. So as you might imagine, myself and some of the other members of the CNO team are involved in various industry trade groups. And as an example, I sit on the Board of the American Council of Life Insurers, and a variety of industry trade groups have really done a deep dive, and I think it made a pretty credible case that this is deeply flawed regulation. I'm not sure if it's going to get implemented or not. And even if it does, I wouldn't rule out it being turned over as we saw happen in the past. I will tell you, it feels a little bit like a solution in search of a problem. Now all of that said, your question was what could the potential impact to CNO Financial be? And we've been very fortunate, I think. Again, pure luck, we started our broker-dealer, as an example, in 2016 when this was hanging over the industry. So when we built out our processes and some of our systems and how we approach these things, we had this in the back of our mind. So the short answer is, I don't expect -- first, I don't expect it to go through as is. And if it does, I don't expect it to stay. But that's not an answer to your question. If it does all come to pass, I don't feel like it's going to have a materially adverse impact to our business in terms of the way it's set up, primarily because of the captive distribution, because of the relative recency of the establishment of the broker-dealer and how we approach these things anyway.

Yes. So one more on the regulatory environment for you quickly. There was this proposal around short duration insurance that I think included some things around supplemental health. Do you have any update around that? And does that have any impact just around product structure and some of the things you got to do to comply?

So this again seems to me to be shortsighted in terms of a regulatory objective because with all the high deductible medical plans, these supplemental health products are sort of filling a hole at a price that people can afford and gives them some peace of mind as they think about how things may play out for their health care. Having said that, it's hard to say what the final form of this might look like. I think it's probably not going to look like what's been originally proposed because there's a lot of pushback from the industry. I would imagine there's some pushback from constituents, so it may become more of a political thing as well. Having said all that, if it survived in its current form, it would mostly impact our hospital indemnity and our accident products inside of our supplemental health portfolio of products. And those 2 products represent about 20% of our supplemental health sales and about 10% of our total health product sales, so manageable. We would have to make some tweaks in product design and so forth. But I think we could get through that and still serve our customers in a meaningful way.

Great. Well, I think we're at time. So I will leave it there. Thank you very much for joining us. Thanks, everybody, for being here.

Thank you.

Thank you.