Conseco Negatives Priced In

Conseco Inc.'s (CNO - Analyst Report) share price has steadily gained momentum in the last few months after touching record lows in March 2009. The company recently announced two events that could benefit its risk-based capital ratio.

Conseco has announced that two insurance companies in its Conseco Insurance Group segment will coinsure about 104,000 non-core life insurance policies with a Minnesota-based reinsurance firm Wilton Reassurance Company ("Wilton Re"). In the transaction, Wilton Re will pay a ceding commission of approximately $57.5 million and 100% coinsure and administer these policies.

The Conseco companies will be transferred to Wilton Re for approximately $409 million in cash, policy loans, $466 million of statutory policy and other reserves. The transaction is expected to be completed in 3Q09. As a result of this deal, Conseco expects to record an increase in its deferred tax valuation allowance of approximately $18 million and a deferred gain of approximately $25 million in 3Q09.

The transaction is expected to help streamline the company's administrative operations by shifting focus on core insurance businesses, increasing statutory capital and be benefiting to risk-based capital ratio by 8 percentage points.

Further, Conseco expects the recent National Association of Insurance Commissioners (NAIC) move of modifying the mortgage experience adjustment factor for 2009 to benefit its risk-based capital ratio. The revised calculation will reduce the amount of capital Conseco's insurance subsidiaries are required to hold, thereby increasing its consolidated risk-based capital ratio by more than 25 basis points. However, we believe that the NAIC may modify, extend or even terminate the proposal beyond 2009 based on market conditions.

We also remain concerned about the quality of Conseco's investment portfolio. The company had approximately $43.7 million (market value) of subprime home equity securities (0.20% of total portfolio) as of March 31, of which $17.6 million (0.18% of invested assets) had a rating of "A" or less.

We believe that our concerns are already reflected in the current share price and that CNO continues to be one of the cheapest stocks compared to its peer group even after gaining sufficient momentum in the recent months.

At its current price level, the shares of Conseco trade at 0.28x its 1Q09 book value of $18.57 per diluted share (excluding AOCI), about 60% discount to the 0.69x median of the peer group. This compares to price-to-book value of approximately 100% of its rivals like Unum Group (UNM - Analyst Report), Torchmark Corp. (TMK - Analyst Report) and StanCorp Financial Group Inc. (SFG - Analyst Report).

Therefore, we maintain our Hold recommendation on the shares of Conseco.