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CNO Financial Group, Inc. (CNO - Analyst Report) reported its first-quarter net operating income of $51.9 million or 18 cents per share, well ahead of the Zacks Consensus Estimate of 17 cents. This also compares favorably with income of $38.2 million or 14 cents in the year-ago quarter.

The improved showing was the result of strong top-line growth in all the business segments and improved capital ratios.

The net operating earnings exclude $2.0 million or 1 cent related to net realized investment gains and loss on extinguishment of debt in the first quarter of 2011, whereas it excludes $4.3 million or 1 cent of net realized investment losses and loss on extinguishment of debt in the prior year quarter.

Including one-time items, CNO Financial’s net income jumped to $53.9 million or 19 cents in the reported quarter as opposed to $33.9 million or 13 cents in the prior-year quarter.

Business Update

CNO Financial’s revenues increased 4.7% to $1.05 billion in the current quarter from $1.00 billion in the prior-year quarter, primarily due to a rise in net investment income. The revenues also exceeded the Zacks Consensus Estimate of $992.0 million.

Collected premiums showed a year-over-year decline in CNO Financial in the segments of Bankers Life and other CNO business segments, whereas it increased in the segments of Washington National and Colonial Penn.

CNO Financial’s results reflected a 28% year-over-year increase in EBIT (income before net realized investment gains or losses, corporate interest expense, loss on extinguishment or modification of debt and taxes) to $101.1 million, while corporate interest expense increased 5.6% to $20.6 million in the first quarter.

A modest EBIT growth was witnessed across Bankers Life, Colonial Penn and other CNO businesses, partially offset by a decline in Washington National in the first quarter of 2011.

In the Bankers Life segment, EBIT climbed 20.1% to $63.9 million from the prior-year quarter of $53.2 million. The results were impacted by $14 million higher investment spreads for annuity products primarily reflecting growth in the business and lower crediting rates, partially offset by lower earned yields.

The results also reflected the favorable impact of $11 million on long-term care reserves of development of prior period claim reserves and policyholder decisions to surrender or reduce coverage following rate increases.

However, they were unfavorably impacted by lower earnings in the Medicare supplement block in the first quarter of 2011.

Washington National’s EBIT declined 9% to $25.2 million, from $27.6 million in the prior-year quarter, reflecting the $2 million favorable impact of life insurance product reserve refinements in the prior year quarter.

Colonial Penn’s EBIT were almost in line with the prior year quarter.

Other CNO businesses reported gains of $7.1 million in the reported quarter, as against losses of $1.9 million in the prior-year quarter. The growth in the reported quarter reflected favorable mortality.

CNO Financial’s Corporate Operations, which include investment advisory subsidiary and corporate expenses, reflect lower expenses of $0.5 million in the reported quarter as against $5.0 million in the prior year quarter.

The results in the reported quarter were favorably impacted by trading account activities and income related to company-owned life insurance ("COLI"), which was included in this segment effective January 1, 2011. CNO Financial recognized $6.2 million of income from trading account activities and COLI in the quarter.

Corporate interest expense also increased in the reported quarter, primarily due to a higher average interest rate.

The first quarter of 2011 includes a $0.9 million loss on extinguishment of debt, net of income taxes, related to the prepayment of $50.0 million principal amount outstanding under a senior secured credit agreement. The prior year quarter includes a $1.2 million loss on extinguishment of debt, net of income taxes, related to the repurchase of $64.0 million aggregate principal amount of 3.5% convertible senior debentures.

Net realized investment gains of CNO Financial were $2.9 million (net of related amortization and taxes) in the first quarter 2011, which include other-than-temporary impairment losses of $13.3 million. In the prior-year quarter, net realized investment losses were $3.1 million (net of related amortization and taxes), and include other-than-temporary impairment losses of $17.7 million.

Evaluation of Financial Strength

During the quarter, the consolidated statutory risk-based capital ratio of CNO Financial’s insurance subsidiaries increased 9 percentage points to 341%, driven by statutory earnings of $101 million, but partially offset by $60 million of dividend payments to the holding company.

In addition, unrestricted cash held by the non-insurance subsidiaries increased $8 million to $169 million, reflecting dividend payments offset by $50 million of debt prepayment.

As of March 31, 2011, debt-to-total capital ratio reduced to 19.2% from 20.0% at the end of December 31, 2010. Book value per common share, excluding accumulated other comprehensive income (loss) also increased to $16.48 from $16.28 at the end of December 31, 2010.

As of March 31, 2011, total assets of CNO Financial were $32.1 billion and shareholders’ equity was $4.4 billion.

Its competitor, Torchmark Corporation (TMK - Analyst Report) reported first-quarter net operating income of $1.62 per share on April 27, lagging the Zacks Consensus Estimate by 2 cents. Another rival Unum Group (UNM - Analyst Report) reported first-quarter operating income of 69 cents per share on the same day, as compared with the Zacks Consensus Estimate of 70 cents.

We remain concerned about CNO Financial’s pricing challenges in its long-term care business, which in turn are influencing the losses in its investment portfolio.

Currently, CNO Financial carries a Zacks #2 Rank, which translates into a short-term Buy recommendation, indicating a slight upward pressure on the stock over the near term.

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