Bankers Conseco Life Insurance Company (BCLIC) and Washington National Insurance Company (WNIC), the subsidiaries of CNO Financial Group (CNO), are terminating reinsurance agreements with Beechwood Re (BRe) and recapturing about $550m of closed block long-term care liabilities.
As previously disclosed in a Form 8-K that was filed on August 1, 2016, CNO had commenced an independent third party audit of approximately $116m of Level 3 investments that were held in trusts on behalf of BCLIC and WNIC.
Based on the information obtained in the audit, CNO, along with the New York Department of Financial Services (NYDFS) and the Indiana Department of Insurance (IDOI), have concluded that a significant portion of the investments do not comply with applicable regulatory requirements for assets supporting the reinsurance agreements.
As such, the NYDFS and IDOI directed BCLIC and WNIC, respectively, to remedy the resultant deficiency.
In order to protect the interests of CNO, BCLIC, WNIC and their respective stakeholders, the CNO companies have taken the following actions:
BCLIC and WNIC sent written notice to Wilmington Trust, N.A. (Wilmington), as trustee to the reinsurance trusts, that BCLIC and WNIC exercised their rights to immediately withdraw all assets from the trusts, and instructed Wilmington to deliver the assets to custodial accounts of BCLIC and WNIC.
BCLIC and WNIC gave written notice to BRe that they are terminating their reinsurance agreements with BRe, effective immediately.
BCLIC and WNIC recently expanded the scope of the audit to include additional Level 3 investments with a reported amount of approximately $90m.
BCLIC and WNIC commenced an arbitration proceeding and demanded emergency relief, specifically, that BRe provide immediate access to certain documents and information regarding the trust assets, which will allow the audit of the aforementioned Level 3 investments to be concluded.
BCLIC and WNIC are also seeking compensatory, consequential and punitive damages from BRe as part of the arbitration.
BCLIC and WNIC have also commenced litigation against current and former individual principals of BRe (Mark Feuer, Scott Taylor and David Levy) for the damages caused by their actions.
The CNO companies are resuming responsibility for all aspects of policyholder administration. We expect no impact to policyholders as a result of these actions.
A recapture of this business requires CNO to revalue the assets and liabilities based on valuation methodologies that are consistent with the methodologies used by CNO to value its own investments and insurance liabilities.
While the audit of certain Level 3 investments is still in progress, preliminary information indicates that CNO would record an after-tax charge of approximately $55m, calculated on a pro forma basis as if a recapture of this business had occurred on June 30, 2016.
The estimated pro forma net loss is based on numerous assumptions, including our current best estimate of the fair value of investments and the amount of insurance liabilities expected to be received as a result of the recapture.
These estimated values are based on information currently available to us and may change based on, among other factors: (i) additional information we may obtain; (ii) the actual fair value of the related investments on the recapture date; and (iii) actual assumptions used to value the insurance liabilities.
After the adjustments summarized above, the remaining value of the Level 3 investments is $200m (including $67m of investments included in the initial scope of the audit, $65 million included in the additional scope of the audit, and $68m of other investments).
As a result of the recapture, related charge and additional capital required to support the assets and liabilities of this business, CNO will contribute approximately $200m to its insurance subsidiaries.
Approximately one-half of this contribution is attributable to the expected reduction in statutory surplus reflecting the charge recognized upon the recapture of the business; and approximately one-half is attributable to the expected increase in risk-based capital primarily affecting the additional credit and investment concentration risk associated with the trust assets.
After giving effect to this contribution, CNO expects to have approximately $175m of cash and investments at the holding company as of September 30, 2016, and expects its consolidated risk-based capital ratio to be approximately 450%.
In order to increase its excess capital position at the holding company, CNO has suspended its share repurchase program for the remainder of 2016.
As of September 29, 2016, CNO had repurchased $203m of common stock in 2016 at an average price of $17.37 per share. A recapture of the business is not expected to have a material impact to the ongoing free cash flow generation of the company, which is currently estimated at $75m per quarter.