Hello everyone, and thank you for joining the CNO Financial Group second quarter 2022 earnings results call. My name is Darius, and I'll be moderating your call today. Before handing over to host, Adam Auvil, I would like to remind you if you would like to ask a question during the Q&A session at the end of the call, please press star followed by one on your telephone keypad. I now have the pleasure of handing you over to your host, Adam Auvil. Please go ahead.
Good morning, and thank you for joining us on CNO Financial Group's second quarter 2022 earnings conference call. Today's presentation will include remarks from Gary Bhojwani, Chief Executive Officer, and Paul McDonough, Chief Financial Officer. Following the presentation, we will also have other business leaders available for the question and answer period. During this conference call, we will be referring to information contained in yesterday's press release. You can obtain the release by visiting the media section of our website at cnoinc.com. This morning's presentation is also available in the investors section of our website and was filed in a Form 8-K yesterday. We expect to file our Form 10-Q and post it on our website on or before August 5.
Let me remind you that any forward-looking statements we make 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. Today's presentation contains a number of non-GAAP measures, which should not be considered as substitutes for the most directly comparable GAAP measures. You'll find a reconciliation of the non-GAAP measures to the corresponding GAAP measures in the appendix. Throughout the presentation, we will be making performance comparisons, unless otherwise specified, any comparisons made will be referring to changes between second quarter 2022 and second quarter 2021. With that, I'll turn the call over to Gary.
Thanks, Adam. Good morning, everyone, and thank you for joining us. Turning to slide 4 in our second quarter performance. We reported strong earnings and solid overall sales for the quarter. Operating earnings per share were $0.85, up 29% over the prior year. Excluding significant items, operating earnings per share were up 3%. Variable investment income results performed well in the quarter, showing resilience during a period of continued market volatility. Our underlying business results remained strong with insurance product margins performing as expected. The value of recent strategic investments to accelerate growth and enhance agent productivity were on display in the quarter. We were especially pleased with the performance of our annuities, our direct-to-consumer businesses, and our worksite insurance sales. We continue to advance key strategic initiatives in both the consumer and worksite divisions.
Notably, we introduced our new Medicare Supplement product and launched Optavise, our new worksite brand, in the quarter. We returned $77 million to shareholders and reduced the weighted average shares outstanding by 12%. Our capital position remains within risk tolerance levels, and our balance sheet is well positioned to respond to changing macroeconomic conditions. We increased book value per diluted share, excluding AOCI, by 15%. Turning to slide five and our growth scorecard. The strength and value of our diversified product portfolio and distribution channels contributed to solid overall sales in the quarter. I'll touch on the specifics by division in the next two slides. Beginning with the consumer division on slide six. Our results demonstrate continued improvement in agent productivity and reflect some pluses and minuses across our product portfolio. Life and Health sales were down 9% as compared to the prior year.
We expect to see this trajectory change in the second half of the year based on recent updates to our Medicare Supplement portfolio and positive trends in agent recruiting. Direct-to-consumer life sales were up 9%. This channel continues to benefit from investments in opportunistic advertising spend and enhanced distribution. Turning to Medicare Supplement. By the end of August, we expect to have launched our new Med Sup plans in 44 states. These states represented 96% of our 2021 Med Sup sales. This is a competitive product that squarely addresses the needs of our middle-income consumers. Early results are encouraging. We are seeing strong momentum with a significant increase in application submissions and new sales, which we expect to be reflected in our results in the third and fourth quarters.
Please recall that the Medicare Annual Enrollment Period, or AEP, occurs in the final months of the year, making the fourth quarter the most telling marker for this product launch. Third-party Medicare Advantage sales were up 32% year- over- year in the second quarter and up 21% over the last twelve months. As a reminder, fee business is not reflected in that. We continue to expand the number of Medicare Advantage carrier plans available for sale through our My Health Policy platform, which enables customers to buy plans through direct enrollment online or through our field agents. Our omni-channel model is a unique strength in how we acquire, service and retain our clients. We expect the combination of our new Medicare Supplement plans and our growing Medicare Advantage plan options to position us well to grow market share in this important market segment. Our annuity sales remain robust.
Annuity collected premiums were up 26% compared to the prior year, and the average annuity policy size rose by 6%. Fixed index annuity products tend to perform well in an environment of rising interest rates and uncertain equity markets. The need for reliable retirement income, combined with the increased riskiness of pure equity investments, continues to make these attractive products to our customers. Client assets in brokerage and advisory were down 3% year-over-year to $2.6 billion in the second quarter, driven by declining equity impacts on account balances. New accounts, however, were up 10%, which partially offset the decline in asset values. Producing agent count was down 9% for the quarter. However, the softening macro environment appears to be helping our recruiting and retention efforts.
Sequentially, we recorded 2% growth in recruiting, leading to a slight increase in producing agent counts from the first quarter. Our results, plus our leading indicators signal we are at an inflection point on agent recruiting. Veteran agent retention remains stable. Agent productivity was up 10%, and registered agent count was up 6% from the prior year. Turning to slide 7 and our Worksite division performance. This quarter, we announced the launch of Optavise. The move unified our three existing Worksite brands into a single brand. Through Optavise, we now offer employees and employers a unique combination of expert guidance from our agents, benefit educators, and healthcare advocates, voluntary benefits, year-round communications and advocacy services, and benefits administration technology. Our Worksite distribution footprint operates nationwide through a network of 10,000 broker partners and more than 600 dedicated agents.
Through Optavise, we're serving nearly 20,000 businesses and employers from small and medium-sized businesses to Fortune 100 companies. We reported considerable growth in Worksite in the quarter, with insurance sales up 33%, albeit off a low base. Our access to on-site workplace enrollment is steadily increasing as more employees return to the office. Growth in the quarter was driven by a healthy mix of both reservice business and growth in new client acquisition. With the rollout of our hybrid enrollment platform last quarter, our agents can now reach employees however they choose. Separately, we launched new dental and vision distribution partnerships to broaden our product portfolio. This coverage is popular with employees, and we expect it to drive higher attendance at our enrollment events. Retention of our existing employer customers remains strong, and employee persistency within these employer groups continues to be stable.
Our producing agent count was down 9% year-over-year but grew 13% sequentially. We reported our strongest recruiting quarter since the start of the pandemic. These results suggest we are on a path of sustained recruiting growth similar to the Consumer division. We are also encouraged to see increased momentum in our field recruiting, driven in large part by the field agent referral program that we launched in the fourth quarter of 2021. The integration of our fee-based businesses is progressing well and should accelerate with the single Optavise brand. Fee revenue within Worksite was flat due to fewer off-cycle enrollments in the quarter. We continue to see cross-sale success between our fee-based businesses. Turning to slide 8. We returned $77 million to shareholders in the second quarter, including $60 million in share buybacks. Our capital allocation strategy remains unchanged.
We intend to deploy 100% of our excess capital to its highest and best use over time. While share repurchases form a critical component of our strategy, organic and inorganic investments also play an important role. With that, I'll turn it over to Paul.
Thanks, Gary, and good morning, everyone. Turning to the financial highlights on slide 9, we generated operating earnings per share of $0.85 in the quarter, which is up 29% year-over-year as reported and up 3% excluding significant items in both periods. Results in the period reflect favorable variable investment income and life margins, partially offset by lower annuity and health margins. Annuity results were again affected by largely non-economic impacts relating to market volatility. The significant item reported in the quarter is an experience refund of $22 and a half million earned under the terms of the legacy long-term care reinsurance agreement and based on the successful regulatory approval and implementation of certain rate increases. Fee income was down $3 million year-over-year, primarily due to higher expenses related to the business.
The sum of expenses allocated to products and not allocated to products, excluding significant items, was up 7%, primarily reflecting continued investment in growth initiatives. Our annualized effective tax rate was up 80 basis points to 23.5% from the year ago period, but down 130 basis points from the first quarter of 2022. The change from prior year is driven by a change in Illinois state income taxes as discussed last quarter. The sequential decline reflects lower Illinois state income and the impact of state tax credits identified and applied in the second quarter. We deployed $60 million of capital on share repurchases in the quarter, contributing to a 12% reduction in weighted average diluted shares outstanding year- over- year.
For the 12 months ending June 30, 2022, operating return on equity was 11.5% or 10.3% excluding significant items. Turning to slide 10. Insurance product margin was down $19 million or 9% in the second quarter as compared to the prior year period. Adjusting for the market impacts on our FIA margins, COVID impacts across all of our products, and the decrease in non-deferred advertising expense, as referenced on the slide, total margin was favorable by $3 million, reflecting the continued stable underlying dynamics of the business. As usual, there were some puts and takes by product line. Adjusting for these items, the annuity margin was down by $2 million, health margin was up by $1 million, and life margin was up by $4 million. Turning to slide 11.
Investment income allocated to products was flat as the impact from growth in the net liabilities and related assets was offset by a decline in yield. Our new money rate of 5.53% for the quarter was up 180 basis points sequentially, reflecting higher interest rates and spreads, and also benefiting from an allocation to alternative investments in the quarter. Investment income not allocated to products, which is where the variable components of investment income flow through, increased by $21 million or 43%, reflecting higher call and prepayment income, higher contribution from the FHLB program, and the addition of the FABN program. Our new investments comprise roughly $1 billion of assets with an average rating of single A and an average duration of 7.5 years.
Our new investments are summarized in more detail on slides 22 and 23 of the deck. Turning to slide 12. At quarter end, our invested assets totaled roughly $25 billion, down 10% year-over-year, reflecting declining market values in the quarter, driven primarily by higher interest rates. Approximately 96% of our fixed maturity portfolio at quarter end was investment grade rated with an average rating of single A, reflecting our up in quality actions over the last several quarters. The allocation to single A-rated or higher securities is up 220 basis points year-over-year, while the triple D allocation is down 210 basis points year-over-year and up 100 basis points sequentially.
The remaining 4% of the fixed income portfolio at quarter end was rated below investment grade, which is down 10 basis points year-over-year. Turning to slide 13. Free cash flow conversion on a trailing 12-month basis remains strong, though the absolute level of dividends out of the operating companies declined in the quarter. This is driven largely by the impact of the decline in equity market valuations on statutory income and capital due to the statutory accounting for fixed index annuities. The increase in required capital related to the recent investment in Rialto Capital was also a contributing factor. Turning to slide 14. At quarter end, our consolidated RBC ratio was 360% and our hold co liquidity was $140 million.
Taken together, that's approximately $95 million below our target RBC of 375% and holdco liquidity of $150 million. In general, in stressed market conditions, such as we're experiencing this year, we expect to flex the RBC ratio down subject to a minimum of 350%, and then to build it back up over time as market conditions stabilize. It's worth noting that the adverse impact of the decline in equity markets on our statutory income and capital related to our fixed index annuities in the first half of the year would not have a similar impact in future quarters in the event that equities were to trade down further.
The reason for the adverse impact in the first half of the year relates to the statutory accounting treatment of the call options we use to hedge the equity participation rate in our fixed index annuities and the related reserve. As equity markets trade down, the value of the call options declines more than the related statutory reserve due to the required statutory reserving methodology. The hedge is nearly perfect on an economic basis, but not on a statutory accounting basis. Given the current market value of a good portion of these options is approaching zero, additional downward movements in equity markets would not have a materially adverse impact on the value of the call options, and therefore no material adverse impact on statutory income and capital. Turning to slide 15.
In general, we are pleased with our earnings results in the first half of 2022, and our outlook continues to hold in most respects. Looking to the second half of the year, we expect increasing positive sales momentum while our directional earnings expectations with respect to COVID impacts, investment income, fee income, and expenses have not changed materially. The percentage increase in expenses, ex significant items in the first half of the year is a good indicator of our expected increase in expenses for the full year, with the second and third quarters a bit elevated relative to the full year expectation, and the first and the fourth quarters slightly lower than the full year average. Free cash flow on a run rate basis remains strong, but will be pressured in the near term as we build back to our targeted RBC and holdco liquidity levels.
Before I turn it back to Gary, I'd like to provide a brief update on where we stand with our progress in adopting ASC 944 or the long duration targeted improvement standard. First, it's important to note that the accounting change will have no impact on statutory accounting or the capital required by regulators, cash flows or lifetime GAAP profits. We made significant progress toward the January 1, 2023 adoption of the standard and expect to provide quantitative impacts, including pro forma results in the fourth quarter. For additional information, please refer to the comments and materials provided during our first quarter reporting that detail the estimated balance sheet impacts of that transition. With that, I'll turn it back to Gary.
Thanks, Paul. Next week, we will release our third corporate social responsibility report, where we share CNO's various commitments to ESG. These commitments, coupled with how CNO operates every day, is what we believe will best sustain our long-term performance. We do what's right for our associates, agents, customers and investors. We offer products that make our customers' lives better. We're helping improve our communities and the environment. I invite you to read the report to learn more about how CNO and our remarkable associates and agents are working to create a more sustainable future. Thank you for your support of and interest in CNO Financial Group. We will now open it up for questions. Operator?
Thank you. If you'd like to ask a question, please press star followed by one on telephone keypad. If you change your mind, please press star followed by two. When preparing to ask your question, please ensure your phone's unmuted locally. Our first question comes from Ryan Krueger from KBW. Please go ahead, Ryan.
Hi. Thanks. Good morning. Could you first talk about how you're thinking about the pace of share repurchase going forward and if you have any view on the timeframe that you'd like to build back the RBC ratio up to the 375 target?
Sure, Ryan. Hey, it's Paul. A little context and perspective, and then I think Gary will probably want to provide some color as well. First of all, $50 million, $50 million of the $60 million of share repurchases in the quarter was through a 10b5-1 program in the earnings blackout period in April. In May and June, we dialed back our share repurchase due to market conditions and also the Rialto Capital investment that we made in late April. You'll recall we issued a press release on that. We didn't dial back to zero given where our stock was trading at the time. In the near term, certainly you should expect that we'll continue to dial back our share repurchase as we build back to our target RBC and core liquidity levels.
I also want to just emphasize a couple things. Number one, our business should continue to generate healthy levels of free cash flow. Number two, we hit two very important inflection points in the quarter that we referenced in our prepared remarks. Number one, a new money rate above the portfolio rate. Number two, sequential improvement in producing agent count in both consumer and worksite. We expect both of those dynamics to persist, which should translate to a tailwind going forward in terms of sales, earnings and free cash flow. With that, Gary, I'll defer to you for additional perspective and color.
No, I think I'm good, Paul. I'll see if Ryan's got any follow-up on that, but other than that, I think we're good.
Okay. Sounds good.
Thanks. I had a separate follow-up. You had a pretty big uptick in the non-variable component of unallocated investment income in FHLB and the FABN program. Is that type of level that you had in this quarter something you'd expect to continue given the higher interest rate environment? If you could give us any more color on that. Thanks.
Sure. Eric Johnson is here with us, and Eric I'll defer to you to provide some color on those two.
Yeah, sure. I think during the period, we were fortunate enough to benefit from wider credit spreads, particularly in kind of the intermediate part of the curve and particularly in securitized markets as markets became less liquid and you know, we were able to add an increment over the cost of funds that was pretty healthy. You know, I would not assume that that's a permanent persisting dynamic although I think we're continuing to make some progress this quarter of a similar type. As long as the market makes that possible for us, we'll do it.
Now, bearing in mind, however also that those programs, you know, you don't turn all the assets over every quarter, and there's just only a certain amount of turnover, and new money investment opportunity to be had. I think, you know, I'm not expecting that increment to run off in the near term, and we might get a little additional tailwind in the near term. You know, it's kind of how I'm thinking about it.
Just one quick follow-up. What's the duration of the assets that are backing FHLB and FABN programs?
Sure. Well, as you know, we've done a handful of funding agreement issues, threes, fives and sevens. You should assume that the assets have a symmetrical quality such that we have good duration matches in each of those three buckets. If you look at Federal Home Loan Bank, the great bulk of the liabilities and assets are on a floating rate basis, and so you know have very short durations on both sides of the balance sheet.
The cash flows are, you know, very carefully modeled and, you know, we feel comfortable that, you know, we have good, you know, good asset and liability management in both of those programs such that they were not likely to, you know, have any kind of disintermediation effect or anything like that.
Got it. Thanks a lot.
You're welcome.
Our next question comes from Daniel Bergman from Jefferies. Please go ahead, Dan.
Thanks. Good morning. Your comments on not expecting further pressure on the RBC from the statutory impact of weak markets on that FIA block were very helpful. I just wanted to see if you could provide some thoughts on whether we should expect any snapback in the RBC ratio or reversal of that, you know, pressure we saw in the first half if equity markets are favorable in the third quarter, given the momentum we saw in July. Just trying to get a sense of if there's how the symmetry works there or would the recovery be more gradual? Just any more color on how that statutory accounting works would be helpful.
Sure. Dan, it basically works in reverse, you know, subject to this floor you have on the call options that limits the downside, you know, sort of from where we sit here. The movement you saw in the first half of the year, you know, is traded down, you know, would be largely symmetrical going the other way.
Got it. That's really helpful. Thanks. Maybe shifting gears a little bit, it looked like the life advertising spend was down, I think both year-over-year and quarter-over-quarter after a seemingly, you know, meaningful step up last quarter. Just wanted to see if there's any more color you can give on the, you know, what you're seeing in terms of the cost of advertising and any pressure impact you're seeing from inflation.
Sure. I'll take a first crack at that. Essentially, Dan, with our advertising, we manage to a number of internal metrics to make sure that we're getting the expected sort of productivity out of the ad spend. In particular, what's the relationship between the premium that we're generating and the ad spend. We're also very opportunistic in terms of, you know, where we're placing those ads. And that, you know, generally drives the level of the ad spend in any given quarter. I guess I'd leave it there. Gary, would you add anything to that?
Paul, the only thing I would just emphasize, and you touched on it, if an opportunity presents itself where we think we can really maintain or increase the yield, we would be willing to spend more. As we've said throughout, we dial the expenses up and down depending on the efficacy of the advertising.
Got it. Makes sense. Thank you.
Next question comes from John Barnidge from Piper Sandler. Please go ahead, John.
Thank you very much. The NAIC is considering increased RBC charges on CLO investments. What are your views on the proposal? Maybe discuss potential impact on required capital in RBC.
Hey, John, it's Paul. You're asking about the NAIC capital changes?
Yes, that's correct.
I just wanted to make sure I heard yeah. Okay. You know, as you know, they put it out for proposal, got some feedback, you know, withdrew it. Are expecting to, you know, sort of resubmit it for comment, with the goal, I think, of implementing at year-end. At this stage, you know, we're primarily just staying tuned. I think it's, you know. However it shakes out, it will be very manageable. We may have to make some adjustments in the context of, you know, revised capital charges. I'd say that's where we are with it at this stage.
Okay, great. Thank you. My follow-up, annuity growth deposits were rather strong in the quarter. Can you talk about outlook for that, maybe where that demand came from? Thank you.
Yeah. So, John, this is Gary. Thanks for the question. A couple of things. Remember that we've been on a voyage for quite a long time to have an increasing number of our agents get their securities license. The main reason we've been undertaking that strategy is to fundamentally change the relationship we have with our consumers so that it's no longer a transactional relationship where they're simply buying an insurance product and paying the premium, and of course, that can be canceled at any time. When consumers entrust us with their assets like annuity, the relationship changes because now we're viewed as an investment as opposed to an expense. We've been on the journey for a long time to do more and more of that. We very much like the business.
It's a great service to our consumer, and we like the margins we make on the products and so on. Then you have, I think, an environmental set of forces. Generally speaking, during periods of market volatility and/or interest rates rising, these products become more and more interesting to consumers because they represent a way for the consumers to participate in the upside of the equity markets or insulate themselves against significant downside, and still participate in that upside if it should happen to turn around. We see the demand for these products grow in volatile times like this. That, combined with our own internal efforts, I think led to this growth. We've been enjoying some good growth on our annuity sales for a couple of years now.
I don't know that we're gonna continue to grow at this rate. 26% is a pretty robust clip. We like the product, we continue to push it, and we continue to develop internal skills to go after it.
The next question is from Erik Bass from Autonomous Research. Please go ahead, Eric.
Hi. Thank you. I just wanted to follow up on the equity market sensitivity in the annuities block. I think your answer is very clear on kind of what happens on the capital front, at least in the short term. Just was hoping you could provide a similar sensitivity on GAAP, and is it a similar dynamic where, if markets fall further, there's less impact to the downside and that you would see benefit to the upside if markets rise? I guess the other question is just on capital. I mean, your call option portfolio is continuously changing as you sell new business and as the options expire. How does that sensitivity change as we move forward, a few quarters? Does it go back to being sort of you're exposed to upside and downside?
Hey, Erik, it's Paul. On the GAAP side, it certainly does work in both directions, and by and large, symmetrical. There are more moving pieces on the GAAP side. It's sort of complicated to draw the line between operating income and non-operating income. Directionally, you know, you should expect favorable impacts if market conditions are sort of the reverse of what we've experienced in the first half of this year. With respect to the statutory dynamic, you're exactly right. You know, we're purchasing call options every month, you know, as we write new business and as annuities are reaching their anniversary. You know, it is a dynamic process.
You're right, you would get back to a point where there's symmetry up and down.
Got it. Just on the GAAP side, just to be clear, so if markets were to go down again from here, would you expect a negative adjustment in the quarter, or would that be largely or a lot smaller now, given that you've essentially zeroed out index credits?
Yeah. A couple thoughts. Number one, on the GAAP side, it's sensitive to equity valuations. Although, you know, equities are sort of a sub of the puzzle. I think, you know, all else equal, up equities would be favorable. But it's, as I say, much more complicated with the different factors, interest rates being, you know, more dominant. Then again, where we draw the line between operating and non-operating.
Got it. I was just curious how you're thinking about the outlook for credit, just given the uncertain economic outlook and how this factors into how you're thinking about the level of capital buffers you may want to maintain in the near term.
Well, you know, the target 375 RBC is really intended to be a target level of capital that we're comfortable with through the cycle, and in stressed market conditions that you know we're comfortable stressing that down, flexing that down. Subject to you know the minimum of 350. You know, in a very bullish markets and you know very healthy sort of economic backdrop you know that would sort of drive the RBC north of 375, all else equal. We would still by and large manage to the 375 to the extent that the dynamic with FIAs you know that we've talked about you know sort of takes you above the 375. I think we have to acknowledge that you know that comes and goes.
That may cause us to, you know, stay above 375 by, you know, some amount, you know, 380, 385.
Got it. I guess it sounds like nothing on the credit front that's worrying you and making you feel the need to be.
No. Again.
-near-term.
No. Again, because the $375 is intended to take us through the credit cycle. Also just in the context of, you know, the composition of our portfolio, our discipline around asset liability matching, and the fact that, you know, the up in quality bias that we've adopted the last several quarters on top of what was already, I think, a fairly conservative bias. I think we're very well positioned for, you know, a potential, you know, more recessionary credit migration and whatnot.
Got it. Thank you.
Today's Q&A session has come to an end. I will hand it back to Adam Auvil for any final remarks.
Thanks, operator. Thanks everyone for joining us today, and thanks for your interest in CNO.
This concludes today's call. Thank you for joining me. Now disconnect your lines.