CNA Financial Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. CNA is a commercial insurer operating Specialty, Commercial, International, Life & Group, and Corporate & Other businesses. Loews Corporation owned approximately 89% of CNA’s common stock.
Financial performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Total revenue | $2.535 billion | $2.330 billion |
| Net earned premiums | $1.785 billion | $1.645 billion |
| Net investment income | $490 million | $545 million |
| Net realized investment gains | $12 million | $36 million |
| Net income | $291 million | $260 million |
| Diluted earnings per share | $1.07 | $0.96 |
| Core income, non-GAAP | $281 million | $235 million |
| Operating cash flow | $218 million | $282 million |
Revenue grew about 9% and net income about 12% year over year. Management said core income increased $46 million, with improved underwriting more than offsetting lower investment income. The lower tax rate also benefited the comparison. Core income excludes specified items, including realized investment gains and losses, and is not a GAAP measure.
Net investment income fell $55 million, mainly because limited partnership returns were 1.2%, compared with 3.8% a year earlier. After-tax net investment income rose to $405 million from $389 million, reflecting the lower federal corporate tax rate. The effective pretax yield on fixed-income securities was 4.7%, versus 4.8%.
Underwriting and segment trends
- Specialty: Core income was $171 million versus $137 million; combined ratio improved to 87.5% from 93.2%. Net written premiums rose to $686 million from $670 million.
- Commercial: Core income was $133 million versus $111 million; combined ratio improved to 97.1% from 101.7%. Net written premiums rose to $832 million from $724 million. The prior-year comparison included a Small Business premium adjustment.
- International: Core income was $23 million versus $20 million; combined ratio increased to 96.6% from 95.1%. Net written premiums increased to $295 million from $238 million, including growth across its platforms.
- Life & Group: Core income was $14 million versus $4 million. Management attributed improvement, excluding the tax-rate effect, to favorable persistency and premium rate increases.
- Corporate & Other: Core loss widened to $60 million from $37 million, reflecting higher adverse A&EP reserve development under the reinsurance arrangement.
Catastrophe losses, net of reinsurance, were $34 million in both periods. Favorable net prior-year reserve development was $39 million, compared with $57 million in Q1 2017.
Cash, balance sheet and capital
- At March 31, 2018, total assets were $57.649 billion and stockholders’ equity was $11.425 billion, compared with $56.567 billion and $12.244 billion, respectively, at year-end.
- Cash was $282 million; short-term investments were $1.230 billion. Total investments were $45.535 billion.
- Short- and long-term debt totaled $2.709 billion, down from $2.858 billion at year-end. CNA repaid $150 million of senior notes during the quarter.
- Operating cash flow was $218 million; investing activities provided $489 million; financing activities used $781 million. Financing outflows included $624 million of common dividends and the $150 million debt repayment. Cash declined $73 million during the quarter.
- CNA declared and paid a $0.30-per-share quarterly dividend and a $2.00-per-share special dividend. A further $0.30-per-share quarterly dividend was declared for payment in May 2018.
- The $250 million revolving credit facility had no borrowings outstanding. Management said current cash flows were sufficient for expected working-capital and debt needs and planned to repay Hardy’s $30 million subordinated variable-rate debt later in 2018.
Material changes, accounting and unusual items
- Other comprehensive loss was $416 million, primarily reflecting a $429 million after-tax decline in unrealized gains on other investments. Total comprehensive loss was $125 million, versus comprehensive income of $341 million a year earlier. Accumulated other comprehensive income moved from positive $32 million at year-end to a loss of $400 million.
- Adoption of ASC 606 increased Q1 warranty revenue by $137 million and warranty expense by $138 million, reducing reported pretax income by $1 million. The standard also changes the timing of warranty revenue recognition. Thus, reported warranty revenue and expense are not directly comparable with the prior period.
- ASC 606 increased opening other assets and other liabilities by $1.882 billion and $1.969 billion, respectively. Deferred warranty revenue was $3.0 billion at March 31; CNA expects to recognize approximately $659 million during the remainder of 2018.
- Changes in equity-security accounting resulted in a $15 million pretax loss on non-redeemable preferred stock recognized in realized investment results during Q1.
- For the legacy asbestos and environmental pollution portfolio, CNA recorded $113 million of unfavorable prior-year development before the NICO loss portfolio transfer, a $57 million retroactive reinsurance benefit, and a $40 million net pretax impact. The unrecognized deferred reinsurance benefit was $366 million; the collateral trust fair value was $2.9 billion.
Outlook, risks and contingencies
The filing gives no specific earnings or revenue guidance. Management stated that it expects current cash flows to cover near-term working-capital and debt requirements. Future dividends remain subject to board discretion, earnings, financial condition, business needs and regulatory constraints.
- Results are sensitive to insurance reserve estimates, particularly long-tail claims and A&EP exposures; actual claims may exceed current estimates. Reinsurance recoverability and counterparties’ performance are also risks.
- Management cited market and credit conditions, investment returns and valuations, competition and pricing, inflation in medical and repair costs, litigation and regulatory developments, and catastrophic events as risks that could affect results.
- CNA expects Brexit to require changes to its European operating platform and has begun establishing a Luxembourg subsidiary; management expects increased regulatory complexity and cost.
- A class-action matter involving the CNA 401(k) Plus Plan had agreed settlement terms, subject to final agreements and court approval. Management did not expect a material impact.
- Workers’ compensation premium refunds related to Small Business rating errors were expected in the second half of 2018; the estimated refund liability, including interest, was $60 million at quarter-end.
- CNA disclosed approximately $1.8 billion of potential future payments under guarantees related to structured-settlement annuities, payable over annuitants’ lifetimes. The company said payment was not expected, citing a supporting trust.
Important facts for investors to verify
- Whether premium growth and improved combined ratios persist, especially after accounting for the prior-year Small Business premium adjustment and reserve-development differences.
- Whether investment income recovers from lower limited partnership returns, and how market-rate changes affect investment valuations and accumulated other comprehensive income.
- Future reserve development, including A&EP experience, the NICO transfer’s remaining protection and recoverability of reinsurance.
- The ongoing effects of ASC 606 on warranty revenue, expenses, deferred balances and comparability with earlier periods.
- Dividend capacity and holding-company liquidity, including regulatory limits on insurance-subsidiary dividends and the planned debt repayment.
- Resolution of the 401(k) litigation, payment of the workers’ compensation refunds, and exposure under guarantees and indemnities.