CNA Financial Corporation — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Amounts are in millions of dollars except per-share data and ratios. CNA is a commercial property-and-casualty insurer; Loews Corporation owned approximately 90% of its common stock.
Financial performance
- Second quarter: Revenue was $2,327, down 5% from $2,440 a year earlier. Net earned premiums were $1,735 (down 4%) and net investment income was $500 (down 9%). Continuing-operations income was $138, compared with $261; net income was also $138 versus $267. Diluted EPS was $0.51 versus $0.98.
- First half: Revenue was $4,679, down 5%; net earned premiums were $3,422, down 5%, and net investment income was $1,058, down 2%. Continuing-operations income was $371 versus $481. Net income was $371 versus $280, but the 2014 comparison included a $214 after-tax loss on the sale of discontinued life subsidiary Continental Assurance Company. First-half diluted EPS was $1.37 versus $1.03.
- Operating results: Net operating income was $132 in Q2 versus $272 and $357 for the first half versus $462. Excluding the specified significant items, management said net operating income decreased $30 in Q2 but increased $5 in the first half. Q2 included a $54 after-tax charge related to A&EP reserve development under the Loss Portfolio Transfer (LPT); Q2 2014 included a $56 after-tax postretirement curtailment gain.
- Underwriting: Q2 combined ratios were Specialty 91.2% (87.5% prior year), Commercial 107.2% (118.1%), and International 92.2% (89.9%). First-half ratios were 92.9%, 105.3%, and 95.1%, respectively. Commercial improved substantially year over year, while its ratio remained above 100%. Core-segment prior-year development was favorable by $20 in Q2 and $18 in the first half, versus unfavorable development of $22 and $16 in the comparable 2014 periods.
- Segment trends: Q2 net operating income was Specialty $137 (down from $167), Commercial $78 (up from $49), International $22 (up from $20), Life & Group Non-Core loss $24 (versus income of $9), and Corporate & Other Non-Core loss $81 (versus income of $27). The Life & Group decline reflected less favorable long-term-care morbidity experience; the corporate comparison was affected by the LPT charge and prior-year curtailment gain.
- Cash flow and capital: First-half operating cash flow was $540 versus $587; investing activities provided $87 versus using $734; financing activities used $670 versus providing $163. Financing outflows included $676 of common dividends, including the $2.00-per-share special dividend. Cash ended at $145, down from $190 at year-end 2014.
Balance sheet, liquidity and investment portfolio
- At June 30, total assets were $55,022, total liabilities $42,788, and stockholders’ equity $12,234, compared with $55,566, $42,772, and $12,794 at December 31, 2014.
- Long-term debt was $2,560, essentially unchanged from year-end; its estimated fair value was $2,843. CNA reported no borrowings under its $250 revolving credit facility or through the Federal Home Loan Bank of Chicago. Cash and short-term investments totaled $1,817.
- Management said current cash flows were sufficient for expected working-capital and debt needs and that it did not expect this to change in the near term. Insurance subsidiary CCC paid its parent $700 in dividends during the first half; approximately $216 of additional ordinary dividends could be paid without prior regulatory approval as of June 30.
- Fixed-maturity investments had a fair value of $39,849; 92% were investment grade. Q2 after-tax investment income fell $35 year over year, primarily because limited partnerships returned 1.6% versus 3.5%. First-half after-tax investment income fell $12. Net OTTI losses recognized in earnings were $31 in Q2 and $43 in the first half.
- Other comprehensive loss was $278 in Q2 and $257 in the first half, primarily reflecting lower unrealized investment gains; accumulated other comprehensive income fell to $143 from $400 at year-end.
Material changes, outlook and risks
- Management provided no specific earnings or revenue guidance in the supplied filing text. It highlighted uncertainty in insurance reserve estimates, investment returns, competitive pricing, economic conditions, and catastrophe losses.
- Q2 catastrophe losses, net of reinsurance, were $60 versus $56; first-half losses were $89 versus $130. The filing attributes 2015 catastrophe losses primarily to U.S. weather events.
- The second-quarter A&EP reserve review identified $150 of adverse development, driven by reduced expected asbestos reinsurance recoveries and higher pollution claim severity. The amount was ceded under the 2010 LPT; a $71 first-half retroactive reinsurance benefit was recognized, while the unrecognized deferred benefit was $255 at June 30. The resulting Q2 pretax impact from the unrecognized benefit was $84.
- Management emphasized that reserve estimates may prove inadequate, particularly for long-tail, asbestos and environmental claims. It also cited risks relating to reinsurer performance, interest rates and credit spreads, market liquidity, foreign exchange, regulation, litigation and severe weather. Management said unrealized security losses were primarily market-related and that it did not intend, and was not more likely than not required, to sell affected securities before recovery.
- Contingencies include approximately $2.0 billion of potential future payments under guarantees of structured settlement annuities; management considered payment unlikely, citing a supporting trust. A joint-venture lease guarantee could require up to $37 of payments beyond recorded amounts. Routine litigation was described as not material. The filing also reports $375 of quantifiable guarantees, $260 of indemnification agreements and certain unlimited indemnifications.
- The company eliminated future accruals under its retirement plan effective June 30, 2015; the curtailment reduced the plan benefit obligation by $55. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of the Q2 and first-half earnings comparison reflects the A&EP LPT charge, the 2014 pension curtailment gain, and the 2014 discontinued-operation impairment?
- Whether Commercial underwriting improvement is sustainable, given the 105.3% first-half combined ratio and remaining reserve-development exposures.
- How long-term-care morbidity, claim severity, reserve assumptions and future A&EP reinsurance recoveries could affect earnings and equity.
- Whether investment income—particularly limited-partnership returns—and unrealized investment values recover or remain under pressure.
- The impact of the special dividend on capital flexibility, subsidiary dividend capacity and future distributions.