CNA Financial Corporation — Q3 2013 Form 10-Q
Business context and reporting period. This unaudited quarterly filing covers the three and nine months ended September 30, 2013, compared with the corresponding 2012 periods. CNA’s core operations are commercial property and casualty insurance: CNA Specialty, CNA Commercial and Hardy. Life & Group Non-Core and Corporate & Other Non-Core are managed separately. Loews Corporation owned approximately 90% of CNA’s common stock.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Total revenue | $2.504B | $2.466B | $7.500B | $7.113B |
| Net earned premiums | $1.825B | $1.781B | $5.389B | $5.098B |
| Net investment income | $597M | $601M | $1.808B | $1.719B |
| Net operating income | $269M | $216M | $704M | $594M |
| Net income | $272M | $221M | $716M | $637M |
| Diluted earnings per share | $1.01 | $0.82 | $2.65 | $2.36 |
- Profitability and underwriting: Q3 net income rose $51M year over year, primarily on higher operating income. Nine-month net income rose $79M, despite lower realized investment gains. Core segments’ nine-month net operating income increased $147M; non-core segment results declined $37M.
- Combined ratios: Specialty improved to 85.3% in Q3 from 93.7%, and to 90.1% for nine months from 95.1%. Commercial improved to 103.0% in Q3 from 106.0%, but deteriorated to 107.2% for nine months from 106.8%. Hardy was 85.1% in Q3 versus 85.8%, and 95.4% for nine months versus 85.8%. A ratio below 100% indicates underwriting profit before investment income.
- Cash flow: Nine-month operating cash flow was $921M, versus $993M; 2012 included a $75M tax refund. Investing activities used $689M, compared with $747M, and financing activities used $200M, compared with $195M. Ending cash was $185M, up from $156M at year-end 2012.
- Balance sheet and debt: At September 30, assets were $57.187B and liabilities $45.034B, compared with $58.522B and $46.208B at December 31, 2012. Stockholders’ equity was $12.153B, down from $12.314B, chiefly reflecting a $718M decline in accumulated other comprehensive income. Long-term debt was $2.559B; short-term debt was zero. The fair value of long-term debt was $2.928B.
- Capital and investments: The fixed-maturity portfolio was $41.274B at fair value; 92% was investment grade. Nine-month fixed-maturity yield was 5.2%, versus 5.4%. Net investment income growth chiefly reflected higher limited-partnership results, partly offset by lower fixed-maturity income.
Material changes versus prior periods
- Nine-month net earned premiums increased $291M; the comparison includes Hardy only from its July 2012 acquisition date. Specialty and Commercial also recorded year-over-year increases in nine-month earned premiums.
- Core underwriting results benefited from improved non-catastrophe current-year performance, while catastrophe losses increased. Net catastrophe losses were $146M for nine months, versus $123M; after-tax catastrophe losses were $96M versus $80M.
- Favorable net prior-year development was $76M in Q3, versus $47M, but $128M for nine months, versus $165M. Commercial’s nine-month development was unfavorable by $5M, versus $66M favorable in 2012.
- Q3 net realized investment gains after tax were $3M, versus $5M; nine-month gains were $12M, versus $43M. Nine-month other comprehensive income was a loss of $718M, versus income of $650M, largely due to a decline in unrealized investment gains.
- Common dividends paid were $0.60 per share for nine months, versus $0.45. The board declared a further $0.20-per-share dividend payable November 26, 2013.
Management commentary, outlook and risks
- Management said existing cash flows were sufficient for current and expected working-capital and debt needs, with no near-term change expected. No quantitative earnings or revenue guidance was provided.
- In June 2013, S&P upgraded CNA’s property-and-casualty insurer financial-strength ratings to A with a stable outlook and CNAF senior debt to BBB. The $250M revolving credit facility had no borrowings. CNA’s insurance subsidiary CCC could pay about $550M in dividends during the balance of 2013 without prior Illinois regulatory approval. FHLB Chicago membership provided access to approximately $330M of additional liquidity; no FHLB borrowings were outstanding.
- Q3’s $30M after-tax workers’ compensation residual-market litigation settlement benefit contributed to nine-month core results. Conversely, 2013 New York legislation regarding the Fund for Reopened Cases required additional workers’ compensation reserves; CNA recorded $23M after tax in Commercial. Long-term-care results also weakened, with unfavorable morbidity partly offset by rate increases and persistency.
- Insurance reserve estimates are inherently uncertain, particularly for long-tail claims. CNA recorded favorable development, but states that ultimate claims could exceed current estimates. Catastrophes, reinsurance recoveries, A&E liabilities, investment-market changes, competition, regulation, ratings and long-term-care experience are identified risks.
- Commitments included approximately $405M of future limited-partnership capital calls and $172M of additional purchases or funding under privately placed debt arrangements. A joint-venture office-lease guarantee could require up to approximately $90M beyond recorded amounts if other shareholders fail to fund; management considered that outcome unlikely. Quantifiable indemnification agreements totaled $723M; recorded related liabilities were about $7M. Routine litigation was described as not material.
Important facts for investors to verify
- Whether favorable reserve development persists, especially in Specialty, and whether Commercial workers’ compensation reserves adequately reflect the New York law change and claim severity trends.
- How much of earnings growth reflects durable underwriting improvement versus reserve releases, the $30M settlement benefit, investment results and other unusual items.
- Catastrophe exposure and the effect of rising catastrophe losses on segment combined ratios and future results.
- Long-term-care morbidity, rate actions and persistency, as well as the adequacy of related reserves.
- Investment-portfolio sensitivity to interest rates and credit spreads, the unrealized-loss position, and the liquidity and credit quality of investments and reinsurance recoverables.
- Ability to sustain dividends and subsidiary distributions while meeting policyholder obligations, debt needs and potential guarantee or indemnification claims.