CNA Financial Corporation — Q3 2018 Form 10-Q
Business context and period. CNA is a commercial insurer with Specialty, Commercial and International property-and-casualty operations, plus Life & Group and Corporate & Other. This unaudited filing covers the three and nine months ended September 30, 2018; comparisons are with the same 2017 periods. Loews Corporation owned approximately 89% of CNA’s common stock.
Financial performance
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Total revenue | $2.622B | $2.398B | $7.731B | $7.094B |
| Net income | $336M | $144M | $897M | $676M |
| Diluted EPS | $1.23 | $0.53 | $3.29 | $2.48 |
| Core income (non-GAAP) | $317M | $159M | $868M | $633M |
| Operating cash flow | Not stated quarterly | Not stated quarterly | $868M | $894M |
Net earned premiums were $1.853B in Q3 and $5.453B year to date, up from $1.806B and $5.185B, respectively. Net investment income declined to $487M in Q3 and $1.483B for nine months from $509M and $1.529B. Nine-month net realized investment gains were $25M, versus $62M a year earlier. The filing does not provide a single consolidated operating-margin measure; segment combined ratios are provided below.
Balance sheet and liquidity at September 30, 2018: Total assets were $57.259B; investments, $44.929B; cash, $310M; and stockholders’ equity, $11.510B, down from $12.244B at year-end 2017. The equity decline chiefly reflects a $773M nine-month other comprehensive loss, largely from investment valuation changes. Long-term debt was $2.680B, with no short-term debt, compared with $150M short-term and $2.708B long-term debt at year-end. Nine-month investing cash flow was positive $80M, versus negative $218M in 2017; financing cash outflow was $989M, including $801M of common dividends paid.
Material changes and operating drivers
- Reported revenue growth was substantially affected by adopting revenue-recognition guidance for non-insurance warranties. The change increased reported warranty revenue by $149M in Q3 and $429M year to date, and warranty expense by $153M and $436M, respectively; it reduced net income by $3M and $5M. Prior-year figures were not restated, so reported revenue comparisons are not fully like-for-like.
- Core income increased $158M in Q3 and $235M for nine months. Management attributed much of the improvement to lower catastrophe losses, partly offset by weaker limited-partnership investment returns and less favorable prior-year reserve development. The lower federal corporate tax rate also affected comparisons.
- Net catastrophe losses fell to $46M in Q3 and $106M year to date, versus $269M and $342M in 2017. Q3 2018 catastrophe losses included $35M related to Hurricane Florence.
- Favorable prior-year reserve development was $62M in Q3 and $160M year to date, compared with $115M and $227M in 2017. The favorable development was concentrated in Specialty; some medical professional liability and other lines had unfavorable development.
- Q3 combined ratios were 87.0% Specialty, 97.4% Commercial and 103.9% International. Nine-month ratios were 87.1%, 97.0% and 101.8%, respectively. International remained above 100%, meaning underwriting losses before investment income.
- Q3 Commercial core income rose to $127M from $32M, helped by lower catastrophe losses. Life & Group core income was $32M versus $10M, including a $24M after-tax benefit from the annual long-term-care claims experience study.
Outlook, risks and unusual items
- No formal earnings or revenue guidance is provided. Management said current operating, investing and financing cash flows are expected to meet working-capital and debt obligations in the near term. The $250M revolving credit facility had no borrowings outstanding.
- Long-term-care reserves remain sensitive to assumptions. The September 2018 valuation showed an estimated $182M margin in active-life reserves. CNA expects to begin adding reserves in Q4 2018 for projected profits in earlier years that offset expected losses in later years. Illustrative assumption changes could materially reduce pretax income, though the filing says these hypothetical revisions are not currently required or anticipated.
- For legacy asbestos and environmental pollution liabilities, CNA recorded $113M of unfavorable development before the loss portfolio transfer in the first nine months, partly offset by reinsurance accounting; the reported pretax impact of the deferred reinsurance accounting was $13M. The unrecognized deferred benefit was $339M, and NICO’s collateral trust fair value was $3.2B. Recovery depends on reinsurance performance and reserve estimates.
- Management identified insurance reserve adequacy, reinsurance collectibility, investment valuation, long-term-care assumptions, catastrophes, litigation, market conditions and regulation as key risks. CNA also noted Brexit-related European restructuring and expected elevated compliance costs. CNA Hardy ceased writing certain Lloyd’s property treaty, marine hull and construction-risk classes from October 1, 2018, potentially reducing premiums.
- Other notable items: nine-month Corporate & Other core loss included $27M of non-recurring costs tied to a new IT infrastructure provider; CNA declared $2.95 per share in dividends for the first nine months, including a $2.00 special dividend. A $0.35 quarterly dividend was declared for payment in December.
Important facts for investors to verify
- Separate underlying premium and earnings trends from the ASC 606 warranty revenue-and-expense gross-up and timing effects.
- Track catastrophe losses, reserve development and subsequent actuarial updates, especially medical professional liability and asbestos/environmental exposures.
- Review the Q4 2018 and 2019 long-term-care reserve actions, assumptions and remaining reserve margin.
- Assess investment portfolio marks, limited-partnership returns, liquidity, and the effects of interest rates and credit spreads on equity and capital.
- Confirm cash generation, subsidiary dividend capacity and capital available for common dividends; CNA reported about $63M of additional 2018 ordinary dividend capacity at CCC without prior regulatory approval as of September 30.