CNA Financial Corporation — Q3 2016 Form 10-Q
Business context and reporting period. CNA is a commercial property-and-casualty insurer with Specialty, Commercial and International core segments, plus Life & Group Non-Core and Corporate & Other Non-Core operations. This unaudited filing covers the quarter and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods. Loews Corporation owned approximately 90% of CNA’s common stock.
Financial performance
| Metric (USD millions, except per-share data) | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Total revenue | 2,433 | 2,153 | 6,976 | 6,832 |
| Net earned premiums | 1,767 | 1,751 | 5,196 | 5,173 |
| Net investment income | 524 | 354 | 1,461 | 1,412 |
| Net realized investment gains (losses) | 46 | (49) | 26 | (39) |
| Net operating income (non-GAAP) | 311 | 210 | 603 | 567 |
| Net income | 343 | 178 | 618 | 549 |
| Diluted earnings per share | $1.26 | $0.66 | $2.28 | $2.03 |
- Q3 revenue rose about 13% and net income about 93% year over year. Management attributed stronger operating income principally to higher investment income, especially limited partnership returns; Q3 investment income included $65 million of limited partnership income versus a $93 million loss in Q3 2015.
- Nine-month revenue increased about 2% and net income about 13%. Nine-month net operating income improved $36 million; stronger non-core results, particularly long-term care, were partly offset by higher underwriting expenses and catastrophe and large losses in core operations.
- Net prior-year development was favorable by $137 million in Q3 and $309 million for nine months, versus $180 million and $198 million in 2015, respectively. Catastrophe losses, net of reinsurance, were $16 million for Q3 and $137 million for nine months, versus $14 million and $103 million in 2015.
- Core segment combined ratios: Specialty was 79.9% in Q3 and 84.9% year to date; Commercial was 99.8% and 101.7%; International was 93.2% and 103.4%. The nine-month International ratio worsened from 93.5% in 2015, principally reflecting catastrophe and large losses.
Financial position, cash flow and capital
- At September 30, total assets were $56.9 billion, total liabilities $44.7 billion, and stockholders’ equity $12.2 billion, compared with $55.0 billion, $43.3 billion and $11.8 billion, respectively, at year-end 2015. Fixed-maturity securities were reported at fair value of $42.3 billion, with $4.1 billion of net unrealized gains.
- Cash was $290 million, down from $387 million at year-end; short-term investments were $1.42 billion, down from $1.66 billion. Nine-month operating cash flow was $1.12 billion versus $1.05 billion in 2015; investing cash use was $604 million and financing cash use was $605 million.
- There was no short-term debt at quarter-end; long-term debt was $2.71 billion versus $2.21 billion at year-end. CNA issued $500 million of 4.50% senior notes due 2026 and redeemed $350 million of 6.50% notes due 2016. The $250 million revolving credit facility was undrawn. Management said current cash flows were sufficient for expected working-capital and debt needs.
- Nine-month common dividends paid totaled $746 million, including a special dividend; declared dividends were $2.75 per share for the period, including the $2.00 special dividend. A further quarterly dividend of $0.25 per share was declared in October.
Outlook, risks and unusual items
- Efficiency actions: A 2016 organization review eliminated approximately 370 positions. CNA expects total termination costs of about $20 million, with $17 million incurred through September and further costs expected through March 2017. Management estimates annual savings of about $50 million and a half-point reduction in the 2017 property-and-casualty expense ratio.
- A&EP reinsurance: A first-quarter reserve review recorded $200 million of net adverse asbestos and environmental pollution development before the 2010 NICO loss portfolio transfer; the additional amount was ceded under the agreement. Retroactive reinsurance accounting limited immediate benefit recognition, contributing to $20 million of after-tax charges in the nine-month comparison. The unrecognized deferred reinsurance benefit was $347 million at September 30. The transfer has a $4 billion aggregate limit; performance and reserve estimates remain risks.
- Long-term care: Following reserve assumption changes in late 2015, 2016 results reflect actual experience against reset assumptions and are not directly comparable with 2015. Q3 non-core operating income was $6 million; favorable morbidity was partly offset by unfavorable persistency.
- Business and market risks: CNA highlighted uncertainty in loss-reserve estimates, reinsurance recoveries, investment returns and market valuations, competition and pricing, catastrophe exposure, litigation and regulation. Brexit may require changes to the European operating platform and increase compliance complexity and costs.
- Contingencies: A September 2016 class action concerning the CNA 401(k) Plan alleges fiduciary-duty and prohibited-transaction violations. Management described loss as reasonably possible but said any amount could not yet be estimated; no class had been certified. Other disclosed exposures include guarantees for previously issued structured-settlement annuities with potential future payments of approximately $1.9 billion, supported by a trust, and certain sale-related indemnities, including unlimited indemnifications.
- No specific earnings or revenue guidance was provided. Management stated the interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether favorable reserve development—$309 million for the first nine months—continues, and how much reflects underlying loss trends versus prior-year reserve releases.
- The sustainability of investment income and limited partnership returns, which materially supported Q3 earnings.
- Commercial and International underwriting performance, including catastrophe and large-loss trends, and the effect of pricing, retention and expense increases.
- The timing and earnings impact of recognizing deferred benefits under the NICO A&EP transfer, and the sufficiency of reserves and reinsurance recoveries.
- Execution of the organization savings plan and the effect of remaining restructuring costs; potential Brexit-related operating costs and the outcome of the 401(k) litigation.
- Liquidity and capital needs, dividend capacity and the effect of debt refinancing; also note that dividend payments remain subject to board discretion and regulatory constraints.