CNA Financial Corporation — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; unaudited. Unless noted otherwise, amounts are in millions of dollars. CNA is a commercial property and casualty insurer with Specialty, Commercial and Hardy operations, alongside non-core businesses. Loews Corporation owned approximately 90% of CNA’s common stock. CNA acquired Hardy in July 2012, so Hardy had no comparable Q1 2012 segment results.
Financial results and position
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Total revenue | $2,503 | $2,401 | +$102 |
| Net earned premiums | $1,764 | $1,649 | +$115 |
| Net investment income | $633 | $648 | -$15 |
| Net realized investment gains | $28 | $36 | -$8 |
| Net operating income | $231 | $226 | +$5 |
| Net income | $250 | $250 | Unchanged |
| Diluted EPS | $0.93 | $0.93 | Unchanged |
| Operating cash flow | $191 | $312 | -$121 |
Operating revenue, excluding realized investment gains, was $2,475 versus $2,365. Income before tax was $363 versus $364; income tax expense was $113 versus $114. Dividends were $0.20 per share, compared with $0.15 a year earlier.
Balance sheet and liquidity at March 31, 2013: Total assets were $58,727 and stockholders’ equity was $12,405. Total investments were $47,593 and cash was $123. Insurance reserves included $24,511 of claim and claim adjustment expense reserves, $3,759 of unearned premiums and $11,469 of future policy benefits. Short-term debt was $13 and long-term debt was $2,558; long-term debt’s estimated fair value was $3,016. The $250 revolving credit facility had no amounts outstanding.
Operating cash flow declined from the prior-year quarter, which included a $75 tax refund; 2013 cash flow was also reduced by greater trading-portfolio activity. Investing activities used $161, versus $287, and financing activities used $56, versus $42. Cash ended the quarter at $123, down $33 from year-end 2012.
Material changes and segment performance
- Premium growth: Earned premiums increased 7%, reflecting Hardy’s acquisition and growth in CNA Commercial and CNA Specialty. Net written premiums grew $38 in Specialty and $75 in Commercial versus Q1 2012.
- Core underwriting: Specialty’s combined ratio improved to 95.0% from 97.3%; its net operating income rose to $140 from $132. Commercial’s combined ratio worsened to 106.8% from 106.2%; net operating income fell to $125 from $139. Hardy reported a 105.5% combined ratio and an $8 net operating loss.
- Non-core: Life & Group Non-Core reported net income of $9, compared with a net loss of $11, primarily reflecting favorable morbidity and persistency in long-term care and favorable mortality. Corporate & Other Non-Core reported a $22 net loss, similar to the prior-year loss of $23.
- Reserve development and catastrophes: Favorable net prior-year development was $39, versus $43. Net catastrophe losses were $39 pretax ($25 after tax), versus $28 pretax ($18 after tax), primarily from U.S. storms.
- Investments and comprehensive income: Fixed-maturity effective income yield declined to 5.2% from 5.5%; management attributed lower investment income mainly to purchases at lower interest rates. Total comprehensive income was $146 versus $534, as other comprehensive income swung to a $104 loss from $284 income, including lower unrealized investment gains and a foreign-currency translation loss.
Outlook, risks and unusual items
Management stated that existing cash flows were sufficient for current and expected working-capital and debt needs and did not expect this to change in the near term. The filing provides no specific earnings or revenue guidance. The board declared a Q2 dividend of $0.20 per share; future dividends remain subject to board discretion, financial condition, business needs and regulatory constraints. CNA’s primary operating subsidiary, Continental Casualty Company, paid CNAF a $100 dividend in Q1 and could pay approximately $600 more during the remainder of 2013 without prior Illinois regulatory approval.
- Key uncertainties include adequacy of insurance reserves, especially long-tail and asbestos/environmental pollution claims; reinsurance recoverability and performance; catastrophe frequency and severity; claim-cost inflation; pricing and competition; investment returns, interest rates, credit spreads and liquidity; regulatory constraints; and successful integration of Hardy.
- Gross unrealized losses on available-for-sale securities were $158. Management attributed these mainly to market conditions and stated it did not intend, and was not more likely than not required, to sell the securities before recovery; it recorded no additional OTTI losses beyond those reported.
- Hardy results included $3 of non-run-rate purchase-accounting expenses and $2 of foreign-currency transaction losses. Hardy also recorded $3 of unfavorable net prior-year development and $4 of unfavorable premium development.
- A real-estate joint-venture lease guarantee could expose CNA to approximately $98 of future payments and related costs beyond amounts recorded if other shareholders fail to fund the venture; management considered this unlikely. Routine litigation was described as not material. Recorded liabilities for indemnification agreements were approximately $7.
- Management reported disclosure controls and procedures were effective at quarter-end. Hardy was excluded from the internal-control evaluation under SEC rules while integration was underway; management expected to complete integration by June 30, 2013.
Important facts for investors to verify
- Whether favorable prior-year reserve development and current-year catastrophe losses are recurring or materially affect the underlying underwriting trend.
- Reserve adequacy, particularly in workers’ compensation, long-tail casualty, long-term care, and asbestos/environmental pollution exposures.
- Whether premium growth and rate increases can sustain underwriting profitability, especially given Commercial’s combined ratio above 100%.
- Investment income and portfolio sensitivity to lower yields, credit deterioration, market liquidity and unrealized losses.
- Hardy’s ongoing underwriting performance, integration progress and related purchase-accounting effects.
- Availability of subsidiary dividends, regulatory capital constraints, debt obligations and the contingent lease guarantee.