CNA Financial Corporation — Q2 2016 Form 10-Q
Business and period. CNA is a commercial insurer with Specialty, Commercial and International property-and-casualty operations and non-core Life & Group and Corporate operations. Loews Corporation owned approximately 90% of CNA’s common stock. This unaudited filing covers the quarter and six months ended June 30, 2016, compared with the corresponding 2015 periods.
Financial results
| Metric | Q2 2016 | Q2 2015 | H1 2016 | H1 2015 |
|---|---|---|---|---|
| Total revenue | $2.348bn | $2.327bn | $4.543bn | $4.679bn |
| Net earned premiums | $1.730bn | $1.735bn | $3.429bn | $3.422bn |
| Net investment income | $502m | $500m | $937m | $1.058bn |
| Net operating income | $201m | $132m | $292m | $357m |
| Net income | $209m | $138m | $275m | $371m |
| Diluted EPS | $0.77 | $0.51 | $1.02 | $1.37 |
| Operating cash flow | — | $613m | $540m |
Balance sheet and liquidity. At June 30, total assets were $56.906bn, total liabilities $45.020bn and stockholders’ equity $11.886bn. Cash was $289m and investments totaled $46.549bn. Short-term debt was zero; long-term debt was $2.708bn, compared with $350m and $2.210bn, respectively, at year-end 2015. CNA issued $500m of 4.50% senior notes due 2026 and redeemed $350m of 6.50% notes due 2016. Management said current cash flows were sufficient for expected working capital and debt needs; the $250m revolving credit facility was undrawn.
For the first half, investing activities used $167m and financing activities used $538m; cash declined $98m to $289m. Common dividends paid totaled $677m, including a declared $2.50 per share for the half-year that included a $2.00 special dividend. The board declared a further quarterly dividend of $0.25 per share, payable August 31, 2016.
Performance changes and operating trends
- Q2 net operating income rose $69m year over year, helped by better core underwriting and comparison with a 2015 non-core charge related to the A&EP reinsurance transaction. First-half net operating income fell $65m, principally due to lower investment income—especially lower limited-partnership returns—and higher current-year non-catastrophe losses in core operations.
- Favorable prior-year development in Specialty, Commercial and International was $106m in Q2 and $172m for H1, versus $20m and $18m in 2015. This reserve benefit materially supported results.
- Specialty’s combined ratio improved to 85.4% in Q2 and 87.4% for H1. Commercial improved to 103.5% and 102.7%, respectively, but remained above 100%. International deteriorated to 118.6% and 108.8%, respectively, amid large losses, catastrophe claims and foreign-exchange effects.
- International net operating results shifted to losses of $27m in Q2 and $21m for H1, from income of $22m and $31m. The filing attributes pressure to large political-risk, property and financial-institution losses, Fort McMurray wildfire claims and currency movements. International written premiums also declined.
- Net investment income for H1 fell $121m year over year. Limited partnerships returned 1.2%, compared with 5.5% in the prior-year half. Fixed-maturity portfolio pretax yield was 4.8% for H1.
Outlook, risks and unusual items
- No specific earnings or premium guidance is provided. Management expressed confidence in near-term liquidity, while noting future dividends remain at the board’s discretion and subject to earnings, financial condition, business needs and regulatory constraints.
- The Q1 2016 A&EP reserve review recorded $200m of adverse development before the Loss Portfolio Transfer (LPT). The development was ceded to NICO, but retroactive reinsurance accounting delayed recognition of part of the benefit. For H1, the filing reports a $118m pretax impact from unrecognized deferred LPT benefit; the unrecognized deferred benefit was $359m at June 30. The LPT’s collateral trust fair value was $2.6bn, and Berkshire Hathaway guaranteed specified NICO obligations.
- Net catastrophe losses were $121m for H1, compared with $89m in 2015; 2016 losses primarily reflected U.S. weather events and the Fort McMurray wildfires. Reserve adequacy remains estimation-sensitive, particularly for long-tail claims, A&EP and long-term care.
- The U.K. Brexit vote may require changes to CNA’s European operating platform and could increase regulatory complexity and costs; the future arrangements were unknown. Other disclosed risks include reinsurance performance, investment and market volatility, competition and pricing, litigation, regulation, catastrophes and potential reserve revisions.
- The sale of CNA’s principal executive offices generated $107m of investing cash in Q1. CNA said the transaction also eliminated subtenant revenue and increased lease expense.
- Routine litigation was described as not material based on currently known facts. A joint-venture guarantee had a maximum potential loss of approximately $16m beyond amounts recorded. Structured-settlement guarantees could involve approximately $2.0bn of future payments over annuitants’ lifetimes, but management considered payment unlikely given the related trust.
Investor facts to verify
- How much of reported earnings depended on the $172m of favorable prior-year development, and whether the favorable trends persist.
- Whether International underwriting improves after the large losses, catastrophe activity, lower retention and adverse currency effects.
- Long-term care reserve assumptions and the timing and amount of future A&EP LPT benefit recognition; also verify NICO and collateral performance.
- Investment income sensitivity, particularly limited-partnership returns, and the effect of interest rates and credit spreads on the large fixed-maturity portfolio.
- Debt costs and maturities, insurance-subsidiary dividend capacity, and the sustainability of common and special dividends.
- Potential regulatory and operating consequences of Brexit for CNA’s European business.