CNA Financial Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unaudited results. CNA is a commercial insurer; Loews Corporation owned approximately 89% of CNA’s common stock.
Financial results
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $2.574 billion | $2.366 billion | $5.109 billion | $4.696 billion |
| Net earned premiums | $1.815 billion | $1.734 billion | $3.600 billion | $3.379 billion |
| Net investment income | $506 million | $475 million | $996 million | $1.020 billion |
| Income before tax | $330 million | $370 million | $676 million | $713 million |
| Net income | $270 million | $272 million | $561 million | $532 million |
| Diluted EPS | $0.99 | $1.00 | $2.06 | $1.96 |
| Core income (non-GAAP) | $270 million | $239 million | $551 million | $474 million |
Cash flow and liquidity: Operating cash flow was $354 million for the first half, down from $515 million, primarily due to lower limited-partnership distributions and higher net claim payments. Investing activities provided $439 million; financing activities used $855 million, including $706 million of common dividends and repayment of $150 million of debt. Cash ended the period at $288 million, versus $355 million at year-end 2017.
Balance sheet and debt: Total assets were $57.858 billion and stockholders’ equity was $11.415 billion at June 30, compared with $56.567 billion and $12.244 billion, respectively, at year-end. Short- and long-term debt totaled $2.709 billion, down from $2.858 billion. The $250 million revolving credit facility was undrawn. Management said current cash flows are sufficient for expected working-capital and debt needs and intended to repay Hardy’s $30 million subordinated debt later in 2018.
Insurance performance: Q2 combined ratios were 86.8% for Specialty, 96.6% for Commercial and 104.7% for International; a ratio below 100% generally indicates underwriting profit. First-half ratios were 87.2%, 96.8% and 100.8%, respectively. Consolidated favorable prior-year reserve development was $59 million in Q2 and $98 million in the first half. Net catastrophe losses were $26 million and $60 million, respectively.
Material changes and management commentary
- First-half net income increased 5% year over year, while pretax income declined. Management reported first-half core income growth, citing improved Property & Casualty underwriting and a higher after-tax contribution from the lower federal tax rate; lower limited-partnership returns partly offset operating gains.
- Q2 reported revenue growth includes the effect of adopting revenue-recognition guidance: non-insurance warranty revenue and expense are now reported gross in certain transactions, and warranty revenue is recognized over the expected claims-emergence pattern. Adoption added $143 million to Q2 revenue and $145 million to Q2 expense, with a negligible net-income effect. The filing says prior-period figures were not recast.
- Q2 Specialty core income rose to $183 million from $131 million, supported by improved underwriting and investment income. Commercial core income rose to $143 million from $120 million, though its combined ratio worsened as favorable reserve development fell and large property losses increased. International moved to a $7 million core loss from $10 million income, with large property losses contributing to weaker underwriting.
- First-half net investment income declined 2% to $996 million; management attributed the pretax decline to lower limited-partnership and common-stock returns. Net realized investment gains fell to $11 million from $86 million. New accounting treatment for equity securities contributed $25 million of first-half pretax realized losses on non-redeemable preferred stock.
- Other comprehensive loss was $205 million in Q2 and $621 million in the first half, largely reflecting unrealized investment losses and foreign-currency translation. This reduced reported equity during the period.
Outlook, risks and contingencies
- The filing provides no specific full-year earnings or revenue guidance. Management expressed confidence in near-term liquidity and described planned debt repayment; future dividends remain subject to board discretion, earnings, financial condition, business needs and regulatory constraints.
- Management identified insurance-reserve estimates, reinsurance collectibility, investment valuation, long-term-care liabilities and taxes as critical estimates. Actual claim costs may differ materially from reserves, especially for long-tail liability and catastrophe claims.
- Legacy asbestos and environmental-pollution exposures remain subject to a loss-portfolio-transfer agreement with NICO. First-half A&EP adverse development before the agreement was $113 million; the unrecognized deferred reinsurance benefit was $351 million at June 30. The filing notes potential risk from reinsurance performance and claims not covered by the agreement.
- Workers’ compensation policyholder refunds related to prior small-business rating errors were estimated at $47 million, including interest, at June 30; refunds were expected to be completed by year-end 2018. A proposed settlement in 401(k) plan litigation had preliminary court approval; management did not expect a material impact.
- Other risks include catastrophe frequency and severity, inflation in claim costs, competitive pricing, investment-market volatility, regulatory restrictions on insurer dividends, ratings changes and increased European compliance complexity related to Brexit. A $23 million Q2 cost associated with transition to a new IT infrastructure provider was described as non-recurring.
Important facts for investors to verify
- How much reported revenue growth reflects underlying premiums and business activity versus the warranty-accounting gross-up and timing effects.
- Whether favorable reserve development continues and whether International’s underwriting performance improves, particularly after large property losses.
- The adequacy of long-tail, long-term-care and A&EP reserves, and the collectibility and coverage limits of reinsurance recoveries.
- Investment portfolio exposure to unrealized losses, credit risk and lower limited-partnership returns, and the effect of these factors on earnings and equity.
- Cash generation, dividend capacity at insurance subsidiaries, planned debt repayment and the remaining small-business refund obligation.