CNA Financial Corporation — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Financial statements are unaudited. Loews Corporation owned approximately 90% of CNA Financial’s common stock.
Financial performance
- Q2 revenue: $2.366 billion, up from $2.348 billion a year earlier. Net earned premiums were $1.734 billion versus $1.730 billion; net investment income was $475 million versus $502 million.
- Q2 earnings: Net income was $272 million ($1.00 diluted EPS), compared with $209 million ($0.77). Net operating income, a company-defined non-GAAP measure, was $239 million versus $201 million. Pretax income was $370 million; income tax expense was $98 million.
- First-half revenue and earnings: Revenue was $4.696 billion versus $4.543 billion; net earned premiums were $3.379 billion versus $3.429 billion. Net income was $532 million ($1.96 diluted EPS), compared with $275 million ($1.02); net operating income was $474 million versus $292 million.
- Claims and underwriting: Total claims, benefits and expenses were $1.996 billion in Q2 and $3.983 billion in the first half, down from $2.060 billion and $4.198 billion, respectively, in 2016. Q2 catastrophe losses were $39 million before tax ($24 million after tax), versus $85 million before tax in Q2 2016. First-half catastrophe losses were $73 million before tax ($48 million after tax), versus $121 million before tax.
- Investment results: Realized investment gains were $50 million in Q2 and $86 million in the first half, compared with $16 million and a $20 million loss in 2016. First-half net investment income rose to $1.020 billion from $937 million, mainly reflecting stronger limited-partnership returns; Q2 net investment income declined, largely due to lower partnership returns.
- Cash flow: Operating cash flow was $515 million for the first half, down from $613 million. Investing activities provided $111 million, versus $167 million used in 2016; financing activities used $677 million. Cash ended at $225 million, down from $271 million at year-end 2016.
- Balance sheet and debt: Total assets were $56.205 billion and stockholders’ equity $12.028 billion at June 30, compared with $55.233 billion and $11.969 billion at year-end. Short-term debt was $150 million and long-term debt $2.561 billion, versus no short-term debt and $2.710 billion long-term debt at year-end.
- Dividends and liquidity: CNA declared and paid $2.50 per share during the first half, including a $2.00 special dividend. After quarter-end, the board declared a $0.30 quarterly dividend. The company said expected cash flows were sufficient for near-term needs; its $250 million revolving credit facility had no borrowings. CNA’s principal insurance subsidiary had about $100 million of ordinary dividend capacity without prior regulatory approval at June 30.
Material changes and segment trends
- Q2 net operating income increased $38 million year over year, driven by better core underwriting and lower catastrophe losses, partly offset by lower investment income. First-half net operating income increased $182 million, reflecting higher investment income, improved underwriting and a smaller non-core loss.
- Specialty: Q2 net operating income fell to $136 million from $164 million; combined ratio rose to 89.9% from 85.4%. First-half operating income was nearly unchanged at $290 million versus $291 million; combined ratio rose to 90.1% from 87.4%.
- Commercial: Q2 net operating income increased to $115 million from $92 million; combined ratio improved to 95.1% from 103.5%. First-half operating income rose to $209 million from $166 million; combined ratio improved to 99.8% from 102.7%. Small Business rating errors adversely affected first-half premium development.
- International: Q2 operating results improved to $10 million from a $27 million loss; combined ratio was 100.1% versus 118.6%. First-half operating income was $30 million versus a $21 million loss; combined ratio improved to 97.7% from 108.8%.
- Across Specialty, Commercial and International, favorable prior-year development was $63 million in Q2 and $95 million in the first half, versus $106 million and $172 million in 2016.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management states that interim results are not necessarily indicative of full-year results and describes forward-looking statements as subject to significant uncertainties.
- Small Business refunds: Rating errors led to an estimated $96 million refund liability at June 30. First-half premium development was adverse by $37 million, with $6 million of pretax interest expense recorded. Rating-process fixes were implemented for multi-peril policies in Q2 and were expected by the end of Q3 for workers’ compensation. Potential fines or penalties were considered reasonably possible but not expected to be material.
- Asbestos and environmental pollution: First-half adverse prior-year development before the Loss Portfolio Transfer was $60 million, largely from higher anticipated asbestos payouts. The related retroactive reinsurance benefit was $43 million; the unrecognized deferred benefit was $351 million at June 30. Cumulative amounts ceded to NICO were $2.9 billion, supported by a collateral trust valued at $2.8 billion and a Berkshire Hathaway guarantee, subject to the contract terms.
- Legal matter: A 401(k) plan class-action lawsuit remains at an early stage; no class had been certified. Management considered a loss reasonably possible but said it could not predict the outcome, and did not expect a material financial-statement impact based on its current assessment and available coverage.
- Other exposures: CNA disclosed $434 million of quantifiable guarantees, $254 million of quantifiable indemnifications and approximately $1.8 billion of potential lifetime payments under structured-settlement annuity guarantees; management did not believe payment under the latter guarantees was likely.
- Business and market risks: Management highlighted reserve-estimation uncertainty, reinsurance collectibility, catastrophe exposure, investment and credit-market volatility, competition, regulation and litigation. Brexit may require changes to the European operating platform; CNA had begun establishing a Luxembourg subsidiary and expected increased compliance complexity and cost.
- Investment and accounting items: CNA reported no additional OTTI losses on securities in unrealized-loss positions, citing no intent or expected need to sell before recovery. It was evaluating several upcoming accounting standards; it did not expect the revenue-recognition standard to have a material effect, while the lease standard was expected to increase reported assets and liabilities without a material effect.
Important facts for investors to verify
- Whether the improved earnings and segment combined ratios persist without relying on realized investment gains, favorable reserve development or lower catastrophe losses.
- Further developments in the $96 million Small Business refund liability, including completion of workers’ compensation system fixes and any additional refunds, interest, fines or penalties.
- Future reserve development, particularly long-tail claims and A&EP exposures, and the performance and coverage limits of the NICO reinsurance arrangement.
- Investment income sensitivity to limited-partnership returns, interest rates, credit spreads and market valuations, and the liquidity of the investment portfolio.
- Capital and subsidiary dividend capacity after the special dividend, together with debt levels and ongoing claim-payment needs.
- Developments in the 401(k) litigation, Brexit-related restructuring and the stated guarantee and indemnification exposures.