filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
133K characters. Original on sec.gov · Markdown
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Management’s discussion and analysis of financial condition and results of operations is comprised of the following sections:
OVERVIEW
We are a holding company and have five reportable segments comprised of four individual operating subsidiaries, CNA Financial Corporation (“CNA”), Diamond Offshore Drilling, Inc. (“Diamond Offshore”), Boardwalk Pipeline Partners, LP (“Boardwalk Pipelines”) and Loews Hotels Holding Corporation (“Loews Hotels & Co”); and the Corporate segment, which includes the operations of Altium Packaging LLC (“Altium Packaging”). Each of our operating subsidiaries is headed by a chief executive officer who is responsible for the operation of its business and has the duties and authority commensurate with that position.
We rely upon our invested cash balances and distributions from our subsidiaries to generate the funds necessary to meet our obligations and to declare and pay any dividends to our shareholders. The ability of our subsidiaries to pay dividends is subject to, among other things, the availability of sufficient earnings and funds in such subsidiaries, applicable state laws, including in the case of the insurance subsidiaries of CNA, laws and rules governing the payment of dividends by regulated insurance companies (see Note 14 of the Notes to Consolidated Financial Statements included under Item 8) and compliance with covenants in their respective loan agreements. Claims of creditors of our subsidiaries will generally have priority as to the assets of such subsidiaries over our claims and those of our creditors and shareholders.
Unless the context otherwise requires, references in this Report to “Loews Corporation,” “the Company,” “Parent Company,” “we,” “our,” “us” or like terms refer to the business of Loews Corporation excluding its subsidiaries.
The following discussion should be read in conjunction with Item 1A, Risk Factors, and Item 8, Financial Statements and Supplementary Data of this Form
10-K.
For a discussion of changes in results of operations comparing the years ended December 31, 2018 and 2017 for Loews Corporation and its subsidiaries see Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form
10-K
for the year ended December 31, 2018, filed with the SEC on February 13, 2019.
RESULTS OF OPERATIONS
Consolidated Financial Results
The following table summarizes net income attributable to Loews Corporation by segment and net income per share attributable to Loews Corporation for the years ended December 31, 2019 and 2018:
| Year Ended December 31 | 2019 | 2018 | ||||||
| (In millions, except per share) | ||||||||
| CNA Financial | $ | 894 | $ | 726 | ||||
| Diamond Offshore | (175) | (112) | ||||||
| Boardwalk Pipelines | 209 | 135 | ||||||
| Loews Hotels & Co | (31) | 48 | ||||||
| Corporate | 35 | (161) | ||||||
| Net income attributable to Loews Corporation | $ | 932 | $ | 636 | ||||
| Basic net income per common share | $ | 3.08 | $ | 1.99 | ||||
| Diluted net income per common share | 3.07 | 1.99 | ||||||
2019 Compared with 2018
Consolidated net income attributable to Loews Corporation for 2019 was $932 million, or $3.07 per share, compared to $636 million, or $1.99 per share, in 2018.
Net income for 2019 increased due to higher earnings at CNA and Boardwalk Pipelines, as well as higher parent company net investment income. These increases were partially offset by lower results at Diamond Offshore and Loews Hotels & Co.
CNA Financial
The following table summarizes the results of operations for CNA for the years ended December 31, 2019 and 2018 as presented in Note 20 of the Notes to Consolidated Financial Statements included under Item 8. For further discussion of Net investment income and Net investment gains or losses, see the Investments section of this MD&A.
| Year Ended December 31 | 2019 | 2018 | ||||||||||
| (In millions) | ||||||||||||
| Revenues: | ||||||||||||
| Insurance premiums | $ | 7,428 | $ | 7,312 | ||||||||
| Net investment income | 2,118 | 1,817 | ||||||||||
| Investment gains (losses) | 49 | (57 | ) | |||||||||
| Non-insurance warranty revenue | 1,161 | 1,007 | ||||||||||
| Operating revenues and other | 32 | 55 | ||||||||||
| Total | 10,788 | 10,134 | ||||||||||
| Expenses: | ||||||||||||
| Insurance claims and policyholders’ benefits | 5,806 | 5,572 | ||||||||||
| Amortization of deferred acquisition costs | 1,383 | 1,335 | ||||||||||
| Non-insurance warranty expense | 1,082 | 923 | ||||||||||
| Other operating expenses | 1,141 | 1,203 | ||||||||||
| Interest | 152 | 138 | ||||||||||
| Total | 9,564 | 9,171 | ||||||||||
| Income before income tax | 1,224 | 963 | ||||||||||
| Income tax expense | (224 | ) | (151 | ) | ||||||||
| Net income | 1,000 | 812 | ||||||||||
| Amounts attributable to noncontrolling interests | (106 | ) | (86 | ) | ||||||||
| Net income attributable to Loews Corporation | $ | 894 | $ | 726 | ||||||||
2019 Compared with 2018
Net income attributable to Loews Corporation increased $168 million in 2019 as compared with 2018 primarily due to higher net investment income driven by limited partnership and common stock returns and favorable current accident year underwriting results. Earnings also benefited from higher net realized investment results driven by the change in fair value of
non-redeemable
preferred stock still held as of December 31, 2019 and lower adverse prior year A&EP reserve development. These increases were partially offset by a $151 million charge (after tax and noncontrolling interests) related to the recognition of a premium deficiency as a result of the third quarter 2019 gross premium valuation (“GPV”) and lower favorable net prior period loss reserve development in the current year.
CNA’s Property & Casualty and Other Insurance Operations
CNA’s commercial property and casualty insurance operations (“Property & Casualty Operations”) include its Specialty, Commercial and International lines of business. CNA’s Other Insurance Operations outside of Property & Casualty Operations include its long term care business that is in
run-off,
certain corporate expenses, including interest on CNA’s corporate debt, and certain property and casualty businesses in
run-off,
including CNA Re and A&EP. CNA’s products and services are primarily marketed through independent agents, brokers and managing general underwriters to a wide variety of customers, including small, medium and large businesses, insurance companies, associations, professionals and other groups. We believe the presentation of CNA as one reportable segment is appropriate in accordance with applicable accounting standards on segment reporting. However, for purposes of this discussion and analysis of the results of operations, we provide greater detail with respect to CNA’s Property & Casualty Operations and Other Insurance Operations to enhance the reader’s understanding and to provide further transparency into key drivers of CNA’s financial results.
In assessing CNA’s insurance operations, the Company utilizes the core income (loss) financial measure. Core income (loss) is calculated by excluding from net income (loss) (i) net investment gains or losses, (ii) income or loss from discontinued operations, (iii) any cumulative effects of changes in accounting guidance and (iv) deferred tax asset and liability remeasurement as a result of an enacted U.S. federal tax rate change. In addition, core income (loss) excludes the effects of noncontrolling interests. The calculation of core income (loss) excludes net investment gains or losses because net investment gains or losses are generally driven by economic factors that are not reflective of CNA’s primary insurance operations. Core income (loss) is deemed to be a
non-GAAP
financial measure and management believes this measure is useful for investors to evaluate its insurance operations.
Property & Casualty Operations
In evaluating the results of Property & Casualty Operations, CNA utilizes the loss ratio, the expense ratio, the dividend ratio and the combined ratio. These ratios are calculated using GAAP financial results. The loss ratio is the percentage of net incurred claim and claim adjustment expenses to net earned premiums. The expense ratio is the percentage of insurance underwriting and acquisition expenses, including the amortization of deferred acquisition costs, to net earned premiums. The dividend ratio is the ratio of policyholders’ dividends incurred to net earned premiums. The combined ratio is the sum of the loss, expense and dividend ratios. In addition, CNA also utilizes renewal premium change, rate, retention and new business in evaluating operating trends. Renewal premium change represents the estimated change in average premium on policies that renew, including rate and exposure changes. Rate represents the average change in price on policies that renew excluding exposure change. For certain products within Small Business, where quantifiable, rate includes the influence of new business as well. Exposure represents the measure of risk used in the pricing of the insurance product. Retention represents the percentage of premium dollars renewed in comparison to the expiring premium dollars from policies available to renew. Renewal premium change, rate and retention presented for the prior year are updated to reflect subsequent activity on policies written in the period. New business represents premiums from policies written with new customers and additional policies written with existing customers. Gross written premiums, excluding third party captives, represents gross written premiums excluding business which is mostly ceded to third party captives, including business related to large warranty programs.
The following tables summarize the results of CNA’s Property & Casualty Operations for the years ended December 31, 2019 and 2018.
| Year Ended December 31, 2019 | Specialty | Commercial | International | Total | ||||||||||||||
| (In millions, except %) | ||||||||||||||||||
| Gross written premiums | $ 6,900 | $ 3,693 | $ 1,111 | $ 11,704 | ||||||||||||||
| Gross written premiums excluding third party captives | 3,015 | 3,609 | 1,111 | 7,735 | ||||||||||||||
| Net written premiums | 2,848 | 3,315 | 971 | 7,134 | ||||||||||||||
| Net earned premiums | 2,773 | 3,162 | 974 | 6,909 | ||||||||||||||
| Net investment income | 556 | 654 | 63 | 1,273 | ||||||||||||||
| Core income | 671 | 489 | 30 | 1,190 | ||||||||||||||
| Other performance metrics: | ||||||||||||||||||
| Loss and loss adjustment expense ratio | 57.5 | % | 67.3 | % | 64.1 | % | 62.9 | % | ||||||||||
| Expense ratio | 32.5 | 32.9 | 37.7 | 33.5 | ||||||||||||||
| Dividend ratio | 0.2 | 0.6 | 0.3 | |||||||||||||||
| Combined ratio | 90.2 | % | 100.8 | % | 101.8 | % | 96.7 | % | ||||||||||
| Rate | 5% | 3% | 8% | 5% | ||||||||||||||
| Renewal premium change | 6 | 5 | 7 | 6 | ||||||||||||||
| Retention | 87 | 86 | 71 | 84 | ||||||||||||||
| New business | $ 367 | $ 683 | $ 273 | $ 1,323 |
| Year Ended December 31, 2018 | ||||||||||||||||||||
| Gross written premiums | $ 6,904 | $ 3,350 | $ 1,150 | $ 11,404 | ||||||||||||||||
| Gross written premiums excluding third party captives | 2,834 | 3,267 | 1,150 | 7,251 | ||||||||||||||||
| Net written premiums | 2,744 | 3,060 | 1,018 | 6,822 | ||||||||||||||||
| Net earned premiums | 2,732 | 3,050 | 1,001 | 6,783 | ||||||||||||||||
| Net investment income | 439 | 500 | 57 | 996 | ||||||||||||||||
| Core income (loss) | 629 | 357 | (19 | ) | 967 | |||||||||||||||
| Other performance metrics: | ||||||||||||||||||||
| Loss and loss adjustment expense ratio | 55.9 | % | 67.3 | % | 69.8 | % | 63.1 | % | ||||||||||||
| Expense ratio | 32.1 | 33.1 | 36.7 | 33.2 | ||||||||||||||||
| Dividend ratio | 0.2 | 0.7 | 0.4 | |||||||||||||||||
| Combined ratio | 88.2 | % | 101.1 | % | 106.5 | % | 96.7 | % | ||||||||||||
| Rate | 2% | 1% | 4% | 2% | ||||||||||||||||
| Renewal premium change | 5 | 5 | 6 | 5 | ||||||||||||||||
| Retention | 85 | 85 | 77 | 84 | ||||||||||||||||
| New business | $ 353 | $ 566 | $ 307 | $ 1,226 |
2019 Compared with 2018
Total gross written premiums increased $300 million in 2019 as compared with 2018. Total net written premiums increased $312 million in 2019 as compared with 2018.
Gross written premiums for Commercial increased $343 million in 2019 as compared with 2018 driven by higher new business and rate. Net written premiums for Commercial increased $255 million in 2019 as compared with 2018. The increase in net earned premiums was consistent with the trend in net written premiums for Commercial.
Gross written premiums for Specialty, excluding third party captives, increased $181 million in 2019 as compared with 2018 driven by strong retention and rate. Net written premiums for Specialty increased $104 million in 2019 as compared with 2018. The increase in net earned premiums was consistent with the trend in net written premiums for Specialty.
Gross written premiums for International decreased $39 million in 2019 as compared with 2018. Excluding the effect of foreign currency exchange rates, gross written premiums decreased $7 million, driven by the premium reduction from Hardy’s strategic exit from certain business classes announced in the fourth quarter of 2018 largely offset by growth in Canada and Europe. Net written premiums for International decreased $47 million in 2019 as compared with 2018. Excluding the effect of foreign currency exchange rates, net written premiums decreased $16 million. The decrease in net earned premiums was consistent with the trend in net written premiums for International.
Core income increased $223 million in 2019 as compared with 2018 primarily due to higher net investment income driven by limited partnership and common stock returns and improved current accident year underwriting results in International, partially offset by lower favorable net prior year loss reserve development.
Net catastrophe losses were $179 million in 2019 as compared with $252 million in 2018. In 2019 and 2018, Specialty had net catastrophe losses of $15 million and $26 million, Commercial had net catastrophe losses of $154 million and $193 million and International had net catastrophe losses of $10 million and $33 million.
Favorable net prior year loss reserve development of $73 million and $181 million was recorded in 2019 and 2018. In 2019 and 2018, Specialty recorded favorable net prior year loss reserve development of $92 million and $150 million, Commercial recorded favorable net prior year loss reserve development of $2 million as compared with $25 million and International recorded unfavorable net prior year loss reserve development of $21 million as compared with favorable net prior year loss reserve development of $4 million. Further information on net prior year loss reserve development is included in Note 8 of the Notes to Consolidated Financial Statements included under Item 8.
Specialty’s combined ratio increased 2.0 points in 2019 as compared with 2018. The loss ratio increased 1.6 points driven by lower favorable net prior year loss reserve development. The expense ratio increased 0.4 points in 2019 as compared with 2018 driven by higher employee costs.
Commercial’s combined ratio improved 0.3 points in 2019 as compared with 2018. The loss ratio was consistent with the prior year. Less favorable net prior year loss reserve development and unfavorable retrospective premium development were largely offset by lower catastrophe losses. The expense ratio was largely consistent with 2018.
International’s combined ratio improved 4.7 points in 2019 as compared with 2018. The loss ratio improved 5.7 points, driven by improved current accident year underwriting results partially offset by unfavorable net prior year loss reserve development in the current year. The expense ratio increased 1.0 point in 2019 as compared with 2018 driven by lower net earned premiums.
Other Insurance Operations
The following table summarizes the results of CNA’s Other Insurance Operations for the years ended December 31, 2019 and 2018.
| Years Ended December 31 | 2019 | 2018 | ||||||||||||||
| (In millions) | ||||||||||||||||
| Net earned premiums | $ | 520 | $ | 530 | ||||||||||||
| Net investment income | 845 | 821 | ||||||||||||||
| Core loss | (211 | ) | (122 | ) |
2019 Compared with 2018
Core loss increased $89 million in 2019 as compared with 2018 driven by a $170 million charge related to recognition of an active life reserve premium deficiency partially offset by a $44 million reduction in long term care claim reserves resulting from the annual claim experience study in the third quarter of 2019. The favorable claim reserve development was primarily due to lower claim severity than anticipated in the reserve estimates. The prior year included a $24 million reduction in long term care reserves resulting from the 2018 annual claim study. Core results benefited from lower adverse net prior year reserve development recorded in 2019 for A&EP under the loss portfolio transfer as further discussed in Note 8 of the Notes to Consolidated Financial Statements included under Item 8. Additionally, 2018 included
non-recurring
costs of $27 million associated with the transition to a new IT infrastructure service provider.
Non-GAAP
Reconciliation of Core Income to Net Income
The following table reconciles core income to net income attributable to Loews Corporation for the CNA segment for the years ended December 31, 2019 and 2018:
| Year Ended December 31 | 2019 | 2018 | ||||||||||||||
| (In millions) | ||||||||||||||||
| Core income (loss): | ||||||||||||||||
| Property & Casualty Operations | $ | 1,190 | $ | 967 | ||||||||||||
| Other Insurance Operations | (211 | ) | (122 | ) | ||||||||||||
| Total core income | 979 | 845 | ||||||||||||||
| Investment gains (losses) (after tax) | 37 | (43 | ) | |||||||||||||
| Consolidating adjustments including purchase accounting and noncontrolling interests | (122 | ) | (76 | ) | ||||||||||||
| Net income attributable to Loews Corporation | $ | 894 | $ | 726 | ||||||||||||
Diamond Offshore
Overview
Over the past several years, crude oil prices have been volatile, reaching a high of $115 per barrel in 2014 but dropping to $55 per barrel by the end of 2014. In 2015, oil prices continued to decline, closing at $37 per barrel at the end of the year, and continuing to fall to a low of $28 per barrel during 2016 before recovering to nearly $57 per barrel by the end of 2016. The price of crude oil continued to fluctuate in 2017 and 2018, with oil prices in the $60 per barrel range at the beginning of 2019. As of the date of this Report, Brent crude oil prices were in the mid $50 per barrel range, having started 2020 in the
mid-to-upper
$60 per barrel range. As a result of, among other things, this continued volatility in commodity price and its uncertain future, the offshore drilling industry has experienced a substantial decline in demand for its services, as well as a significant decline in dayrates for contract drilling services.
Industry-wide floater utilization was approximately 66% at the end of 2019 based on industry analyst reports, which was unchanged from the third quarter of 2019, but an increase from nearly 60% utilization at the end of 2018. Tendering activity has also increased in some markets, but drilling programs remain primarily short term in nature, with options for future wells. Industry analysts have reported that capital investments are expected to increase slightly in 2020 compared to recent years, but forecasted spending in 2020 remains lower than previous spending levels. Dayrates remain low and pricing power currently remains with the customer, as some industry analysts have indicated that, based on historical data, utilization rates must increase to the 80%-range before pricing power shifts to the drilling contractor.
From a supply perspective, the offshore floater market remains oversupplied with approximately 240 rigs available based on industry reports. Over the last six years, 135 floaters reportedly have been scrapped; however, the pace of rig attrition has now slowed. Industry reports indicate that there remain approximately 25 newbuild floaters on order with scheduled deliveries in 2020 through 2022. Of these newbuild rigs, 16 are scheduled for delivery in 2020, but only one is under contract as of the date of this Report. In addition, over the next twelve months, more than 60 currently contracted floaters are estimated to roll off their contracts, further adding to the oversupply of floaters. This combination of factors points to a continued, challenging offshore drilling market and a continuation of the protracted industry downturn.
Diamond Offshore evaluates its drilling rigs for impairment whenever changes in circumstances indicate that the carrying value may not be recoverable. The current oversupply of rigs, together with the current protracted industry downturn, heightens the risk of the need for future rig impairments.
As a result of the continuing protracted industry downturn and these challenges, Diamond Offshore is continuing to actively seek ways to drive efficiency, reduce
non-productive
time and provide technical innovation to its customers. Diamond Offshore expects these innovations and efficiencies to result in faster and safer drilling and completion of wells, leading to lower overall well costs to the benefit of its customers.
Contract Drilling Backlog
Diamond Offshore’s contract drilling backlog was $1.6 billion, $1.8 billion and $2.0 billion as of January 1, 2020 (based on contract information known at that time), October 1, 2019 (the date reported in our Quarterly Report on Form
10-Q
for the quarter ended September 30, 2019) and January 1, 2019 (the date reported in our Annual Report on Form
10-K
for the year ended December 31, 2018). The contract drilling backlog by year as of January 1, 2020 is $802 million in 2020, $486 million in 2021 and an aggregate of $323 million in 2022 through 2023. Contract drilling backlog excludes a future gross margin commitment of approximately $25 million in 2020 and an aggregate of approximately $75 million for the three year period ending December 31, 2023, payable by a customer in the form of a guarantee of gross margin to be earned on future contracts or by direct payment at the end of each of the two respective periods, pursuant to terms of an existing contract.
Contract drilling backlog includes only firm commitments (typically represented by signed contracts) and is calculated by multiplying the contracted operating dayrate by the firm contract period. Diamond Offshore’s calculation also assumes full utilization of its drilling equipment for the contract period (excluding scheduled shipyard and survey days); however, the amount of actual revenue to be earned and the actual periods during which revenues will be earned will be different than the amounts and periods stated above due to various factors affecting utilization such as weather conditions and unscheduled repairs and maintenance. Contract drilling backlog excludes revenues for mobilization, demobilization, contract preparation and customer reimbursables. Changes in Diamond Offshore’s contract drilling backlog between periods are generally a function of the performance of work on term contracts, as well as the extension or modification of existing term contracts and the execution of additional contracts. In addition, under certain circumstances, Diamond Offshore’s customers may seek to terminate or renegotiate its contracts, which could adversely affect its reported backlog.
Results of Operations
Diamond Offshore’s pretax operating income (loss) is primarily a function of contract drilling revenue earned less contract drilling expenses incurred or recognized. The two most significant variables affecting Diamond Offshore’s contract drilling revenues are dayrates earned and rig utilization rates achieved by its rigs, each of which is a function of rig supply and demand in the marketplace. Revenues are also affected by the acquisition or disposal of rigs, rig mobilizations, required surveys and shipyard projects.
Operating expenses represent all direct and indirect costs associated with the operation and maintenance of Diamond Offshore’s drilling equipment. The principal components of Diamond Offshore’s operating expenses include direct and indirect costs of labor and benefits, repairs and maintenance, freight, regulatory inspections, boat and helicopter rentals and insurance.
The following table summarizes the results of operations for Diamond Offshore for the years ended December 31, 2019 and 2018 as presented in Note 20 of the Notes to Consolidated Financial Statements included under Item 8:
| Year Ended December 31 | 2019 | 2018 | ||||||||||||||
| (In millions) | ||||||||||||||||
| Revenues: | ||||||||||||||||
| Net investment income | $ | 6 | $ | 8 | ||||||||||||
| Contract drilling revenues | 935 | 1,060 | ||||||||||||||
| Other revenues | 47 | 25 | ||||||||||||||
| Total | 988 | 1,093 | ||||||||||||||
| Expenses: | ||||||||||||||||
| Contract drilling expenses | 793 | 723 | ||||||||||||||
| Other operating expenses: | ||||||||||||||||
| Impairment of assets | 27 | |||||||||||||||
| Other expenses | 474 | 446 | ||||||||||||||
| Interest | 123 | 123 | ||||||||||||||
| Total | 1,390 | 1,319 | ||||||||||||||
| Loss before income tax | (402 | ) | (226 | ) | ||||||||||||
| Income tax benefit | 60 | 30 | ||||||||||||||
| Amounts attributable to noncontrolling interests | 167 | 84 | ||||||||||||||
| Net loss attributable to Loews Corporation | $ | (175 | ) | $ | (112 | ) | ||||||||||
2019 Compared with 2018
Contract drilling revenue decreased $125 million in 2019 as compared with 2018, primarily due to lower average daily revenue, partially offset by the effect of an increase in revenue earning days and recognition of revenues related to a gross margin commitment from a customer. Contract drilling expense increased $70 million in 2019 as compared with 2018, primarily due to incremental amortization of previously deferred contract preparation and mobilization costs, incremental contract drilling expense for a rig which was reactivated for a new contract in 2019 and increased costs for the 2019 rig fleet. The increase in contract drilling expense was partially offset by reduced costs for a rig which was sold in the second quarter of 2019 and lower fuel costs for the current fleet.
Net loss attributable to Loews Corporation increased $63 million in 2019 as compared with 2018 reflecting lower margins from contract drilling services, primarily driven by lower contract drilling revenue discussed above. The results for 2019 also reflect higher depreciation expense primarily due to capital expenditures and the completion of software implementation projects in 2019, partially offset by the absence of costs related to the settlement of a legal claim in 2018 and a higher income tax benefit.
Boardwalk Pipelines
Overview
Boardwalk Pipelines derives revenues primarily from the transportation and storage of natural gas and natural gas liquids (“NGLs”). Transportation services consist of firm natural gas transportation, where the customer pays a capacity reservation charge to reserve pipeline capacity at receipt and delivery points along pipeline systems, plus a commodity and fuel charge on the volume of natural gas actually transported, and interruptible natural gas transportation, under which the customer pays to transport gas only when capacity is available and used. The transportation rates Boardwalk Pipelines is able to charge customers are heavily influenced by market trends (both short and longer term), including the available natural gas supplies, geographical location of natural gas production, the demand for gas by
end-users
such as power plants, petrochemical facilities and liquefied natural gas (“LNG”) export facilities and the price differentials between the gas supplies and the market demand for the gas (basis differentials). Rates for short term firm and interruptible transportation services are influenced by shorter term market conditions such as current and forecasted weather.
Boardwalk Pipelines offers firm natural gas storage services in which the customer reserves and pays for a specific amount of storage capacity, including injection and withdrawal rights, and interruptible storage and parking and lending (“PAL”) services where the customer receives and pays for capacity only when it is available and used. The value of Boardwalk Pipelines’ storage and PAL services (comprised of parking gas for customers and/or lending gas to customers) is affected by natural gas price differentials between time periods, such as between winter and summer (time period price spreads), price volatility of natural gas and other factors. Boardwalk Pipelines’ storage and parking services have greater value when the natural gas futures market is in contango (a positive time period price spread, meaning that current price quotes for delivery of natural gas further in the future are higher than in the nearer term), while its lending service has greater value when the futures market is backwardated (a negative time period price spread, meaning that current price quotes for delivery of natural gas in the nearer term are higher than further in the future). The value of both storage and PAL services may also be favorably impacted by increased volatility in the price of natural gas, which allows Boardwalk Pipelines to optimize the value of its storage and PAL capacity.
Boardwalk Pipelines also transports and stores NGLs. Contracts for Boardwalk Pipelines’ NGLs services are generally fee based or based on minimum volume requirements, while others are dependent on actual volumes transported. Boardwalk Pipelines’ NGLs storage rates are market-based and contracts are typically fixed price arrangements with escalation clauses. Boardwalk Pipelines is not in the business of buying and selling natural gas and NGLs other than for system management purposes, but changes in natural gas and NGLs prices may impact the volumes of natural gas or NGLs transported and stored by customers on its systems. Due to the capital intensive nature of its business, Boardwalk Pipelines’ operating costs and expenses typically do not vary significantly based upon the amount of products transported, with the exception of fuel consumed at its compressor stations and not included in a fuel tracker.
Firm Agreements
A substantial portion of Boardwalk Pipelines’ transportation and storage capacity is contracted for under firm agreements. For the year ended December 31, 2019, approximately 87% of Boardwalk Pipelines’ revenues, excluding retained fuel, were derived from fixed fees under firm agreements. The table below shows a rollforward of operating revenues under committed firm agreements in place as of December 31, 2018 to December 31, 2019, including agreements for transportation, storage and other services, over the remaining term of those agreements:
| As of December 31, 2019 | ||||||
| (In millions) | ||||||
| Total projected operating revenues under committed firm agreements as of December 31, 2018 | $ | 9,133 | ||||
| Adjustments for: | ||||||
| Actual revenues recognized from firm agreements in 2019 (a) | (1,157 | ) | ||||
| Firm agreements entered into in 2019 | 1,353 | |||||
| Total projected operating revenues under committed firm agreements as of December 31, 2019 | $ | 9,329 | ||||
| (a) | Reflects an increase of $73 million in Boardwalk Pipelines’ actual 2019 revenues recognized from fixed fees under firm agreements as compared with its expected 2019 revenues from fixed fees under firm agreements, including agreements for transportation, storage and other services as of December 31, 2018, primarily due to an increase from contract renewals that occurred in 2019. |
|---|
During 2019, Boardwalk Pipelines entered into approximately $1.4 billion of new firm agreements, of which over half were from new growth projects executed in 2019, but will not be placed into commercial service until 2020 or later years. For Boardwalk Pipelines’ customers that are charged maximum tariff rates related to its FERC-regulated operating subsidiaries, the revenues expected to be earned from fixed fees under committed firm agreements reflect the current tariff rate for such services for the term of the agreements, however, the tariff rates may be subject to future adjustment. The estimated revenues reflected in the table may also include estimated revenues that are anticipated under executed precedent transportation agreements for projects that are subject to regulatory approval. The revenues expected to be earned from fixed fees under committed firm agreements do not include additional revenues Boardwalk Pipelines has recognized and may recognize under firm agreements based on actual utilization of the contracted
pipeline or storage capacity, any expected revenues for periods after the expiration dates of the existing agreements or execution of precedent agreements associated with growth projects or other events that occurred or will occur subsequent to December 31, 2019.
Contract Renewals
Each year a portion of Boardwalk Pipelines’ firm transportation and storage agreements expire. The rates Boardwalk Pipelines is able to charge customers are heavily influenced by market trends (both short and longer term), including the available supply, geographical location of natural gas production, the competition between producing basins, competition with other pipelines for supply and markets, the demand for gas by
end-users
such as power plants, petrochemical facilities and LNG export facilities and the price differentials between the gas supplies and the market demand for the gas (basis differentials) and Boardwalk Pipelines’ storage rates are additionally impacted by natural gas price differentials between time periods, such as winter to summer (time period price spreads), and the volatility in time period price spreads. Demand for firm service is primarily based on market conditions which can vary across Boardwalk Pipelines’ pipeline systems. The amount of change in firm reservation fees under contract reflects the overall market trends, including the impact from Boardwalk Pipelines’ growth projects. Boardwalk Pipelines focuses its marketing efforts on enhancing the value of the capacity that is up for renewal and works with customers to match gas supplies from various basins to new and existing customers and markets, including aggregating supplies at key locations along its pipelines to provide
end-use
customers with attractive and diverse supply options. If the market perceives the value of Boardwalk Pipelines’ available capacity to be lower than its long term view of the capacity, Boardwalk Pipelines may seek to shorten contract terms until market perception improves.
Over the past several years, as a result of market conditions, Boardwalk Pipelines has renewed some expiring contracts at lower rates or for shorter terms than in the past. In addition to normal contract expirations, in the 2018 to 2020 timeframe, transportation agreements associated with its significant pipeline expansion projects that were placed into service in the 2007-2009 timeframe, have expired. A substantial portion of the capacity associated with the pipeline expansion projects was renewed or the contracts were restructured, usually at lower rates or lower volumes. Historically, Boardwalk Pipelines had delivered the majority of production volumes from these pipeline expansion projects to other pipelines. Over the past several years, Boardwalk Pipelines has focused on diversifying its deliveries to
end-use
markets. With the capacity becoming available from contract expirations and the capacity created from its new growth projects, Boardwalk Pipelines was able to execute new firm agreements which has resulted in diversifying its deliveries such that over 75% of its projected future firm reservation revenues, from firm agreements in place as of December 31, 2019, are for deliveries to
end-use
customers.
Pipeline System Maintenance
Boardwalk Pipelines incurs substantial costs for ongoing maintenance of its pipeline systems and related facilities, including those incurred for pipeline integrity management activities, equipment overhauls, general upkeep and repairs. These costs are not dependent on the amount of revenues earned from its transportation services. PHMSA has developed regulations that require transportation pipeline operators to implement integrity management programs to comprehensively evaluate certain areas along pipelines and take additional measures to protect pipeline segments located in highly populated areas. These regulations have resulted in an overall increase in Boardwalk Pipelines’ ongoing maintenance costs, including maintenance capital and maintenance expense. In 2019, PHMSA issued the first part of its gas Mega Rule, which imposes numerous requirements, including MAOP reconfirmation, the periodic assessment of additional pipeline mileage outside of HCAs (in MCAs as well as Class 3 and Class 4 areas), the reporting of exceedances of MAOP and the consideration of seismicity as a risk factor in integrity management. The remaining rulemakings comprising the gas Mega Rule are expected to be issued in 2020 and will include revised pipeline repair criteria as well as more stringent corrosion control requirements. It is expected that these new rules will cause Boardwalk Pipelines to incur increased capital and operating costs, experience operational delays and result in potential adverse impacts to its ability to reliably serve its customers as described under Item 1A, Risk Factors of this Report.
Maintenance costs may be capitalized or expensed, depending on the nature of the activities. For any given reporting period, the mix of projects that Boardwalk Pipelines undertakes will affect the amounts recorded as property, plant and equipment on the Consolidated Balance Sheets or recognize as expenses, which impacts earnings. In 2020, Boardwalk Pipelines expects to spend approximately $370 million to maintain its pipeline systems, of which approximately $155 million is expected to be maintenance capital. In 2019, Boardwalk Pipelines spent $358 million, of which $139 million was recorded as maintenance capital.
Results of Operations
The following table summarizes the results of operations for Boardwalk Pipelines for the years ended December 31, 2019 and 2018 as presented in Note 20 of the Notes to Consolidated Financial Statements included under Item 8:
| Year Ended December 31 | 2019 | 2018 | ||||||||||||
| (In millions) | ||||||||||||||
| Revenues: | ||||||||||||||
| Operating revenues and other | $ | 1,300 | $ | 1,227 | ||||||||||
| Total | 1,300 | 1,227 | ||||||||||||
| Expenses: | ||||||||||||||
| Operating and other | 840 | 820 | ||||||||||||
| Interest | 179 | 176 | ||||||||||||
| Total | 1,019 | 996 | ||||||||||||
| Income before income tax | 281 | 231 | ||||||||||||
| Income tax expense | (72 | ) | (28 | ) | ||||||||||
| Amounts attributable to noncontrolling interests | (68 | ) | ||||||||||||
| Net income attributable to Loews Corporation | $ | 209 | $ | 135 | ||||||||||
2019 Compared with 2018
Total revenues increased $73 million in 2019 as compared with 2018. Excluding the net effect of items offset in fuel and transportation expense and net proceeds of approximately $24 million as a result of drawing on letters of credit due to a customer bankruptcy, operating revenues increased $53 million primarily driven by Boardwalk Pipelines’ recently completed growth projects, partially offset by contract restructurings and contract expirations that were recontracted at overall lower average rates.
Operating expenses increased $20 million in 2019 as compared with 2018. Excluding items offset in operating revenues, operating expenses increased $18 million as compared with the prior year primarily due to higher maintenance project expenses and an increased asset base from recently completed growth projects.
Net income attributable to Loews Corporation increased $74 million in 2019 as compared with 2018 due to the changes discussed above and the impact of the Company owning 100% of Boardwalk Pipelines, which increased from 51% with the purchase of Boardwalk Pipelines common units on July 18, 2018.
Loews Hotels & Co
The following table summarizes the results of operations for Loews Hotels & Co for the years ended December 31, 2019 and 2018 as presented in Note 20 of the Notes to Consolidated Financial Statements included under Item 8:
| Year Ended December 31 | 2019 | 2018 | ||||||||||
| (In millions) | ||||||||||||
| Revenues: | ||||||||||||
| Operating revenues | $ | 578 | $ | 628 | ||||||||
| Gain on sale of owned hotel | 23 | |||||||||||
| Revenues related to reimbursable expenses | 114 | 104 | ||||||||||
| Total | 692 | 755 | ||||||||||
| Expenses: | ||||||||||||
| Operating and other: | ||||||||||||
| Operating | 493 | 533 | ||||||||||
| Asset impairments | 99 | 22 | ||||||||||
| Reimbursable expenses | 114 | 104 | ||||||||||
| Depreciation | 61 | 67 | ||||||||||
| Equity income from joint ventures | (69 | ) | (73 | ) | ||||||||
| Interest | 22 | 29 | ||||||||||
| Total | 720 | 682 | ||||||||||
| Income (loss) before income tax | (28 | ) | 73 | |||||||||
| Income tax expense | (3 | ) | (25 | ) | ||||||||
| Net income (loss) attributable to Loews Corporation | $ | (31 | ) | $ | 48 | |||||||
2019 Compared with 2018
Operating revenues decreased $50 million as compared with 2018 primarily due to an increase in hotel renovations, which reduced the number of available guestrooms at several hotel properties, and the sale of two owned hotel properties, one in the second quarter of 2019 and one in the third quarter of 2018. Revenues were also impacted by lower management fees due to reduced operating revenues at managed properties. In addition, Loews Hotels operating revenues and expenses for 2019 each include a $15 million reduction due to the reclassification of services provided to customers by a third party vendor.
Operating expenses decreased $40 million as compared with 2018 due to the above stated reclassification and the aforementioned sales of owned hotels in 2019 and 2018.
Loews Hotels considers events or changes in circumstances that indicate the carrying amount of a long-lived asset may not be recoverable. During 2019 and 2018, Loews Hotels determined that certain properties, each of which represent an asset group, had carrying values that were not recoverable, and therefore recorded impairment charges of $99 million and $22 million to reduce these properties carrying values to their estimated fair values. There were four properties identified in 2019 and two in 2018.
Interest expense decreased $7 million as compared with 2018 due to additional capitalized interest on development projects in progress.
Equity income from joint ventures decreased $4 million as compared with 2018 primarily due to
pre-opening
expenses for properties recently opened and properties currently under development.
Corporate
Corporate operations consist primarily of investment income at the Parent Company, operating results of Altium Packaging, Parent Company interest expenses and other Parent Company administrative costs. Investment income includes earnings on cash and short term investments held at the Parent Company to meet current and future liquidity needs, as well as results of limited partnership investments and the trading portfolio.
The following table summarizes the results of operations for Corporate for the years ended December 31, 2019 and 2018 as presented in Note 20 of the Notes to Consolidated Financial Statements included under Item 8:
| Year Ended December 31 | 2019 | 2018 | ||||||||||
| (In millions) | ||||||||||||
| Revenues: | ||||||||||||
| Net investment income (loss) | $ | 230 | $ | (10 | ) | |||||||
| Operating revenues and other | 933 | 867 | ||||||||||
| Total | 1,163 | 857 | ||||||||||
| Expenses: | ||||||||||||
| Operating and other | 1,004 | 956 | ||||||||||
| Interest | 115 | 108 | ||||||||||
| Total | 1,119 | 1,064 | ||||||||||
| Income (loss) before income tax | 44 | (207 | ) | |||||||||
| Income tax (expense) benefit | (9 | ) | 46 | |||||||||
| Net income (loss) attributable to Loews Corporation | $ | 35 | $ | (161 | ) | |||||||
2019 Compared with 2018
Net investment income was $230 million in 2019 as compared with a loss of $10 million in 2018, primarily due to improved performance from equity based investments in the Parent Company trading portfolio, partially offset by lower income from limited partnership investments as a result of lower invested balances.
Operating revenues and other include Altium Packaging revenues of $932 million and $867 million for 2019 and 2018. The increase of $65 million in 2019 as compared with 2018, reflects an increase of $97 million related to acquisitions in 2018 and 2019. This increase was partially offset by lower volumes in the existing business and the pass-through effect of lower year-over-year resin prices. Altium Packaging’s contracts generally provide for resin price changes to be passed through to its customers on a short-term lag, generally about one month. When a pass-through occurs, revenues and expenses generally change by the same amount so that Altium Packaging’s gross margin returns to the same level as prior to the change in prices.
Operating and other expenses include Altium Packaging operating expenses of $913 million and $828 million for 2019 and 2018, which include depreciation and amortization expense. The increase in Altium Packaging’s operating expenses of $85 million in 2019 as compared with 2018 is primarily due to an increase of $96 million related to acquisitions in 2018 and 2019, partially offset by lower cost of goods sold due to lower volumes and lower resin prices.
Corporate Operating and other expenses were $91 million and $128 million for 2019 and 2018. The $37 million decrease from 2018 to 2019 stems from lower gross Parent Company expenses, severance costs incurred in 2018, the netting of investment expenses against investment income in 2019 and higher allocations to the subsidiaries in 2019.
LIQUIDITY AND CAPITAL RESOURCES
Parent Company
Parent Company cash and investments, net of receivables and payables, totaled $3.3 billion at December 31, 2019 as compared to $3.1 billion at December 31, 2018. In 2019, we received $927 million in dividends from our subsidiaries, including a special dividend from CNA of $485 million. Cash inflows also included $183 million from Loews Hotels & Co. Cash outflows included the payment of $1.1 billion to fund treasury stock purchases and $76 million of cash dividends to our shareholders. As a holding company we depend on dividends from our subsidiaries and returns on our investment portfolio to fund our obligations. We also have an effective Registration Statement on Form
S-3
on file with the Securities and Exchange Commission (“SEC”) registering the future sale of an unlimited amount of our debt and equity securities. We are not responsible for the liabilities and obligations of our subsidiaries and there are no Parent Company guarantees.
Depending on market and other conditions, we may purchase our shares and shares of our subsidiaries outstanding common stock in the open market or otherwise. In 2019, we purchased 21.5 million shares of Loews common stock. As of February 7, 2020, we had purchased an additional 3.3 million shares of Loews common stock in 2020 at an aggregate cost of $172 million. As of February 7, 2020, there were 287,770,405 shares of Loews common stock outstanding.
In July of 2019, Fitch Ratings Inc., affirmed our unsecured debt rating of A and revised its outlook on the Company from negative to stable. The Company currently has a corporate credit and senior debt rating of A with a stable outlook from S&P Global Ratings (“S&P”) and an unsecured debt rating of A3 with a stable outlook from Moody’s Investors Service (“Moody’s”). Should one or more rating agencies downgrade our credit ratings from current levels, or announce that they have placed us under review for a potential downgrade, our cost of capital could increase and our ability to raise new capital could be adversely affected.
Future uses of our cash may include investing in our subsidiaries, new acquisitions, dividends and/or repurchases of our and our subsidiaries’ outstanding common stock. The declaration and payment of future dividends to holders of our common stock will be at the discretion of our Board of Directors and will depend on many factors, including our earnings, financial condition and business needs.
Subsidiaries
CNA’s cash provided by operating activities was $1.1 billion in 2019 and $1.2 billion in 2018. Cash provided by operating activities in 2019 reflected a $125 million pension contribution, a lower level of distributions on limited partnerships and higher net claim payments, partially offset by an increase in premiums collected as compared with 2018.
CNA paid dividends of $3.40 per share on its common stock, including a special dividend of $2.00 per share in 2019. On February 7, 2020, CNA’s Board of Directors declared a quarterly dividend of $0.37 per share and a special dividend of $2.00 per share payable March 12, 2020 to shareholders of record on February 24, 2020. CNA’s declaration and payment of future dividends is at the discretion of its Board of Directors and will depend on many factors, including CNA’s earnings, financial condition, business needs and regulatory constraints. The payment of dividends by CNA’s insurance subsidiaries without prior approval of the insurance department of each subsidiary’s domiciliary jurisdiction is limited by formula. Dividends in excess of these amounts are subject to prior approval by the respective state insurance departments.
CNA has an effective shelf registration statement under which it may publicly issue debt, equity or hybrid securities from time to time.
Dividends from Continental Casualty Company (“CCC”), a subsidiary of CNA, are subject to the insurance holding company laws of the State of Illinois, the domiciliary state of CCC. Under these laws, ordinary dividends, or dividends that do not require prior approval by the Illinois Department of Insurance (the “Department”), are determined based on the greater of the prior year’s statutory net income or 10% of statutory surplus as of the end of the prior year, as well as the timing and amount of dividends paid in the preceding 12 months. Additionally, ordinary dividends may only be paid from earned surplus, which is calculated by removing unrealized gains from unassigned surplus. As of December 31, 2019, CCC is in a positive earned surplus position. The maximum allowable dividend CCC could pay during 2020 that would not be subject to the Department’s prior approval is $1,078 million, less dividends paid during the preceding 12 months measured at that point in time. CCC paid dividends of $1,065 million in 2019. The actual level of dividends paid in any year is determined after an assessment of available dividend capacity, holding company liquidity and cash needs as well as the impact the dividends will have on the statutory surplus of the applicable insurance company.
In July of 2019, A.M. Best Company (“A.M. Best”) upgraded CNA’s long term issuer credit rating from bbb to bbb+. In November of 2019, S&P upgraded CNA’s financial strength rating from A to A+ and long term issuer credit rating from BBB+ to
A-.
A.M. Best, Moody’s and S&P maintain stable outlooks across CNA’s financial strength and long term issuer credit ratings.
Diamond Offshore’s cash provided by operating activities decreased approximately $223 million in 2019 as compared with 2018, reflecting the effects of the protracted downturn in the offshore drilling industry. Diamond Offshore’s cash flows in 2019, compared to 2018, reflect lower cash receipts for contract drilling services of $194 million, higher income tax payments, net of refunds, primarily in its foreign tax jurisdictions of $17 million and higher cash expenditures for contract drilling services and general and administrative costs of $12 million.
For 2019, Diamond Offshore’s capital expenditures were $326 million and were funded from its operating cash flows and available cash. Diamond Offshore expects cash capital expenditures in 2020 to be approximately $190 million to $210 million. Planned spending in 2020 associated with projects under its capital maintenance and replacement programs, includes equipment upgrades for the
Ocean BlackRhino
and
Ocean BlackLion
and costs associated with the completion of the reactivation and upgrade of the
Ocean Onyx
. At December 31, 2019, Diamond Offshore has no significant purchase obligations, except for those related to its direct rig operations, which arise during the normal course of business.
As of February 7, 2020, Diamond Offshore has no outstanding borrowings and approximately $1.2 billion, in the aggregate, available under its credit agreements. For the credit agreements, $225 million matures in October of 2020, which Diamond Offshore may have difficulty replacing upon maturity, and $950 million matures in October of 2023. These credit agreements may be used for general corporate purposes, including investments, acquisitions and capital expenditures. During 2019, Diamond Offshore’s cash and cash equivalents and marketable securities decreased an aggregate $301 million and during 2018 increased an aggregate $74 million. Based on Diamond Offshore’s cash flow forecast, as of the date of this Report, it expects to generate aggregate negative cash flows for 2020 and to begin to utilize borrowing under its credit agreements in the first half of 2020 to meet its liquidity requirements. Diamond Offshore anticipates ending 2020 with a drawn balance under its $950 million credit agreement. If market conditions do not improve, Diamond Offshore could continue to generate aggregate negative cash flows in future periods.
In September of 2019, S&P downgraded Diamond Offshore’s corporate and senior unsecured notes credit ratings to CCC+ from B. The rating outlook from S&P changed to stable from negative. Diamond Offshore’s current corporate credit rating from Moody’s is B2 and its current senior unsecured notes credit rating from Moody’s is B3. The rating outlook from Moody’s is negative. These credit ratings are below investment grade and could raise Diamond Offshore’s cost of financing. Consequently, Diamond Offshore may not be able to issue additional debt in amounts and/or with terms that it considers to be reasonable. These ratings could limit Diamond Offshore’s ability to pursue other business opportunities or to refinance its indebtedness as it matures.
Diamond Offshore will make periodic assessments of its capital spending programs based on industry conditions and its cash flow forecast. Diamond Offshore, may, from time to time, issue debt or equity securities, or a combination thereof, to finance capital expenditures, the acquisition of assets and businesses or for general corporate purposes. Diamond Offshore has a shelf registration statement under which it may publicly issue from time to time up to $750 million of debt, equity and hybrid securities. Diamond Offshore’s ability to access the capital markets by issuing debt or equity securities will be dependent on its results of operations, financial condition, credit ratings, market conditions and other factors beyond its control at such time.
Boardwalk Pipelines’ cash provided by operating activities increased $96 million in 2019 compared to 2018, primarily due to the change in net income.
For 2019 and 2018, Boardwalk Pipelines’ capital expenditures were $416 million and $468 million, consisting of a combination of growth and maintenance capital. During 2019 and 2018, Boardwalk Pipelines purchased $13 million and $19 million of natural gas to be used as base gas for its pipeline system. Boardwalk Pipelines expects total capital expenditures to be approximately $475 million in 2020, including approximately $155 million for maintenance capital and $320 million related to growth projects.
As of February 10, 2020, Boardwalk Pipelines had $390 million of outstanding borrowings under its credit facility, resulting in an available borrowing capacity of approximately $1.1 billion. Boardwalk Pipelines anticipates that its existing capital resources, including its revolving credit facility and cash flows from operating activities, will be adequate to fund its operations for 2020. Boardwalk Pipelines may seek to access the debt markets to fund some or all capital expenditures for growth projects, acquisitions or for general corporate purposes. Boardwalk Pipelines has an effective shelf registration statement under which it may publicly issue debt securities, warrants or rights from time to time.
During 2020, Loews Hotels & Co anticipates funding approximately $87 million to its developments in progress, which will be derived from cash on hand, cash generated from operations and cash contributions from Loews Corporation.
In 2019, Altium Packaging paid approximately $260 million to complete three acquisitions of plastic packaging manufacturers located in the U.S. and Canada, funded with approximately $250 million of debt financing proceeds and available cash, see Notes 2 and 11 of the Notes to the Consolidated Financial Statements included under Item 8 for further discussion.
Off-Balance
Sheet Arrangements
At December 31, 2019 and 2018, we did not have any
off-balance
sheet arrangements.
Contractual Obligations
Our contractual payment obligations are as follows:
| Payments Due by Period | ||||||||||||||||||||||||
| Less than | More than | |||||||||||||||||||||||
| December 31, 2019 | Total | 1 year | 1-3 years | 3-5 years | 5 years | |||||||||||||||||||
| (In millions) | ||||||||||||||||||||||||
| Debt (a) | $ | 16,279 | $ | 616 | $ | 2,620 | $ | 4,185 | $ | 8,858 | ||||||||||||||
| Operating leases | 860 | 114 | 215 | 170 | 361 | |||||||||||||||||||
| Claim and claim adjustment expense reserves (b) | 22,814 | 5,512 | 5,928 | 2,994 | 8,380 | |||||||||||||||||||
| Future policy benefit reserves (c) | 27,539 | (350 | ) | 55 | 813 | 27,021 | ||||||||||||||||||
| Purchase and other obligations | 485 | 262 | 83 | 80 | 60 | |||||||||||||||||||
| Total | $ | 67,977 | $ | 6,154 | $ | 8,901 | $ | 8,242 | $ | 44,680 | ||||||||||||||
| (a) | Includes estimated future interest payments. |
|---|
| (b) | The claim and claim adjustment expense reserves reflected above are not discounted and represent CNA’s estimate of the amount and timing of the ultimate settlement and administration of gross claims based on its assessment of facts and circumstances known as of December 31, 2019. See the Insurance Reserves section of this MD&A for further information. |
|---|
| (c) | The future policy benefit reserves reflected above are not discounted and represent CNA’s estimate of the ultimate amount and timing of the settlement of benefits based on its assessment of facts and circumstances known as of December 31, 2019. Additional information on future policy benefit reserves is included in Note 1 of the Notes to Consolidated Financial Statements included under Item 8. |
|---|
Further information on our commitments, contingencies and guarantees is provided in the Notes to Consolidated Financial Statements included under Item 8.
INVESTMENTS
Investment activities of
non-insurance
subsidiaries primarily include investments in fixed income securities, including short term investments. The Parent Company portfolio also includes equity securities, including short sales and derivative instruments, and investments in limited partnerships. These types of investments generally present greater volatility, less liquidity and greater risk than fixed income investments and are included within Results of Operations – Corporate.
We enter into short sales and invest in certain derivative instruments that are used for asset and liability management activities, income enhancements to our portfolio management strategy and to benefit from anticipated future movements in the underlying markets. If such movements do not occur as anticipated, then significant losses may occur. Monitoring procedures include senior management review of daily reports of existing positions and valuation fluctuations to seek to ensure that open positions are consistent with our portfolio strategy.
Credit exposure associated with
non-performance
by counterparties to our derivative instruments is generally limited to the uncollateralized change in fair value of the derivative instruments recognized in the Consolidated Balance Sheets. We mitigate the risk of non-performance by monitoring the creditworthiness of counterparties and diversifying derivatives by using multiple counterparties. We occasionally require collateral from our derivative investment counterparties depending on the amount of the exposure and the credit rating of the counterparty.
Insurance
CNA maintains a large portfolio of fixed maturity and equity securities, including large amounts of corporate and government issued debt securities, residential and commercial mortgage-backed securities, and other asset-backed securities and investments in limited partnerships which pursue a variety of long and short investment strategies across a broad array of asset classes. CNA’s investment portfolio supports its obligation to pay future insurance claims and provides investment returns which are an important part of CNA’s overall profitability.
Net Investment Income
The significant components of CNA’s net investment income are presented in the following table. Fixed income securities, as presented, include both fixed maturity securities and
non-redeemable
preferred stock.
| Year Ended December 31 | 2019 | 2018 | ||||||||
| (In millions) | ||||||||||
| Fixed income securities: | ||||||||||
| Taxable fixed income securities | $ | 1,538 | $ | 1,449 | ||||||
| Tax-exempt fixed income securities | 318 | 384 | ||||||||
| Total fixed income securities | 1,856 | 1,833 | ||||||||
| Limited partnership and common stock investments | 226 | (42 | ) | |||||||
| Other, net of investment expense | 36 | 26 | ||||||||
| Pretax net investment income | $ | 2,118 | $ | 1,817 | ||||||
| Fixed income securities after tax and noncontrolling interests | $ | 1,358 | $ | 1,351 | ||||||
| Net investment income after tax and noncontrolling interests | $ | 1,543 | $ | 1,341 | ||||||
| Effective income yield for the fixed income securities portfolio, before tax | 4.8% | 4.7% | ||||||||
| Effective income yield for the fixed income securities portfolio, after tax | 3.9% | 3.9% | ||||||||
| Limited partnership and common stock return | 11.7% | (1.9)% |
Net investment income before tax and noncontrolling interests increased $301 million in 2019 as compared with 2018. The increase was driven by limited partnership and common stock investments.
Net Investment Gains (Losses)
The components of CNA’s net investment gains (losses) are presented in the following table:
| Year Ended December 31 | 2019 | 2018 | ||||||||||||||
| (In millions) | ||||||||||||||||
| Investment gains (losses): | ||||||||||||||||
| Fixed maturity securities: | ||||||||||||||||
| Corporate and other bonds | $ (8 | ) | $ | 26 | ||||||||||||
| States, municipalities and political subdivisions | 13 | 36 | ||||||||||||||
| Asset-backed | (11 | ) | (58 | ) | ||||||||||||
| Total fixed maturity securities | (6 | ) | 4 | |||||||||||||
| Non-redeemable preferred stock | 66 | (74 | ) | |||||||||||||
| Short term and other | (11 | ) | 13 | |||||||||||||
| Total investment gains (losses) | 49 | (57 | ) | |||||||||||||
| Income tax (expense) benefit | (12 | ) | 14 | |||||||||||||
| Amounts attributable to noncontrolling interests | (4 | ) | 5 | |||||||||||||
| Net investment gains (losses) attributable to Loews Corporation | $ 33 | $ | (38 | ) | ||||||||||||
Net investment results after tax and noncontrolling interests improved $71 million in 2019 as compared with 2018. The improvement was driven by the favorable change in fair value of
non-redeemable
preferred stock, partially offset by higher OTTI losses recognized in earnings.
Further information on CNA’s investment gains and losses, including other-than-temporary impairment losses, is set forth in Notes 1 and 3 of the Notes to Consolidated Financial Statements included under Item 8.
Portfolio Quality
The following table presents the estimated fair value and net unrealized gains (losses) of CNA’s fixed maturity securities by rating distribution:
| December 31, 2019 | December 31, 2018 | |||||||||||||||||||
| Estimated Fair Value | Net Unrealized Gains (Losses) | Estimated Fair Value | Net Unrealized Gains (Losses) | |||||||||||||||||
| (In millions) | ||||||||||||||||||||
| U.S. Government, Government agencies and Government-sponsored enterprises | $ | 4,136 | $ | 95 | $ | 4,334 | $ | (24 | ) | |||||||||||
| AAA | 3,254 | 349 | 3,027 | 245 | ||||||||||||||||
| AA | 6,663 | 801 | 6,510 | 512 | ||||||||||||||||
| A | 9,062 | 1,051 | 8,768 | 527 | ||||||||||||||||
| BBB | 16,839 | 1,684 | 14,205 | 274 | ||||||||||||||||
| Non-investment grade | 2,253 | 101 | 2,702 | (73 | ) | |||||||||||||||
| Total | $ | 42,207 | $ | 4,081 | $ | 39,546 | $ | 1,461 | ||||||||||||
As of December 31, 2019 and 2018, only 1% of CNA’s fixed maturity portfolio was rated internally. AAA rated securities included $1.5 billion and $1.3 billion of
pre-funded
municipal bonds as of December 31, 2019 and 2018.
The following table presents CNA’s
available-for-sale
fixed maturity securities in a gross unrealized loss position by ratings distribution:
| December 31, 2019 | Estimated Fair Value | Gross Unrealized Losses | ||||||||
| (In millions) | ||||||||||
| U.S. Government, Government agencies and Government-sponsored enterprises | $ | 271 | $ | 3 | ||||||
| AAA | 91 | 2 | ||||||||
| AA | 165 | 1 | ||||||||
| A | 667 | 6 | ||||||||
| BBB | 832 | 13 | ||||||||
| Non-investment grade | 394 | 20 | ||||||||
| Total | $ | 2,420 | $ | 45 | ||||||
The following table presents the maturity profile for these
available-for-sale
fixed maturity securities. Securities not due to mature on a single date are allocated based on weighted average life:
| December 31, 2019 | Estimated Fair Value | Gross Unrealized Losses | ||||||||
| (In millions) | ||||||||||
| Due in one year or less | $ | 77 | $ | 1 | ||||||
| Due after one year through five years | 613 | 15 | ||||||||
| Due after five years through ten years | 1,367 | 16 | ||||||||
| Due after ten years | 363 | 13 | ||||||||
| Total | $ | 2,420 | $ | 45 | ||||||
Duration
A primary objective in the management of CNA’s investment portfolio is to optimize return relative to the corresponding liabilities and respective liquidity needs. CNA’s views on the current interest rate environment, tax regulations, asset class valuations, specific security issuer and broader industry segment conditions as well as domestic and global economic conditions, are some of the factors that enter into an investment decision. CNA also continually monitors exposure to issuers of securities held and broader industry sector exposures and may from time to time adjust such exposures based on its views of a specific issuer or industry sector.
A further consideration in the management of CNA’s investment portfolio is the characteristics of the corresponding liabilities and the ability to align the duration of the portfolio to those liabilities and to meet future liquidity needs, minimize interest rate risk and maintain a level of income sufficient to support the underlying insurance liabilities. For portfolios where future liability cash flows are determinable and typically long term in nature, CNA segregates investments for asset/liability management purposes. The segregated investments support the long term care and structured settlement liabilities in Other Insurance Operations.
The effective durations of CNA’s fixed income securities and short term investments are presented in the following table. Amounts presented are net of payable and receivable amounts for securities purchased and sold, but not yet settled.
| December 31, 2019 | December 31, 2018 | |||||||||||||||||
| Estimated Fair Value | Effective Duration (In Years) | Estimated Fair Value | Effective Duration (In Years) | |||||||||||||||
| (In millions of dollars) | ||||||||||||||||||
| Investments supporting Other Insurance Operations | $ | 18,015 | 8.9 | $ | 16,212 | 8.4 | ||||||||||||
| Other investments | 26,813 | 4.1 | 25,428 | 4.4 | ||||||||||||||
| Total | $ | 44,828 | 6.0 | $ | 41,640 | 6.0 | ||||||||||||
The investment portfolio is periodically analyzed for changes in duration and related price risk. Certain securities have duration characteristics that are variable based on market interest rates, credit spreads and other factors that may drive variability in the amount and timing of cash flows. Additionally, CNA periodically reviews the sensitivity of the portfolio to the level of foreign exchange rates and other factors that contribute to market price changes. A summary of these risks and specific analysis on changes is included in the Quantitative and Qualitative Disclosures about Market Risk included under Item 7A.
Short Term Investments
The carrying value of the components of CNA’s Short term investments are presented in the following table:
| December 31 | 2019 | 2018 | ||||||||
| (In millions) | ||||||||||
| Short term investments: | ||||||||||
| Commercial paper | $ | 1,181 | $ | 705 | ||||||
| U.S. Treasury securities | 364 | 185 | ||||||||
| Other | 316 | 396 | ||||||||
| Total short term investments | $ | 1,861 | $ | 1,286 | ||||||
INSURANCE RESERVES
The level of claim reserves CNA maintains represents its best estimate, as of a particular point in time, of what the ultimate settlement and administration of claims will cost based on CNA’s assessment of facts and circumstances known at that time. Reserves are not an exact calculation of liability but instead are complex estimates that CNA derives, generally utilizing a variety of actuarial reserve estimation techniques, from numerous assumptions and expectations about future events, both internal and external, many of which are highly uncertain. As noted below, CNA reviews its reserves for each segment of its business periodically, and any such review could result in the need to increase reserves in amounts which could be material and could adversely affect our results of operations and equity and CNA’s business and insurer financial strength and corporate debt ratings. Further information on reserves is provided in Note 8 of the Notes to Consolidated Financial Statements included under Item 8.
Property and Casualty Claim and Claim Adjustment Expense Reserves
CNA maintains loss reserves to cover its estimated ultimate unpaid liability for claim and claim adjustment expenses, including the estimated cost of the claims adjudication process, for claims that have been reported but not yet settled (case reserves) and claims that have been incurred but not reported (“IBNR”). IBNR includes a provision for development on known cases as well as a provision for late reported incurred claims. Claim and claim adjustment expense reserves are reflected as liabilities and are included on the Consolidated Balance Sheets under the heading “Insurance Reserves.” Adjustments to prior year reserve estimates, if necessary, are reflected in results of operations in the period that the need for such adjustments is determined. The carried case and IBNR reserves as of each balance sheet date are provided in the discussion that follows and in Note 8 of the Notes to Consolidated Financial Statements included under Item 8.
There is a risk that CNA’s recorded reserves are insufficient to cover its estimated ultimate unpaid liability for claims and claim adjustment expenses. Unforeseen emerging or potential claims and coverage issues are difficult to predict and could materially adversely affect the adequacy of CNA’s claim and claim adjustment expense reserves and could lead to future reserve additions.
In addition, CNA’s property and casualty insurance subsidiaries also have actual and potential exposures related to A&EP claims, which could result in material losses. To mitigate the risks posed by CNA’s exposure to A&EP claims and claim adjustment expenses, CNA completed a transaction with National Indemnity Company (“NICO”), under which substantially all of CNA’s legacy A&EP liabilities were ceded to NICO effective January 1, 2010. See Note 8 of the Notes to the Consolidated Financial Statements included under Item 8 for further discussion about the transaction with NICO, its impact on CNA’s results of operations, the deferred retroactive reinsurance gain and the amount of remaining reinsurance limit.
Establishing Property & Casualty Reserve Estimates
In developing claim and claim adjustment expense (“loss” or “losses”) reserve estimates, CNA’s actuaries perform detailed reserve analyses that are staggered throughout the year. The data is organized at a reserve group level. A reserve group can be a line of business covering a subset of insureds such as commercial automobile liability for small or middle market customers, or it can be a particular type of claim such as construction defect. Every reserve group is reviewed at least once during the year, but most are reviewed more frequently. The analyses generally review losses gross of ceded reinsurance and apply the ceded reinsurance terms to the gross estimates to establish estimates net of reinsurance. In addition to the detailed analyses, CNA reviews actual loss emergence for all products each quarter.
Most of CNA’s business can be characterized as long-tail. For long-tail business, it will generally be several years between the time the business is written and the time when all claims are settled. CNA’s long-tail exposures include commercial automobile liability, workers’ compensation, general liability, medical professional liability, other professional liability and management liability coverages, assumed reinsurance
run-off
and products liability. Short-tail exposures include property, commercial automobile physical damage, marine, surety and warranty. Property & Casualty Operations contain both long-tail and short-tail exposures. Other Insurance Operations contain long-tail exposures.
Various methods are used to project ultimate losses for both long-tail and short-tail exposures.
The paid development method estimates ultimate losses by reviewing paid loss patterns and applying them to accident or policy years with further expected changes in paid losses. Selection of the paid loss pattern may require consideration of several factors including the impact of inflation on claim costs, the rate at which claims professionals make claim payments and close claims, the impact of judicial decisions, the impact of underwriting changes, the impact of large claim payments and other factors. Claim cost inflation itself may require evaluation of changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors. Because this method assumes that losses are paid at a consistent rate, changes in any of these factors can affect the results. Since the method does not rely on case reserves, it is not directly influenced by changes in their adequacy.
For many reserve groups, paid loss data for recent periods may be too immature or erratic for accurate predictions. This situation often exists for long-tail exposures. In addition, changes in the factors described above may result in inconsistent payment patterns. Finally, estimating the paid loss pattern subsequent to the most mature point available in the data analyzed often involves considerable uncertainty for long-tail products such as workers’ compensation.
The incurred development method is similar to the paid development method, but it uses case incurred losses instead of paid losses. Since the method uses more data (case reserves in addition to paid losses) than the paid development method, the incurred development patterns may be less variable than paid patterns. However, selection of the incurred loss pattern typically requires analysis of all of the same factors described above. In addition, the inclusion of case reserves can lead to distortions if changes in case reserving practices have taken place, and the use of case incurred losses may not eliminate the issues associated with estimating the incurred loss pattern subsequent to the most mature point available.
The loss ratio method multiplies earned premiums by an expected loss ratio to produce ultimate loss estimates for each accident or policy year. This method may be useful for immature accident or policy periods or if loss development patterns are inconsistent, losses emerge very slowly or there is relatively little loss history from which to estimate future losses. The selection of the expected loss ratio typically requires analysis of loss ratios from earlier accident or policy years or pricing studies and analysis of inflationary trends, frequency trends, rate changes, underwriting changes and other applicable factors.
The Bornhuetter-Ferguson method using paid loss is a combination of the paid development method and the loss ratio method. This method normally determines expected loss ratios similar to the approach used to estimate the expected loss ratio for the loss ratio method and typically requires analysis of the same factors described above. This method assumes that future losses will develop at the expected loss ratio level. The percent of paid loss to ultimate loss implied from the paid development method is used to determine what percentage of ultimate loss is yet to be paid. The use of the pattern from the paid development method typically requires consideration of the same factors listed in the description of the paid development method. The estimate of losses yet to be paid is added to current paid losses to estimate the ultimate loss for each year. For long-tail lines, this method will react very slowly if actual ultimate loss ratios are different from expectations due to changes not accounted for by the expected loss ratio calculation.
The Bornhuetter-Ferguson method using incurred loss is similar to the Bornhuetter-Ferguson method using paid loss except that it uses case incurred losses. The use of case incurred losses instead of paid losses can result in development patterns that are less variable than paid patterns. However, the inclusion of case reserves can lead to distortions if changes in case reserving have taken place, and the method typically requires analysis of the same factors that need to be reviewed for the loss ratio and incurred development methods.
The frequency times severity method multiplies a projected number of ultimate claims by an estimated ultimate average loss for each accident or policy year to produce ultimate loss estimates. Since projections of the ultimate number of claims are often less variable than projections of ultimate loss, this method can provide more reliable results for reserve groups where loss development patterns are inconsistent or too variable to be relied on exclusively. In addition, this method can more directly account for changes in coverage that affect the number and size of claims. However, this method can be difficult to apply to situations where very large claims or a substantial number of unusual claims result in volatile average claim sizes. Projecting the ultimate number of claims may require analysis of several factors, including the rate at which policyholders report claims to CNA, the impact of judicial decisions, the impact of underwriting changes and other factors. Estimating the ultimate average loss may require analysis of the impact of large losses and claim cost trends based on changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors.
Stochastic modeling produces a range of possible outcomes based on varying assumptions related to the particular reserve group being modeled. For some reserve groups, CNA uses models which rely on historical development patterns at an aggregate level, while other reserve groups are modeled using individual claim variability assumptions supplied by the claims department. In either case, multiple simulations using varying assumptions are run and the results are analyzed to produce a range of potential outcomes. The results will typically include a mean and percentiles of the possible reserve distribution which aid in the selection of a point estimate.
For many exposures, especially those that can be considered long-tail, a particular accident or policy year may not have a sufficient volume of paid losses to produce a statistically reliable estimate of ultimate losses. In such a case, CNA’s actuaries typically assign more weight to the incurred development method than to the paid development method. As claims continue to settle and the volume of paid loss increases, the actuaries may assign additional weight to the paid development method. For most of CNA’s products, even the incurred losses for accident or policy years that are early in the claim settlement process will not be of sufficient volume to produce a reliable estimate of ultimate losses. In these cases, CNA may not assign much, if any, weight to the paid and incurred development methods. CNA may use the loss ratio, Bornhuetter-Ferguson and/or frequency times severity methods. For short-tail exposures, the paid and incurred development methods can often be relied on sooner primarily because CNA’s history includes a sufficient number of years to cover the entire period over which paid and incurred losses are expected to change. However, CNA may also use the loss ratio, Bornhuetter-Ferguson and/or frequency times severity methods for short-tail exposures.
For other more complex reserve groups where the above methods may not produce reliable indications, CNA uses additional methods tailored to the characteristics of the specific situation.
Periodic Reserve Reviews
The reserve analyses performed by CNA’s actuaries result in point estimates. Each quarter, the results of the detailed reserve reviews are summarized and discussed with CNA’s senior management to determine management’s best estimate of reserves. CNA’s senior management considers many factors in making this decision. CNA’s recorded reserves reflect its best estimate as of a particular point in time based upon known facts and circumstances, consideration of the factors cited above and its judgment. The carried reserve differs from the actuarial point estimate as discussed further below.
Currently, CNA’s recorded reserves are modestly higher than the actuarial point estimate. For Property & Casualty Operations, the difference between CNA’s reserves and the actuarial point estimate is primarily driven by uncertainty with respect to immature accident years, claim cost inflation, changes in claims handling, changes to the tort environment which may adversely affect claim costs and the effects from the economy. For CNA’s legacy A&EP liabilities, the difference between CNA’s reserves and the actuarial point estimate is primarily driven by the potential tail volatility of
run-off
exposures.
The key assumptions fundamental to the reserving process are often different for various reserve groups and accident or policy years. Some of these assumptions are explicit assumptions that are required of a particular method, but most of the assumptions are implicit and cannot be precisely quantified. An example of an explicit assumption is the pattern employed in the paid development method. However, the assumed pattern is itself based on several implicit assumptions such as the impact of inflation on medical costs and the rate at which claim professionals close claims. As a result, the effect on reserve estimates of a particular change in assumptions typically cannot be specifically quantified, and changes in these assumptions cannot be tracked over time.
CNA’s recorded reserves are management’s best estimate. In order to provide an indication of the variability associated with CNA’s net reserves, the following discussion provides a sensitivity analysis that shows the approximate estimated impact of variations in significant factors affecting CNA’s reserve estimates for particular types of business. These significant factors are the ones that CNA believes could most likely materially affect the reserves. This discussion covers the major types of business for which CNA believes a material deviation to its reserves is reasonably possible. There can be no assurance that actual experience will be consistent with the current assumptions or with the variation indicated by the discussion. In addition, there can be no assurance that other factors and assumptions will not have a material impact on CNA’s reserves.
The three areas for which CNA believes a significant deviation to its net reserves is reasonably possible are (i) professional liability, management liability and surety products (ii) workers’ compensation and (iii) general liability.
Professional liability, management liability and surety products include U.S. professional liability coverages provided to various professional firms, including architects, real estate agents, small and
mid-sized
accounting firms, law firms and other professional firms. They also include D&O, employment practices, fiduciary, fidelity and surety coverages and medical liability. The most significant factor affecting reserve estimates for these liability coverages is claim severity. Claim severity is driven by the cost of medical care, the cost of wage replacement, legal fees, judicial decisions, legislative changes and other factors. Underwriting and claim handling decisions such as the classes of business written and individual claim settlement decisions can also affect claim severity. If the estimated claim severity increases by 9%, CNA estimates that net reserves would increase by approximately $400 million. If the estimated claim severity decreases by 3%, CNA estimates that net reserves would decrease by approximately $150 million. CNA’s net reserves for these products were approximately $4.4 billion as of December 31, 2019.
For workers’ compensation, since many years will pass from the time the business is written until all claim payments have been made, the most significant factor affecting workers’ compensation reserve estimate is claim cost inflation on claim payments. Workers’ compensation claim cost inflation is driven by the cost of medical care, the cost of wage replacement, expected claimant lifetimes, judicial decisions, legislative changes and other factors. If estimated workers’ compensation claim cost inflation increases by 100 basis points for the entire period over which claim payments will be made, CNA estimates that its net reserves would increase by approximately $350 million. If estimated workers’ compensation claim cost inflation decreases by 100 basis points for the entire period over which claim payments will be made, CNA estimates that its net reserves would decrease by approximately $350 million. Net reserves for workers’ compensation were approximately $4.0 billion as of December 31, 2019.
For general liability, the most significant factor affecting reserve estimates is claim severity. Claim severity is driven by changes in the cost of repairing or replacing property, the cost of medical care, the cost of wage replacement, judicial decisions, legislation and other factors. If the estimated claim severity for general liability increases by 6%, CNA estimates that its net reserves would increase by approximately $200 million. If the estimated claim severity for general liability decreases by 3%, CNA estimates that its net reserves would decrease by approximately $100 million. Net reserves for general liability were approximately $3.4 billion as of December 31, 2019.
Given the factors described above, it is not possible to quantify precisely the ultimate exposure represented by claims and related litigation. As a result, CNA regularly reviews the adequacy of its reserves and reassesses its reserve estimates as historical loss experience develops, additional claims are reported and settled and additional information becomes available in subsequent periods. In reviewing CNA’s reserve estimates, CNA makes adjustments in the period that the need for such adjustments is determined. These reviews have resulted in CNA’s identification of information and trends that have caused CNA to change its reserves in prior periods and could lead to CNA’s identification of a need for additional material increases or decreases in claim and claim adjustment expense reserves, which could materially affect our results of operations and equity and CNA’s business and insurer financial strength and corporate debt ratings positively or negatively. See Note 8 of the Notes to the Consolidated Financial Statements included under Item 8 for additional information about reserve development.
The following table summarizes gross and net carried reserves for CNA’s Property & Casualty Operations:
| December 31 | 2019 | 2018 | ||||||||
| (In millions) | ||||||||||
| Gross Case Reserves | $ | 6,276 | $ | 6,671 | ||||||
| Gross IBNR Reserves | 9,494 | 9,287 | ||||||||
| Total Gross Carried Claim and Claim Adjustment Expense Reserves | $ | 15,770 | $ | 15,958 | ||||||
| Net Case Reserves | $ | 5,645 | $ | 6,063 | ||||||
| Net IBNR Reserves | 8,508 | 8,290 | ||||||||
| Total Net Carried Claim and Claim Adjustment Expense Reserves | $ | 14,153 | $ | 14,353 | ||||||
The following table summarizes the gross and net carried reserves for other insurance businesses in
run-off,
including CNA Re and A&EP:
| December 31 | 2019 | 2018 | ||||||||
| (In millions) | ||||||||||
| Gross Case Reserves | $ | 1,137 | $ | 1,208 | ||||||
| Gross IBNR Reserves | 1,097 | 1,217 | ||||||||
| Total Gross Carried Claim and Claim Adjustment Expense Reserves | $ | 2,234 | $ | 2,425 | ||||||
| Net Case Reserves | $ | 92 | $ | 96 | ||||||
| Net IBNR Reserves | 83 | 96 | ||||||||
| Total Net Carried Claim and Claim Adjustment Expense Reserves | $ | 175 | $ | 192 | ||||||
Long Term Care Policyholder Reserves
CNA’s Other Insurance Operations includes its
run-off
long term care business as well as structured settlement obligations not funded by annuities related to certain property and casualty claimants. Long term care policies provide benefits for nursing homes, assisted living facilities and home health care subject to various daily and lifetime caps. Generally, policyholders must continue to make periodic premium payments to keep the policy in force and CNA has the ability to increase policy premiums, subject to state regulatory approval.
CNA maintains both claim and claim adjustment expense reserves as well as future policy benefit reserves for policyholder benefits for its long term care business. Claim and claim adjustment expense reserves consist of estimated reserves for long term care policyholders that are currently receiving benefits, including claims that have been incurred but are not yet reported. In developing the claim and claim adjustment expense reserve estimates for CNA’s long term care policies, its actuaries perform a detailed claim experience study on an annual basis. The study reviews the sufficiency of existing reserves for policyholders currently on claim and includes an evaluation of expected benefit utilization and claim duration. CNA’s recorded claim and claim adjustment expense reserves reflect CNA management’s best estimate after incorporating the results of the most recent study. In addition, claim and claim adjustment expense reserves are also maintained for the structured settlement obligations. In developing the claim and claim adjustment expense reserve estimates for CNA’s structured settlement obligations, CNA’s actuaries monitor mortality experience on an annual basis. Both elements of long term care reserves are discounted as discussed in Note 1 to the Consolidated Financial Statements included under Item 8.
Future policy benefit reserves represent the active life reserves related to CNA’s long term care policies which are the present value of expected future benefit payments and expenses less expected future premium. The determination of these reserves requires management to make estimates and assumptions about expected investment and policyholder experience over the life of the contract. Since many of these contracts may be in force for several decades, these assumptions are subject to significant estimation risk.
The actuarial assumptions that management believes are subject to the most variability are morbidity, persistency, discount rates and anticipated future premium rate increases. Morbidity is the frequency and severity of injury, illness, sickness and diseases contracted. Persistency is the percentage of policies remaining in force and can be affected by policy lapses, benefit reductions and death. Discount rates are influenced by the investment yield on assets supporting long term care reserves which is subject to interest rate and market volatility and may also be affected by changes to the Internal Revenue Code. Future premium rate increases are generally subject to regulatory approval, and therefore the exact timing and size of the approved rate increases are unknown. As a result of this variability, CNA’s long term care reserves may be subject to material increases if actual experience develops adversely to its expectations.
Annually, in the third quarter, management assesses the adequacy of its long term care future policy benefit reserves by performing a gross premium valuation (“GPV”) to determine if there is a premium deficiency. Management also uses the GPV process to evaluate the adequacy of CNA’s claim and claim adjustment expense reserves for structured settlement obligations. Under the GPV, management estimates required reserves using best estimate assumptions as of the date of the assessment without provisions for adverse deviation. The GPV required reserves are then compared to the existing recorded reserves. If the GPV required reserves are greater than the existing recorded reserves, the
assumptions are unlocked and future policy benefit reserves are increased to the greater amount. Any such increase is reflected in CNA’s results of operations in the period in which the need for such adjustment is determined. If the GPV required reserves are less than the existing recorded reserves, the assumptions remain locked in and no adjustment is required.
Periodically, CNA engages independent third parties to assess the appropriateness of its best estimate assumptions. The most recent third party assessment, performed in early 2019, validated the assumption setting process and confirmed the best estimate assumptions appropriately reflected the experience data at that time.
Prior to September 30, 2019, the active life reserves for long term care were based on the actuarial best estimate assumptions established at December 31, 2015 as a result of a reserve unlocking in the fourth quarter of 2015. The September 30, 2018 GPV indicated the carried reserves included a margin of approximately $182 million. The September 30, 2019 GPV indicated a premium deficiency of $216 million and future policyholder benefit reserves at that date were increased accordingly. As a result, the long term care active life reserves carried as of September 30, 2019 represent management’s best estimate assumptions at that date with no margin for adverse deviation. A summary of the changes as a result of the 2019 GPV is presented in the table below.
| (In millions) | ||||||||
| Long term care active life reserve - change in estimated reserve margin | ||||||||
| September 30, 2018 estimated margin | $ | 182 | ||||||
| Changes in underlying discount rate assumptions | (280 | ) | ||||||
| Changes in underlying morbidity assumptions | 32 | |||||||
| Changes in underlying persistency assumptions and inforce policy inventory | (234 | ) | ||||||
| Changes in underlying premium rate action assumptions | 58 | |||||||
| Changes in underlying expense and other assumptions | 26 | |||||||
| September 30, 2019 Premium Deficiency | $ (216 | ) | ||||||
The premium deficiency was primarily driven by changes in discount rate assumptions driven by lower expected reinvestment rates, contemplating both near-term market indications and long-term normative assumptions. The premium deficiency was also adversely affected by changes in persistency assumptions, primarily from lower projected active life mortality rates. Recognition of margin in earnings subsequent to the 2018 GPV also contributed to the premium deficiency. These unfavorable drivers were partially offset by higher than expected rate increases on active rate increase programs, new planned rate increase filings and favorable changes to the underlying morbidity and expense assumptions.
Subsequent to the 2018 GPV, as CNA’s projections indicated a pattern of expected profits in earlier future years followed by losses in later future years, CNA established additional future policy benefit reserves determined by applying the ratio of the present value of future losses divided by the present value of future profits from the 2018 GPV to the long term care core income during the quarterly periods. As a result of the premium deficiency, recognized in the third quarter of 2019, CNA’s projections no longer indicate a pattern of expected profits in earlier future years followed by expected losses in later future years. As a result, CNA is not currently establishing additional future policy benefit reserves for profits followed by losses in periods where the long term care business generates core income. The need for these additional future policy benefit reserves will be
re-evaluated
in connection with the next GPV, which is expected to be completed in the third quarter of 2020.
The table below summarizes the estimated pretax impact on CNA’s results of operations from various hypothetical revisions to its active life reserve assumptions. The annual GPV process involves updating all assumptions to management’s then current best estimate, and historically all significant assumptions have been revised each year. In the hypothetical revisions table below, CNA has assumed that revisions to such assumptions would occur in each policy type, age and duration within each policy group and would occur absent any changes, mitigating or otherwise, in the other assumptions. Although such hypothetical revisions are not currently required or anticipated, CNA believes they could occur based on past variances in experience and its expectations of the ranges of future experience that could reasonably occur. Any actual adjustment would be dependent on the specific policies affected and, therefore, may differ from the estimates summarized below.
| 2019 GPV | Estimated Reduction to Pretax Income | |||
| (In millions) | ||||
| Hypothetical revisions | ||||
| Morbidity: | ||||
| 5% increase in morbidity | $ | 664 | ||
| 10% increase in morbidity | 1,329 | |||
| Persistency: | ||||
| 5% decrease in active life mortality and lapse | $ | 208 | ||
| 10% decrease in active life mortality and lapse | 427 | |||
| Discount rates: | ||||
| 50 basis point decline in new money interest rates | $ | 309 | ||
| 100 basis point decline in new money interest rates | 675 | |||
| Premium rate actions: | ||||
| 25% decrease in anticipated future premium rate increases | $ | 58 | ||
| 50% decrease in anticipated future premium rate increases | 115 |
The following tables summarize policyholder reserves for CNA’s long term care operations:
| December 31, 2019 | Claim and claim adjustment expenses | Future policy benefits | Total | |||||||||
| (In millions) | ||||||||||||
| Long term care | $ | 2,863 | $ | 9,470 | $ | 12,333 | ||||||
| Structured settlement annuities | 515 | 515 | ||||||||||
| Other | 12 | 12 | ||||||||||
| Total | 3,390 | 9,470 | 12,860 | |||||||||
| Shadow adjustments (a) | 167 | 2,615 | 2,782 | |||||||||
| Ceded reserves (b) | 159 | 226 | 385 | |||||||||
| Total gross reserves | $ | 3,716 | $ | 12,311 | $ | 16,027 | ||||||
| December 31, 2018 | Claim and claim adjustment expenses | Future policy benefits | Total | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In millions) | ||||||||||||
| Long term care | $ | 2,761 | $ | 9,113 | $ | 11,874 | ||||||
| Structured settlement annuities | 530 | 530 | ||||||||||
| Other | 14 | 14 | ||||||||||
| Total | 3,305 | 9,113 | 12,418 | |||||||||
| Shadow adjustments (a) | 115 | 1,250 | 1,365 | |||||||||
| Ceded reserves (b) | 181 | 234 | 415 | |||||||||
| Total gross reserves | $ | 3,601 | $ | 10,597 | $ | 14,198 | ||||||
| (a) | To the extent that unrealized gains on fixed income securities supporting long term care products and annuity contracts would result in a premium deficiency if those gains were realized, an increase in Insurance reserves is recorded, after tax and noncontrolling interests, as a reduction of net unrealized gains through Other comprehensive income (loss) (“Shadow Adjustments”). |
|---|
| (b) | Ceded reserves relate to claim or policy reserves fully reinsured in connection with a sale or exit from the underlying business. |
|---|
CATASTROPHES AND RELATED REINSURANCE
CNA generally defines catastrophe loss events in the U.S. consistent with the definition of the Property Claims Service (“PCS”). PCS defines a catastrophe as an event that causes damage of $25 million or more in direct insured losses to property and affects a significant number of policyholders and insurers. For events outside of the U.S., CNA defines a catastrophe as an industry recognized event that generates an accumulation of claims amounting to more than $1 million for the International line of business.
Catastrophes are an inherent risk of the property and casualty insurance business and have contributed to material
period-to-period
fluctuations in CNA’s results of operations and/or equity. CNA reported catastrophe losses, net of reinsurance, of $179 million and $252 million for the years ended December 31, 2019 and 2018. Net catastrophe losses for the year ended December 31, 2019 are related primarily to U.S. weather related events. Net catastrophe losses for the year ended December 31, 2018 included $88 million related to Hurricane Michael, $47 million related to the California wildfires and $33 million related to Hurricane Florence. The remaining net catastrophe losses in 2018 resulted primarily from U.S. weather related events.
CNA generally seeks to manage its exposure to catastrophes through the purchase of catastrophe reinsurance and has catastrophe reinsurance treaties that cover property and workers’ compensation losses. CNA conducts an ongoing review of its risk and catastrophe coverages and from time to time make changes as it deems appropriate. The following discussion summarizes CNA’s most significant catastrophe reinsurance coverage at January 1, 2020.
Group North American Property Treaty
CNA purchased corporate catastrophe
excess-of-loss
treaty reinsurance covering its U.S. states and territories and Canadian property exposures underwritten in its North American and European companies. Exposures underwritten through Hardy are excluded. The treaty has a term of January 1, 2019 to May 1, 2020. The 2019 treaty provides coverage for the accumulation of losses from catastrophe occurrences above CNA’s per occurrence retention of $250 million up to $1.0 billion. Losses stemming from terrorism events are covered unless they are due to a nuclear, biological or chemical attack. All layers of the treaty provide for one full reinstatement.
Group Workers Compensation Treaty
CNA also purchased corporate Workers Compensation catastrophe
excess-of-loss
treaty reinsurance for the period January 1, 2020 to January 1, 2021 providing $275 million of coverage for the accumulation of covered losses related to natural catastrophes above CNA’s retention of $25 million. The treaty provides $475 million of coverage for the accumulation of covered losses related to terrorism events above CNA’s retention of $25 million. Of the $475 million in terrorism coverage, $200 million is provided for nuclear, biological, chemical and radiation events. One full reinstatement is available for the first $275 million above the retention, regardless of the covered peril. CNA also purchased a targeted facultative facility to address exposure accumulations in specific peak terrorism zones.
Terrorism Risk Insurance Program Reauthorization Act of 2019 (“TRIPRA”)
CNA’s principal reinsurance protection against large-scale terrorist attacks, including nuclear, biological, chemical or radiological attacks, is the coverage currently provided through TRIPRA which has been extended through the end of 2027. TRIPRA provides a U.S. government backstop for insurance-related losses resulting from any “act of terrorism”, which is certified by the Secretary of Treasury in consultation with the Secretary of Homeland Security for losses that exceed a threshold of $200 million industry-wide for the calendar year 2020. Under the current provisions of the program, in 2020 the federal government will reimburse 80% of CNA’s covered losses in excess of its applicable deductible up to a total industry program cap of $100 billion. CNA’s deductible is based on eligible commercial property and casualty earned premiums for the preceding calendar year. Based on 2019 earned premiums, CNA’s estimated deductible under the program is $850 million for 2020. If an act of terrorism or acts of terrorism result in covered losses exceeding the $100 billion annual industry aggregate limit, Congress would be responsible for determining how additional losses in excess of $100 billion will be paid.
CRITICAL ACCOUNTING ESTIMATES
The preparation of the Consolidated Financial Statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and the related notes. Actual results could differ from those estimates.
The Consolidated Financial Statements and accompanying notes have been prepared in accordance with GAAP, applied on a consistent basis. We continually evaluate the accounting policies and estimates used to prepare the Consolidated Financial Statements. In general, our estimates are based on historical experience, evaluation of current trends, information from third party professionals and various other assumptions that we believe are reasonable under the known facts and circumstances.
We consider the accounting policies discussed below to be critical to an understanding of our Consolidated Financial Statements as their application places the most significant demands on our judgment. Due to the inherent uncertainties involved with these types of judgments, actual results could differ significantly from estimates, which may have a material adverse impact on our results of operations and/or equity and CNA’s insurer financial strength and corporate debt ratings.
Insurance Reserves
Insurance reserves are established for both short and long-duration insurance contracts. Short-duration contracts are primarily related to property and casualty insurance policies where the reserving process is based on actuarial estimates of the amount of loss, including amounts for known and unknown claims. Long-duration contracts are primarily related to long term care policies and are estimated using actuarial estimates about morbidity and persistency as well as assumptions about expected investment returns and future premium rate increases. The reserve for unearned premiums represents the portion of premiums written related to the unexpired terms of coverage. The reserving process is discussed in further detail in the Insurance Reserves section of this MD&A.
Long Term Care Reserves
Future policy benefit reserves for CNA’s long term care policies are based on certain assumptions including morbidity, persistency, inclusive of mortality, discount rates and future premium rate increases. The adequacy of the reserves is contingent upon actual experience and CNA’s future expectations related to these key assumptions. If actual or CNA’s expected future experience differs from these assumptions, the reserves may not be adequate, requiring CNA to add to reserves.
A prolonged period during which interest rates remain at levels lower than those anticipated in CNA’s reserving discount rate assumption could result in shortfalls in investment income on assets supporting CNA’s obligations under long term care policies, which may also require an increase to CNA’s reserves. In addition, CNA may not receive regulatory approval for the premium rate increases it requests.
These changes to CNA’s reserves could materially adversely impact our results of operations and equity. The reserving process is discussed in further detail in the Insurance Reserves section of this MD&A.
Reinsurance and Other Receivables
Exposure exists with respect to the collectibility of ceded property and casualty and life reinsurance to the extent that any reinsurer is unable to meet its obligations or disputes the liabilities CNA has ceded under reinsurance agreements. An allowance for doubtful accounts on reinsurance receivables is recorded on the basis of periodic evaluations of balances due from reinsurers, reinsurer solvency, industry experience and current economic conditions. Further information on CNA’s reinsurance receivables is included in Note 16 of the Notes to Consolidated Financial Statements included under Item 8.
Additionally, exposure exists with respect to the collectibility of amounts due from customers on other receivables. An allowance for doubtful accounts is recorded on the basis of periodic evaluations of balances due, currently as well as in the future, historical reinsurer default data, management’s experience and current economic conditions.
If actual experience differs from the estimates made by management in determining the allowances for doubtful accounts on reinsurance and other receivables, net receivables as reflected on our Consolidated Balance Sheets may not be collected. Therefore, our results of operations and/or equity could be materially adversely affected.
Valuation of Investments and Impairment of Securities
Fixed maturity and equity securities are carried at fair value on the balance sheet. Fair value represents the price that would be received in a sale of an asset in an orderly transaction between market participants on the measurement date, the determination of which may require us to make a significant number of assumptions and judgments. Securities with the greatest level of subjectivity around valuation are those that rely on inputs that are significant to the estimated fair value and that are not observable in the market or cannot be derived principally from or corroborated by observable market data. These unobservable inputs are based on assumptions consistent with what we believe other market participants would use to price such securities. Further information on fair value measurements is included in Note 4 of the Notes to Consolidated Financial Statements included under Item 8.
CNA’s investment portfolio is subject to market declines below amortized cost that may be other-than-temporary and therefore result in the recognition of impairment losses in earnings. Factors considered in the determination of whether or not a decline is other-than-temporary include a current intention or need to sell the security or an indication that a credit loss exists. Significant judgment exists regarding the evaluation of the financial condition and expected near-term and long term prospects of the issuer, or the underlying collateral, the relevant industry conditions and trends, and whether CNA expects to receive cash flows sufficient to recover the entire amortized cost basis of the security. Further information on CNA’s process for evaluating impairments is included in Note 1 of the Notes to Consolidated Financial Statements included under Item 8.
Impairment of Long-Lived Assets
We review our long-lived assets for impairment when changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We use a probability-weighted cash flow analysis to test property and equipment for impairment based on relevant market data. If an asset is determined to be impaired, a loss is recognized to reduce the carrying amount to the fair value of the asset. Management’s cash flow assumptions are an inherent part of our asset impairment evaluation and the use of different assumptions could produce results that differ from the reported amounts.
Income Taxes
Deferred income taxes are recognized for temporary differences between the financial statement and tax return bases of assets and liabilities. Any resulting future tax benefits are recognized to the extent that realization of such benefits is more likely than not, and a valuation allowance is established for any portion of a deferred tax asset that management believes may not be realized. The assessment of the need for a valuation allowance requires management to make estimates and assumptions about future earnings, reversal of existing temporary differences and available tax planning strategies. If actual experience differs from these estimates and assumptions, the recorded deferred tax asset may not be fully realized, resulting in an increase to income tax expense in our results of operations. In addition, the ability to record deferred tax assets in the future could be limited resulting in a higher effective tax rate in that future period.
ACCOUNTING STANDARDS UPDATE
For a discussion of accounting standards updates that have been adopted or will be adopted in the future, please read Note 1 of the Notes to Consolidated Financial Statements included under Item 8.
FORWARD-LOOKING STATEMENTS
Investors are cautioned that certain statements contained in this Report as well as in other SEC filings and periodic press releases of us and our subsidiaries and certain oral statements made by us and our subsidiaries and our and their officials during presentations may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”). Forward-looking statements include, without limitation, any statement that does not directly relate to any historical or current fact and may project, indicate or imply future results, events, performance or achievements. Such statements may contain the words “expect,” “intend,” “plan,” “anticipate,” “estimate,” “believe,” “will be,” “will continue,” “will likely result,” and similar expressions. In addition, any statement concerning future financial performance (including future revenues, earnings or growth rates), ongoing business strategies or prospects, and possible actions taken by us or our subsidiaries are also forward-looking statements as defined by the Act. Forward-looking statements are based on current expectations and projections about future events and are inherently subject to a variety of risks and uncertainties, many of which are beyond our control, that could cause actual results to differ materially from those anticipated or projected.
Developments in any of the risks or uncertainties facing us or our subsidiaries, including those described under Item 1A, Risk Factors of this Report and in our other filings with the SEC, could cause our results to differ materially from results that have been or may be anticipated or projected. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements. Forward-looking statements speak only as of the date they are made and we expressly disclaim any obligation or undertaking to update these statements to reflect any change in our expectations or beliefs or any change in events, conditions or circumstances on which any forward-looking statement is based.
Previous: Item 6. Selected Financial Data. · Next: Item 7A. Quantitative and Qualitative Disclosures about Market Risk.