CNA FINANCIAL CORP - Quarter Report: 2017 September (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
For the quarterly period ended September 30, 2017
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
For the transition period from _____ to _____
Commission File Number 1-5823
CNA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) | 36-6169860 (I.R.S. Employer Identification No.) | |
333 S. Wabash Chicago, Illinois (Address of principal executive offices) | 60604 (Zip Code) | |
(312) 822-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [x] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [x] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [x] | Accelerated filer [ ] | Non-accelerated filer [ ] (Do not check if a smaller reporting company) | Smaller reporting company [ ] | Emerging growth company [ ] | ||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [x]
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class | Outstanding at October 26, 2017 | |
Common Stock, Par value $2.50 | 271,176,870 | |
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PART I. Financial Information
Item 1. Condensed Consolidated Financial Statements
CNA Financial Corporation
Condensed Consolidated Statements of Operations (Unaudited)
Periods ended September 30 | Three Months | Nine Months | |||||||||||||
(In millions, except per share data) | 2017 | 2016 | 2017 | 2016 | |||||||||||
Revenues | |||||||||||||||
Net earned premiums | $ | 1,806 | $ | 1,767 | $ | 5,185 | $ | 5,196 | |||||||
Net investment income | 509 | 524 | 1,529 | 1,461 | |||||||||||
Net realized investment (losses) gains: | |||||||||||||||
Other-than-temporary impairment losses | (5 | ) | (18 | ) | (9 | ) | (56 | ) | |||||||
Other net realized investment (losses) gains | (19 | ) | 64 | 71 | 82 | ||||||||||
Net realized investment (losses) gains | (24 | ) | 46 | 62 | 26 | ||||||||||
Other revenues | 107 | 96 | 318 | 293 | |||||||||||
Total revenues | 2,398 | 2,433 | 7,094 | 6,976 | |||||||||||
Claims, Benefits and Expenses | |||||||||||||||
Insurance claims and policyholders’ benefits | 1,480 | 1,202 | 4,053 | 3,949 | |||||||||||
Amortization of deferred acquisition costs | 309 | 314 | 926 | 926 | |||||||||||
Other operating expenses | 381 | 403 | 1,091 | 1,162 | |||||||||||
Interest | 41 | 39 | 124 | 119 | |||||||||||
Total claims, benefits and expenses | 2,211 | 1,958 | 6,194 | 6,156 | |||||||||||
Income before income tax | 187 | 475 | 900 | 820 | |||||||||||
Income tax expense | (43 | ) | (132 | ) | (224 | ) | (202 | ) | |||||||
Net income | $ | 144 | $ | 343 | $ | 676 | $ | 618 | |||||||
Basic earnings per share | $ | 0.53 | $ | 1.27 | $ | 2.49 | $ | 2.28 | |||||||
Diluted earnings per share | $ | 0.53 | $ | 1.26 | $ | 2.48 | $ | 2.28 | |||||||
Dividends declared per share | $ | 0.30 | $ | 0.25 | $ | 2.80 | $ | 2.75 | |||||||
Weighted Average Outstanding Common Stock and Common Stock Equivalents | |||||||||||||||
Basic | 271.2 | 270.5 | 271.1 | 270.4 | |||||||||||
Diluted | 272.1 | 271.2 | 272.0 | 271.0 | |||||||||||
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).
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CNA Financial Corporation
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
Periods ended September 30 | Three Months | Nine Months | |||||||||||||
(In millions) | 2017 | 2016 | 2017 | 2016 | |||||||||||
Comprehensive Income | |||||||||||||||
Net income | $ | 144 | $ | 343 | $ | 676 | $ | 618 | |||||||
Other Comprehensive Income, Net of Tax | |||||||||||||||
Changes in: | |||||||||||||||
Net unrealized gains on investments with other-than-temporary impairments | 1 | 3 | (3 | ) | 7 | ||||||||||
Net unrealized gains on other investments | 23 | 42 | 167 | 586 | |||||||||||
Net unrealized gains on investments | 24 | 45 | 164 | 593 | |||||||||||
Foreign currency translation adjustment | 41 | (24 | ) | 94 | (58 | ) | |||||||||
Pension and postretirement benefits | 10 | 6 | 22 | 17 | |||||||||||
Other comprehensive income, net of tax | 75 | 27 | 280 | 552 | |||||||||||
Total comprehensive income | $ | 219 | $ | 370 | $ | 956 | $ | 1,170 | |||||||
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).
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CNA Financial Corporation
Condensed Consolidated Balance Sheets
(In millions, except share data) | September 30, 2017 (Unaudited) | December 31, 2016 | |||||
Assets | |||||||
Investments: | |||||||
Fixed maturity securities at fair value (amortized cost of $38,814 and $38,361) | $ | 42,090 | $ | 40,905 | |||
Equity securities at fair value (cost of $118 and $106) | 129 | 110 | |||||
Limited partnership investments | 2,311 | 2,371 | |||||
Other invested assets | 42 | 36 | |||||
Mortgage loans | 722 | 591 | |||||
Short term investments | 1,453 | 1,407 | |||||
Total investments | 46,747 | 45,420 | |||||
Cash | 283 | 271 | |||||
Reinsurance receivables (less allowance for uncollectible receivables of $37 and $37) | 4,332 | 4,416 | |||||
Insurance receivables (less allowance for uncollectible receivables of $46 and $46) | 2,294 | 2,209 | |||||
Accrued investment income | 436 | 405 | |||||
Deferred acquisition costs | 643 | 600 | |||||
Deferred income taxes | 141 | 379 | |||||
Property and equipment at cost (less accumulated depreciation of $275 and $254) | 325 | 310 | |||||
Goodwill | 147 | 145 | |||||
Other assets | 1,234 | 1,078 | |||||
Total assets | $ | 56,582 | $ | 55,233 | |||
Liabilities | |||||||
Insurance reserves: | |||||||
Claim and claim adjustment expenses | $ | 22,209 | $ | 22,343 | |||
Unearned premiums | 4,060 | 3,762 | |||||
Future policy benefits | 11,040 | 10,326 | |||||
Short term debt | 150 | — | |||||
Long term debt | 2,707 | 2,710 | |||||
Other liabilities (includes $25 and $50 due to Loews Corporation) | 4,247 | 4,123 | |||||
Total liabilities | 44,413 | 43,264 | |||||
Commitments and contingencies (Notes C and F) | |||||||
Stockholders' Equity | |||||||
Common stock ($2.50 par value; 500,000,000 shares authorized; 273,040,243 shares issued; 271,176,870 and 270,495,998 shares outstanding) | 683 | 683 | |||||
Additional paid-in capital | 2,167 | 2,173 | |||||
Retained earnings | 9,273 | 9,359 | |||||
Accumulated other comprehensive income (loss) | 107 | (173 | ) | ||||
Treasury stock (1,863,373 and 2,544,245 shares), at cost | (61 | ) | (73 | ) | |||
Total stockholders’ equity | 12,169 | 11,969 | |||||
Total liabilities and stockholders' equity | $ | 56,582 | $ | 55,233 | |||
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).
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CNA Financial Corporation
Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine months ended September 30 | |||||||
(In millions) | 2017 | 2016 | |||||
Cash Flows from Operating Activities | |||||||
Net income | $ | 676 | $ | 618 | |||
Adjustments to reconcile net income to net cash flows provided by operating activities: | |||||||
Deferred income tax expense | 125 | 112 | |||||
Trading portfolio activity | 8 | — | |||||
Net realized investment gains | (62 | ) | (26 | ) | |||
Equity method investees | 89 | 265 | |||||
Net amortization of investments | (30 | ) | (17 | ) | |||
Depreciation and amortization | 66 | 57 | |||||
Changes in: | |||||||
Receivables, net | 18 | (311 | ) | ||||
Accrued investment income | (31 | ) | (30 | ) | |||
Deferred acquisition costs | (34 | ) | (24 | ) | |||
Insurance reserves | 248 | 464 | |||||
Other assets | (121 | ) | (96 | ) | |||
Other liabilities | (106 | ) | 61 | ||||
Other, net | 48 | 47 | |||||
Total adjustments | 218 | 502 | |||||
Net cash flows provided by operating activities | 894 | 1,120 | |||||
Cash Flows from Investing Activities | |||||||
Dispositions: | |||||||
Fixed maturity securities - sales | 4,167 | 4,234 | |||||
Fixed maturity securities - maturities, calls and redemptions | 2,635 | 2,263 | |||||
Equity securities | 22 | 79 | |||||
Limited partnerships | 160 | 200 | |||||
Mortgage loans | 22 | 137 | |||||
Purchases: | |||||||
Fixed maturity securities | (6,877 | ) | (7,472 | ) | |||
Equity securities | (18 | ) | (1 | ) | |||
Limited partnerships | (85 | ) | (222 | ) | |||
Mortgage loans | (153 | ) | (88 | ) | |||
Change in other investments | (2 | ) | 10 | ||||
Change in short term investments | (29 | ) | 241 | ||||
Purchases of property and equipment | (80 | ) | (94 | ) | |||
Disposals of property and equipment | — | 107 | |||||
Other, net | 20 | 2 | |||||
Net cash flows used by investing activities | $ | (218 | ) | $ | (604 | ) | |
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Nine months ended September 30 | |||||||
(In millions) | 2017 | 2016 | |||||
Cash Flows from Financing Activities | |||||||
Dividends paid to common stockholders | $ | (761 | ) | $ | (746 | ) | |
Proceeds from the issuance of debt | 496 | 498 | |||||
Repayment of debt | (391 | ) | (358 | ) | |||
Other, net | (17 | ) | 1 | ||||
Net cash flows used by financing activities | (673 | ) | (605 | ) | |||
Effect of foreign exchange rate changes on cash | 9 | (8 | ) | ||||
Net change in cash | 12 | (97 | ) | ||||
Cash, beginning of year | 271 | 387 | |||||
Cash, end of period | $ | 283 | $ | 290 | |||
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).
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CNA Financial Corporation
Condensed Consolidated Statements of Stockholders' Equity (Unaudited)
Nine months ended September 30 | |||||||
(In millions) | 2017 | 2016 | |||||
Common Stock | |||||||
Balance, beginning of period | $ | 683 | $ | 683 | |||
Balance, end of period | 683 | 683 | |||||
Additional Paid-in Capital | |||||||
Balance, beginning of period | 2,173 | 2,153 | |||||
Stock-based compensation | (6 | ) | 10 | ||||
Balance, end of period | 2,167 | 2,163 | |||||
Retained Earnings | |||||||
Balance, beginning of period | 9,359 | 9,313 | |||||
Dividends paid to common stockholders | (762 | ) | (746 | ) | |||
Net income | 676 | 618 | |||||
Balance, end of period | 9,273 | 9,185 | |||||
Accumulated Other Comprehensive Income (Loss) | |||||||
Balance, beginning of period | (173 | ) | (315 | ) | |||
Other comprehensive income | 280 | 552 | |||||
Balance, end of period | 107 | 237 | |||||
Treasury Stock | |||||||
Balance, beginning of period | (73 | ) | (78 | ) | |||
Stock-based compensation | 12 | 5 | |||||
Balance, end of period | (61 | ) | (73 | ) | |||
Total stockholders' equity | $ | 12,169 | $ | 12,195 | |||
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).
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CNA Financial Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note A. General
Basis of Presentation
The Condensed Consolidated Financial Statements include the accounts of CNA Financial Corporation (CNAF) and its subsidiaries. Collectively, CNAF and its subsidiaries are referred to as CNA or the Company. Loews Corporation (Loews) owned approximately 89% of the outstanding common stock of CNAF as of September 30, 2017.
The accompanying Condensed Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Intercompany amounts have been eliminated. Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, including certain financial statement notes, is not required for interim reporting purposes and has been condensed or omitted. These statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in CNAF's Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2016, including the summary of significant accounting policies in Note A. The preparation of Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the Condensed Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.
The interim financial data as of September 30, 2017 and for the three and nine months ended September 30, 2017 and 2016 is unaudited. However, in the opinion of management, the interim data includes all adjustments, including normal recurring adjustments, necessary for a fair statement of the Company's results for the interim periods. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.
Recently Adopted Accounting Standards Updates (ASU)
In March 2016, the Financial Accounting Standards Board (FASB) issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The updated accounting guidance simplifies the accounting for share-based payment award transactions, including income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. As of January 1, 2017, the Company adopted the updated accounting guidance and began recognizing excess tax benefits or deficiencies on vesting or settlement of awards as an income tax benefit or expense within net income, instead of additional paid-in capital as required under previous guidance. The related cash flows are now classified within operating activities. As a result of this change, excess tax benefits are no longer included in assumed proceeds under the treasury stock method of calculating earnings per share. The impact of the accounting change resulted in a decrease of $2 million and $5 million to income tax expense for the three and nine months ended September 30, 2017.
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Accounting Standards Pending Adoption
In May 2014, the FASB issued ASU No. 2014-09, Revenue Recognition (Topic 606): Revenue from Contracts with Customers. The standard excludes from its scope the accounting for insurance contracts, financial instruments, and certain other agreements that are governed under other GAAP guidance. The updated guidance requires an entity to recognize revenue as performance obligations are met, in an amount that reflects the consideration the entity is entitled to receive for the transfer of the promised goods or services. The standard is effective for interim and annual reporting periods beginning after December 15, 2017 and may be applied retrospectively or through a cumulative effect adjustment to retained earnings at the date of adoption. While the Company continues to evaluate the impacts of this new guidance on the Consolidated financial statements, including disclosures, the Company expects that revenue on warranty products and services will be recognized more slowly than under the current revenue recognition pattern. For a significant portion of warranty products, the Company also expects Other revenues and Other operating expenses to increase to reflect the gross amount paid by consumers to the auto dealer that acts as the Company's agent. The Company expects to adopt this guidance using the modified retrospective approach. While the cumulative effect of adoption using the modified retrospective approach may be significant, the Company does not expect the impact of the new guidance to be material to its results of operations or financial position.
In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The updated accounting guidance requires changes to the reporting model for financial instruments. The guidance is effective for interim and annual periods beginning after December 15, 2017. The Company expects the primary change to be the requirement for equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. Upon adoption, the Company will recognize an adjustment for the cumulative amount of unrealized investment gains and losses related to available-for-sale equity securities within the opening balances of Retained earnings and Accumulated other comprehensive income (loss). The Company does not expect the impact of adopting ASU 2016-01 to have a material effect on the Company’s results of operations or financial position.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842): Accounting for Leases. The updated accounting guidance requires lessees to recognize on the balance sheet the assets and liabilities for the rights and obligations created by all leases, including those historically accounted for as operating leases. The guidance is effective for interim and annual periods beginning after December 15, 2018. The Company is currently evaluating the effect the updated guidance will have on the Company's financial statements. It is expected that assets and liabilities will increase based on the present value of remaining lease payments for leases in place at the adoption date; however, this is not expected to be material to the Company's results of operations or financial position.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The updated accounting guidance requires changes to the recognition of credit losses on financial instruments not accounted for at fair value through net income. The guidance is effective for interim and annual periods beginning after December 15, 2019. The Company is currently evaluating the effect the guidance will have on the Company's financial statements, but expects the primary changes to be the use of the expected credit loss model for its mortgage loan portfolio and reinsurance receivables and the presentation of credit losses within the available-for-sale fixed maturities portfolio through an allowance method rather than as a direct write-down. The expected credit loss model will require a financial asset to be presented at the net amount expected to be collected. The allowance method for available-for-sale debt securities will allow the Company to record reversals of credit losses if the estimate of credit losses declines.
In March 2017, the FASB issued ASU No. 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The updated accounting guidance requires changes to the presentation of the components of net periodic benefit cost on the income statement by requiring service cost to be presented with other employee compensation costs and other components of net periodic pension cost to be presented outside of any subtotal of operating income. The ASU also stipulates that only the service cost component of net benefit cost is eligible for capitalization. The guidance is effective for interim and annual periods beginning after December 15, 2017. The Company is currently evaluating the effect the guidance will have on the Company's financial statements.
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Note B. Earnings Per Share
Earnings per share is based on the weighted average number of outstanding common shares. Basic earnings (loss) per share excludes the effect of dilutive securities and is computed by dividing Net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
For the three and nine months ended September 30, 2017, approximately 907 thousand and 916 thousand potential shares attributable to exercises or conversions into common stock under stock-based employee compensation plans were included in the calculation of diluted earnings per share. For those same periods, less than 1 thousand and approximately 4 thousand potential shares attributable to exercises or conversions into common stock under stock-based employee compensation plans were not included in the calculation of diluted earnings per share, because the effect would have been antidilutive.
For the three and nine months ended September 30, 2016, approximately 707 thousand and 549 thousand potential shares attributable to exercises or conversions into common stock under stock-based employee compensation plans were included in the calculation of diluted earnings per share. For those same periods, approximately 175 thousand and 178 thousand potential shares attributable to exercises or conversions into common stock under stock-based employee compensation plans were not included in the calculation of diluted earnings per share, because the effect would have been antidilutive.
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Note C. Investments
The significant components of Net investment income are presented in the following table.
Periods ended September 30 | Three Months | Nine Months | |||||||||||||
(In millions) | 2017 | 2016 | 2017 | 2016 | |||||||||||
Fixed maturity securities | $ | 455 | $ | 457 | $ | 1,367 | $ | 1,352 | |||||||
Equity securities | 1 | 1 | 4 | 8 | |||||||||||
Limited partnership investments | 51 | 65 | 157 | 97 | |||||||||||
Mortgage loans | 9 | 8 | 24 | 30 | |||||||||||
Short term investments | 4 | 2 | 10 | 6 | |||||||||||
Trading portfolio | 3 | 1 | 9 | 7 | |||||||||||
Other | 1 | 4 | 2 | 4 | |||||||||||
Gross investment income | 524 | 538 | 1,573 | 1,504 | |||||||||||
Investment expense | (15 | ) | (14 | ) | (44 | ) | (43 | ) | |||||||
Net investment income | $ | 509 | $ | 524 | $ | 1,529 | $ | 1,461 | |||||||
Net realized investment gains (losses) are presented in the following table.
Periods ended September 30 | Three Months | Nine Months | |||||||||||||
(In millions) | 2017 | 2016 | 2017 | 2016 | |||||||||||
Net realized investment gains (losses): | |||||||||||||||
Fixed maturity securities: | |||||||||||||||
Gross realized gains | $ | 34 | $ | 67 | $ | 139 | $ | 152 | |||||||
Gross realized losses | (18 | ) | (20 | ) | (47 | ) | (106 | ) | |||||||
Net realized investment gains (losses) on fixed maturity securities | 16 | 47 | 92 | 46 | |||||||||||
Equity securities: | |||||||||||||||
Gross realized gains | — | 1 | 1 | 5 | |||||||||||
Gross realized losses | — | (4 | ) | (1 | ) | (10 | ) | ||||||||
Net realized investment gains (losses) on equity securities | — | (3 | ) | — | (5 | ) | |||||||||
Derivatives | (1 | ) | 1 | (3 | ) | (12 | ) | ||||||||
Short term investments and other | (39 | ) | 1 | (27 | ) | (3 | ) | ||||||||
Net realized investment gains (losses) | $ | (24 | ) | $ | 46 | $ | 62 | $ | 26 | ||||||
Net realized investment gains (losses) for the three and nine months ended September 30, 2017 included a $42 million loss related to the redemption of the Company's $350 million senior notes due November 2019. Net realized investment gains (losses) for the nine months ended September 30, 2016 included a $8 million loss related to the first quarter 2016 redemption of the Company's $350 million senior notes due August 2016.
The components of Other-than-temporary impairment (OTTI) losses recognized in earnings by asset type are presented in the following table.
Periods ended September 30 | Three Months | Nine Months | |||||||||||||
(In millions) | 2017 | 2016 | 2017 | 2016 | |||||||||||
Fixed maturity securities available-for-sale: | |||||||||||||||
Corporate and other bonds | $ | 4 | $ | 14 | $ | 8 | $ | 43 | |||||||
Asset-backed: | |||||||||||||||
Residential mortgage-backed | 1 | — | 1 | 1 | |||||||||||
Other asset-backed | — | — | — | 3 | |||||||||||
Total asset-backed | 1 | — | 1 | 4 | |||||||||||
Total fixed maturity securities available-for-sale | 5 | 14 | 9 | 47 | |||||||||||
Equity securities available-for-sale -- Common stock | — | 4 | — | 9 | |||||||||||
OTTI losses recognized in earnings | $ | 5 | $ | 18 | $ | 9 | $ | 56 | |||||||
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The following tables present a summary of fixed maturity and equity securities.
September 30, 2017 | Cost or Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | Unrealized OTTI Losses (Gains) | ||||||||||||||
(In millions) | |||||||||||||||||||
Fixed maturity securities available-for-sale: | |||||||||||||||||||
Corporate and other bonds | $ | 17,965 | $ | 1,645 | $ | 26 | $ | 19,584 | $ | — | |||||||||
States, municipalities and political subdivisions | 12,462 | 1,501 | 7 | 13,956 | (14 | ) | |||||||||||||
Asset-backed: | |||||||||||||||||||
Residential mortgage-backed | 4,906 | 127 | 28 | 5,005 | (28 | ) | |||||||||||||
Commercial mortgage-backed | 1,858 | 55 | 13 | 1,900 | — | ||||||||||||||
Other asset-backed | 1,047 | 18 | 4 | 1,061 | — | ||||||||||||||
Total asset-backed | 7,811 | 200 | 45 | 7,966 | (28 | ) | |||||||||||||
U.S. Treasury and obligations of government-sponsored enterprises | 115 | 3 | 3 | 115 | — | ||||||||||||||
Foreign government | 439 | 10 | 4 | 445 | — | ||||||||||||||
Redeemable preferred stock | 18 | 2 | — | 20 | — | ||||||||||||||
Total fixed maturity securities available-for-sale | 38,810 | 3,361 | 85 | 42,086 | $ | (42 | ) | ||||||||||||
Total fixed maturity securities trading | 4 | 4 | |||||||||||||||||
Equity securities available-for-sale: | |||||||||||||||||||
Common stock | 16 | 7 | 1 | 22 | |||||||||||||||
Preferred stock | 102 | 5 | — | 107 | |||||||||||||||
Total equity securities available-for-sale | 118 | 12 | 1 | 129 | |||||||||||||||
Total | $ | 38,932 | $ | 3,373 | $ | 86 | $ | 42,219 | |||||||||||
December 31, 2016 | Cost or Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | Unrealized OTTI Losses (Gains) | ||||||||||||||
(In millions) | |||||||||||||||||||
Fixed maturity securities available-for-sale: | |||||||||||||||||||
Corporate and other bonds | $ | 17,711 | $ | 1,323 | $ | 76 | $ | 18,958 | $ | (1 | ) | ||||||||
States, municipalities and political subdivisions | 12,060 | 1,213 | 33 | 13,240 | (16 | ) | |||||||||||||
Asset-backed: | |||||||||||||||||||
Residential mortgage-backed | 5,004 | 120 | 51 | 5,073 | (28 | ) | |||||||||||||
Commercial mortgage-backed | 2,016 | 48 | 24 | 2,040 | — | ||||||||||||||
Other asset-backed | 1,022 | 8 | 5 | 1,025 | — | ||||||||||||||
Total asset-backed | 8,042 | 176 | 80 | 8,138 | (28 | ) | |||||||||||||
U.S. Treasury and obligations of government-sponsored enterprises | 83 | 10 | — | 93 | — | ||||||||||||||
Foreign government | 435 | 13 | 3 | 445 | — | ||||||||||||||
Redeemable preferred stock | 18 | 1 | — | 19 | — | ||||||||||||||
Total fixed maturity securities available-for-sale | 38,349 | 2,736 | 192 | 40,893 | $ | (45 | ) | ||||||||||||
Total fixed maturity securities trading | 12 | 12 | |||||||||||||||||
Equity securities available-for-sale: | |||||||||||||||||||
Common stock | 13 | 6 | — | 19 | |||||||||||||||
Preferred stock | 93 | 2 | 4 | 91 | |||||||||||||||
Total equity securities available-for-sale | 106 | 8 | 4 | 110 | |||||||||||||||
Total | $ | 38,467 | $ | 2,744 | $ | 196 | $ | 41,015 | |||||||||||
13
The net unrealized gains on investments included in the tables above are recorded as a component of Accumulated other comprehensive income (AOCI). When presented in AOCI, these amounts are net of tax and any required Shadow Adjustments. To the extent that unrealized gains on fixed income securities supporting certain products within the Life & Group Non-Core segment would result in a premium deficiency if realized, a related increase in Insurance reserves is recorded, net of tax, as a reduction of net unrealized gains through Other comprehensive income (loss) (Shadow Adjustments). As of September 30, 2017 and December 31, 2016, the net unrealized gains on investments included in AOCI were correspondingly reduced by Shadow Adjustments of $1,321 million and $1,014 million.
14
The following tables present the estimated fair value and gross unrealized losses of fixed maturity and equity securities in a gross unrealized loss position by the length of time in which the securities have continuously been in that position.
Less than 12 Months | 12 Months or Longer | Total | |||||||||||||||||||||
September 30, 2017 | Estimated Fair Value | Gross Unrealized Losses | Estimated Fair Value | Gross Unrealized Losses | Estimated Fair Value | Gross Unrealized Losses | |||||||||||||||||
(In millions) | |||||||||||||||||||||||
Fixed maturity securities available-for-sale: | |||||||||||||||||||||||
Corporate and other bonds | $ | 1,216 | $ | 21 | $ | 91 | $ | 5 | $ | 1,307 | $ | 26 | |||||||||||
States, municipalities and political subdivisions | 583 | 6 | 56 | 1 | 639 | 7 | |||||||||||||||||
Asset-backed: | |||||||||||||||||||||||
Residential mortgage-backed | 1,522 | 25 | 106 | 3 | 1,628 | 28 | |||||||||||||||||
Commercial mortgage-backed | 378 | 6 | 138 | 7 | 516 | 13 | |||||||||||||||||
Other asset-backed | 129 | 4 | 10 | — | 139 | 4 | |||||||||||||||||
Total asset-backed | 2,029 | 35 | 254 | 10 | 2,283 | 45 | |||||||||||||||||
U.S. Treasury and obligations of government-sponsored enterprises | 67 | 3 | 6 | — | 73 | 3 | |||||||||||||||||
Foreign government | 191 | 4 | 5 | — | 196 | 4 | |||||||||||||||||
Total fixed maturity securities available-for-sale | 4,086 | 69 | 412 | 16 | 4,498 | 85 | |||||||||||||||||
Equity securities available-for-sale: | |||||||||||||||||||||||
Common stock | 2 | 1 | — | — | 2 | 1 | |||||||||||||||||
Preferred stock | 16 | — | — | — | 16 | — | |||||||||||||||||
Total equity securities available-for-sale | 18 | 1 | — | — | 18 | 1 | |||||||||||||||||
Total | $ | 4,104 | $ | 70 | $ | 412 | $ | 16 | $ | 4,516 | $ | 86 | |||||||||||
Less than 12 Months | 12 Months or Longer | Total | |||||||||||||||||||||
December 31, 2016 | Estimated Fair Value | Gross Unrealized Losses | Estimated Fair Value | Gross Unrealized Losses | Estimated Fair Value | Gross Unrealized Losses | |||||||||||||||||
(In millions) | |||||||||||||||||||||||
Fixed maturity securities available-for-sale: | |||||||||||||||||||||||
Corporate and other bonds | $ | 2,615 | $ | 61 | $ | 254 | $ | 15 | $ | 2,869 | $ | 76 | |||||||||||
States, municipalities and political subdivisions | 959 | 32 | 23 | 1 | 982 | 33 | |||||||||||||||||
Asset-backed: | |||||||||||||||||||||||
Residential mortgage-backed | 2,136 | 44 | 201 | 7 | 2,337 | 51 | |||||||||||||||||
Commercial mortgage-backed | 756 | 22 | 69 | 2 | 825 | 24 | |||||||||||||||||
Other asset-backed | 398 | 5 | 24 | — | 422 | 5 | |||||||||||||||||
Total asset-backed | 3,290 | 71 | 294 | 9 | 3,584 | 80 | |||||||||||||||||
U.S. Treasury and obligations of government-sponsored enterprises | 5 | — | — | — | 5 | — | |||||||||||||||||
Foreign government | 108 | 3 | — | — | 108 | 3 | |||||||||||||||||
Total fixed maturity securities available-for-sale | 6,977 | 167 | 571 | 25 | 7,548 | 192 | |||||||||||||||||
Equity securities available-for-sale -- Preferred stock | 12 | — | 13 | 4 | 25 | 4 | |||||||||||||||||
Total | $ | 6,989 | $ | 167 | $ | 584 | $ | 29 | $ | 7,573 | $ | 196 | |||||||||||
15
Based on current facts and circumstances, the Company believes the unrealized losses presented in the September 30, 2017 securities in a gross unrealized loss position table above are not indicative of the ultimate collectibility of the current amortized cost of the securities, but rather are attributable to changes in interest rates, credit spreads and other factors. The Company has no current intent to sell securities with unrealized losses, nor is it more likely than not that it will be required to sell prior to recovery of amortized cost; accordingly, the Company has determined that there are no additional OTTI losses to be recorded as of September 30, 2017.
The following table presents the activity related to the pretax credit loss component reflected in Retained earnings on fixed maturity securities still held as of September 30, 2017 and 2016 for which a portion of an OTTI loss was recognized in Other comprehensive income (loss).
Periods ended September 30 | Three Months | Nine Months | |||||||||||||
(In millions) | 2017 | 2016 | 2017 | 2016 | |||||||||||
Beginning balance of credit losses on fixed maturity securities | $ | 30 | $ | 41 | $ | 36 | $ | 53 | |||||||
Reductions for securities sold during the period | (2 | ) | (2 | ) | (8 | ) | (14 | ) | |||||||
Reductions for securities the Company intends to sell or more likely than not will be required to sell | — | (1 | ) | — | (1 | ) | |||||||||
Ending balance of credit losses on fixed maturity securities | $ | 28 | $ | 38 | $ | 28 | $ | 38 | |||||||
Contractual Maturity
The following table presents available-for-sale fixed maturity securities by contractual maturity.
September 30, 2017 | December 31, 2016 | ||||||||||||||
(In millions) | Cost or Amortized Cost | Estimated Fair Value | Cost or Amortized Cost | Estimated Fair Value | |||||||||||
Due in one year or less | $ | 1,374 | $ | 1,404 | $ | 1,779 | $ | 1,828 | |||||||
Due after one year through five years | 7,931 | 8,293 | 7,566 | 7,955 | |||||||||||
Due after five years through ten years | 15,853 | 16,574 | 15,892 | 16,332 | |||||||||||
Due after ten years | 13,652 | 15,815 | 13,112 | 14,778 | |||||||||||
Total | $ | 38,810 | $ | 42,086 | $ | 38,349 | $ | 40,893 | |||||||
Actual maturities may differ from contractual maturities because certain securities may be called or prepaid. Securities not due at a single date are allocated based on weighted average life.
Derivative Financial Instruments
The Company holds an embedded derivative on a funds withheld liability with a notional value of $170 million and $174 million as of September 30, 2017 and December 31, 2016 and a fair value of $(1) million and $3 million as of September 30, 2017 and December 31, 2016. The embedded derivative on the funds withheld liability is accounted for separately and reported with the funds withheld liability in Other liabilities on the Condensed Consolidated Balance Sheets.
Investment Commitments
As of September 30, 2017, the Company had committed approximately $405 million to future capital calls from various third-party limited partnership investments in exchange for an ownership interest in the related partnerships.
As of September 30, 2017, the Company had mortgage loan commitments of $68 million representing signed loan applications received and accepted.
The Company invests in various privately placed debt securities, including bank loans, as part of its overall investment strategy and has committed to additional future purchases, sales and funding. Purchases and sales of privately placed debt securities are recorded once funded. As of September 30, 2017, the Company had commitments to purchase or fund additional amounts of $205 million and sell $185 million under the terms of such securities.
16
Note D. Fair Value
Fair value is the price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The following fair value hierarchy is used in selecting inputs, with the highest priority given to Level 1, as these are the most transparent or reliable.
Level 1 - Quoted prices for identical instruments in active markets.
Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets.
Level 3 - Valuations derived from valuation techniques in which one or more significant inputs are not observable.
Prices may fall within Level 1, 2 or 3 depending upon the methodology and inputs used to estimate fair value for each specific security. In general, the Company seeks to price securities using third-party pricing services. Securities not priced by pricing services are submitted to independent brokers for valuation and, if those are not available, internally developed pricing models are used to value assets using a methodology and inputs the Company believes market participants would use to value the assets. Prices obtained from third-party pricing services or brokers are not adjusted by the Company.
The Company performs control procedures over information obtained from pricing services and brokers to ensure prices received represent a reasonable estimate of fair value and to confirm representations regarding whether inputs are observable or unobservable. Procedures may include i) the review of pricing service methodologies or broker pricing qualifications, ii) back-testing, where past fair value estimates are compared to actual transactions executed in the market on similar dates, iii) exception reporting, where period-over-period changes in price are reviewed and challenged with the pricing service or broker based on exception criteria, iv) deep dives, where the Company performs an independent analysis of the inputs and assumptions used to price individual securities and v) pricing validation, where prices received are compared to prices independently estimated by the Company.
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Assets and Liabilities Measured at Fair Value
Assets and liabilities measured at fair value on a recurring basis are presented in the following tables.
September 30, 2017 | Total Assets/Liabilities at Fair Value | ||||||||||||||
(In millions) | Level 1 | Level 2 | Level 3 | ||||||||||||
Assets | |||||||||||||||
Fixed maturity securities: | |||||||||||||||
Corporate and other bonds | $ | — | $ | 19,469 | $ | 119 | $ | 19,588 | |||||||
States, municipalities and political subdivisions | — | 13,955 | 1 | 13,956 | |||||||||||
Asset-backed: | |||||||||||||||
Residential mortgage-backed | — | 4,829 | 176 | 5,005 | |||||||||||
Commercial mortgage-backed | — | 1,876 | 24 | 1,900 | |||||||||||
Other asset-backed | — | 915 | 146 | 1,061 | |||||||||||
Total asset-backed | — | 7,620 | 346 | 7,966 | |||||||||||
U.S. Treasury and obligations of government-sponsored enterprises | 115 | — | — | 115 | |||||||||||
Foreign government | — | 445 | — | 445 | |||||||||||
Redeemable preferred stock | 20 | — | — | 20 | |||||||||||
Total fixed maturity securities | 135 | 41,489 | 466 | 42,090 | |||||||||||
Equity securities | 110 | — | 19 | 129 | |||||||||||
Other invested assets | — | 5 | — | 5 | |||||||||||
Short term investments | 479 | 876 | — | 1,355 | |||||||||||
Total assets | $ | 724 | $ | 42,370 | $ | 485 | $ | 43,579 | |||||||
Liabilities | |||||||||||||||
Other liabilities | $ | — | $ | 1 | $ | — | $ | 1 | |||||||
Total liabilities | $ | — | $ | 1 | $ | — | $ | 1 | |||||||
December 31, 2016 | Total Assets/Liabilities at Fair Value | ||||||||||||||
(In millions) | Level 1 | Level 2 | Level 3 | ||||||||||||
Assets | |||||||||||||||
Fixed maturity securities: | |||||||||||||||
Corporate and other bonds | $ | — | $ | 18,840 | $ | 130 | $ | 18,970 | |||||||
States, municipalities and political subdivisions | — | 13,239 | 1 | 13,240 | |||||||||||
Asset-backed: | |||||||||||||||
Residential mortgage-backed | — | 4,944 | 129 | 5,073 | |||||||||||
Commercial mortgage-backed | — | 2,027 | 13 | 2,040 | |||||||||||
Other asset-backed | — | 968 | 57 | 1,025 | |||||||||||
Total asset-backed | — | 7,939 | 199 | 8,138 | |||||||||||
U.S. Treasury and obligations of government-sponsored enterprises | 93 | — | — | 93 | |||||||||||
Foreign government | — | 445 | — | 445 | |||||||||||
Redeemable preferred stock | 19 | — | — | 19 | |||||||||||
Total fixed maturity securities | 112 | 40,463 | 330 | 40,905 | |||||||||||
Equity securities | 91 | — | 19 | 110 | |||||||||||
Other invested assets | — | 5 | — | 5 | |||||||||||
Short term investments | 475 | 853 | — | 1,328 | |||||||||||
Life settlement contracts, included in Other assets | — | — | 58 | 58 | |||||||||||
Total assets | $ | 678 | $ | 41,321 | $ | 407 | $ | 42,406 | |||||||
Liabilities | |||||||||||||||
Other liabilities | $ | — | $ | (3 | ) | $ | — | $ | (3 | ) | |||||
Total liabilities | $ | — | $ | (3 | ) | $ | — | $ | (3 | ) | |||||
18
The tables below present a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3).
Level 3 (In millions) | Balance as of July 1, 2017 | Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) included in net income (loss)* | Net change in unrealized appreciation (depreciation) included in Other comprehensive income (loss) | Purchases | Sales | Settlements | Transfers into Level 3 | Transfers out of Level 3 | Balance as of September 30, 2017 | Unrealized gains (losses) on Level 3 assets and liabilities held as of September 30, 2017 recognized in Net income (loss)* | |||||||||||||||||||||||||||||
Fixed maturity securities: | |||||||||||||||||||||||||||||||||||||||
Corporate and other bonds | $ | 100 | $ | 1 | $ | 1 | $ | 13 | $ | — | $ | (11 | ) | $ | 15 | $ | — | $ | 119 | $ | — | ||||||||||||||||||
States, municipalities and political subdivisions | 1 | — | — | — | — | — | — | — | 1 | — | |||||||||||||||||||||||||||||
Asset-backed: | |||||||||||||||||||||||||||||||||||||||
Residential mortgage-backed | 123 | 1 | 1 | — | — | (7 | ) | 58 | — | 176 | — | ||||||||||||||||||||||||||||
Commercial mortgage-backed | 13 | — | (1 | ) | 12 | — | (2 | ) | 2 | — | 24 | — | |||||||||||||||||||||||||||
Other asset-backed | 82 | (1 | ) | 1 | 27 | — | (4 | ) | 41 | — | 146 | — | |||||||||||||||||||||||||||
Total asset-backed | 218 | — | 1 | 39 | — | (13 | ) | 101 | — | 346 | — | ||||||||||||||||||||||||||||
Total fixed maturity securities | 319 | 1 | 2 | 52 | — | (24 | ) | 116 | — | 466 | — | ||||||||||||||||||||||||||||
Equity securities | 19 | — | — | — | — | — | — | — | 19 | — | |||||||||||||||||||||||||||||
Life settlement contracts | 1 | — | — | — | (1 | ) | — | — | — | — | — | ||||||||||||||||||||||||||||
Total | $ | 339 | $ | 1 | $ | 2 | $ | 52 | $ | (1 | ) | $ | (24 | ) | $ | 116 | $ | — | $ | 485 | $ | — | |||||||||||||||||
19
Level 3 (In millions) | Balance as of July 1, 2016 | Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) included in net income (loss)* | Net change in unrealized appreciation (depreciation) included in Other comprehensive income (loss) | Purchases | Sales | Settlements | Transfers into Level 3 | Transfers out of Level 3 | Balance as of September 30, 2016 | Unrealized gains (losses) on Level 3 assets and liabilities held as of September 30, 2016 recognized in Net income (loss)* | |||||||||||||||||||||||||||||
Fixed maturity securities: | |||||||||||||||||||||||||||||||||||||||
Corporate and other bonds | $ | 242 | $ | 1 | $ | 7 | $ | 16 | $ | — | $ | (5 | ) | $ | — | $ | — | $ | 261 | $ | — | ||||||||||||||||||
States, municipalities and political subdivisions | 2 | — | — | — | — | (1 | ) | — | — | 1 | — | ||||||||||||||||||||||||||||
Asset-backed: | |||||||||||||||||||||||||||||||||||||||
Residential mortgage-backed | 134 | — | (1 | ) | 5 | — | (1 | ) | — | (58 | ) | 79 | — | ||||||||||||||||||||||||||
Commercial mortgage-backed | 11 | — | — | 23 | — | (8 | ) | — | (2 | ) | 24 | — | |||||||||||||||||||||||||||
Other asset-backed | 45 | — | — | 34 | — | — | — | (36 | ) | 43 | — | ||||||||||||||||||||||||||||
Total asset-backed | 190 | — | (1 | ) | 62 | — | (9 | ) | — | (96 | ) | 146 | — | ||||||||||||||||||||||||||
Total fixed maturity securities | 434 | 1 | 6 | 78 | — | (15 | ) | — | (96 | ) | 408 | — | |||||||||||||||||||||||||||
Equity securities | 19 | (1 | ) | 1 | — | — | — | — | — | 19 | (2 | ) | |||||||||||||||||||||||||||
Life settlement contracts | 67 | — | — | — | — | — | — | — | 67 | — | |||||||||||||||||||||||||||||
Total | $ | 520 | $ | — | $ | 7 | $ | 78 | $ | — | $ | (15 | ) | $ | — | $ | (96 | ) | $ | 494 | $ | (2 | ) | ||||||||||||||||
20
Level 3 (In millions) | Balance as of January 1, 2017 | Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) included in net income (loss)* | Net change in unrealized appreciation (depreciation) included in Other comprehensive income (loss) | Purchases | Sales | Settlements | Transfers into Level 3 | Transfers out of Level 3 | Balance as of September 30, 2017 | Unrealized gains (losses) on Level 3 assets and liabilities held as of September 30, 2017 recognized in Net income (loss)* | ||||||||||||||||||||||||||||||
Fixed maturity securities: | ||||||||||||||||||||||||||||||||||||||||
Corporate and other bonds | $ | 130 | $ | 1 | $ | 2 | $ | 18 | $ | (1 | ) | $ | (36 | ) | $ | 15 | $ | (10 | ) | $ | 119 | $ | — | |||||||||||||||||
States, municipalities and political subdivisions | 1 | — | — | — | — | — | — | — | — | 1 | — | |||||||||||||||||||||||||||||
Asset-backed: | ||||||||||||||||||||||||||||||||||||||||
Residential mortgage-backed | 129 | 3 | 4 | — | — | — | (18 | ) | 58 | — | 176 | — | ||||||||||||||||||||||||||||
Commercial mortgage-backed | 13 | — | (1 | ) | — | 12 | — | (2 | ) | 2 | — | 24 | — | |||||||||||||||||||||||||||
Other asset-backed | 57 | (2 | ) | 1 | — | 78 | — | (6 | ) | 93 | (75 | ) | 146 | — | ||||||||||||||||||||||||||
Total asset-backed | 199 | 1 | 4 | 90 | — | (26 | ) | 153 | (75 | ) | 346 | — | ||||||||||||||||||||||||||||
Total fixed maturity securities | 330 | 2 | 6 | 108 | (1 | ) | (62 | ) | 168 | (85 | ) | 466 | — | |||||||||||||||||||||||||||
Equity securities | 19 | — | 2 | — | 1 | (3 | ) | — | — | — | 19 | — | ||||||||||||||||||||||||||||
Derivative financial instruments | — | 1 | — | — | — | (1 | ) | — | — | — | — | — | ||||||||||||||||||||||||||||
Life settlement contracts | 58 | 6 | — | — | (59 | ) | (5 | ) | — | — | — | — | ||||||||||||||||||||||||||||
Total | $ | 407 | $ | 9 | $ | 8 | $ | 109 | $ | (64 | ) | $ | (67 | ) | $ | 168 | $ | (85 | ) | $ | 485 | $ | — | |||||||||||||||||
21
Level 3 (In millions) | Balance as of January 1, 2016 | Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) included in net income (loss)* | Net change in unrealized appreciation (depreciation) included in Other comprehensive income (loss) | Purchases | Sales | Settlements | Transfers into Level 3 | Transfers out of Level 3 | Balance as of September 30, 2016 | Unrealized gains (losses) on Level 3 assets and liabilities held as of September 30, 2016 recognized in Net income (loss)* | |||||||||||||||||||||||||||||
Fixed maturity securities: | |||||||||||||||||||||||||||||||||||||||
Corporate and other bonds | $ | 168 | $ | 1 | $ | 14 | $ | 163 | $ | (36 | ) | $ | (15 | ) | $ | — | $ | (34 | ) | $ | 261 | $ | — | ||||||||||||||||
States, municipalities and political subdivisions | 2 | — | — | — | — | (1 | ) | — | — | 1 | — | ||||||||||||||||||||||||||||
Asset-backed: | |||||||||||||||||||||||||||||||||||||||
Residential mortgage-backed | 134 | 2 | (2 | ) | 15 | — | (10 | ) | — | (60 | ) | 79 | — | ||||||||||||||||||||||||||
Commercial mortgage-backed | 22 | — | — | 32 | — | (17 | ) | 3 | (16 | ) | 24 | — | |||||||||||||||||||||||||||
Other asset-backed | 53 | — | 2 | 69 | (25 | ) | (1 | ) | 2 | (57 | ) | 43 | — | ||||||||||||||||||||||||||
Total asset-backed | 209 | 2 | — | 116 | (25 | ) | (28 | ) | 5 | (133 | ) | 146 | — | ||||||||||||||||||||||||||
Total fixed maturity securities | 379 | 3 | 14 | 279 | (61 | ) | (44 | ) | 5 | (167 | ) | 408 | — | ||||||||||||||||||||||||||
Equity securities | 20 | (1 | ) | — | — | — | — | — | — | 19 | (2 | ) | |||||||||||||||||||||||||||
Life settlement contracts | 74 | 10 | — | — | — | (17 | ) | — | — | 67 | 2 | ||||||||||||||||||||||||||||
Total | $ | 473 | $ | 12 | $ | 14 | $ | 279 | $ | (61 | ) | $ | (61 | ) | $ | 5 | $ | (167 | ) | $ | 494 | $ | — | ||||||||||||||||
22
*Net realized and unrealized gains and losses from Level 3 securities and derivatives are reported in Net income (loss) as follows:
Major Category of Assets and Liabilities | Condensed Consolidated Statements of Operations Line Items | |
Fixed maturity securities available-for-sale (1) | Net realized investment gains (losses) | |
Fixed maturity securities trading | Net investment income | |
Equity securities (1) | Net realized investment gains (losses) | |
Other invested assets - Derivative financial instruments held in a trading portfolio | Net investment income | |
Other invested assets - Derivative financial instruments not held in a trading portfolio | Net realized investment gains (losses) | |
Life settlement contracts | Other revenues | |
Other liabilities - Derivative financial instruments | Net realized investment gains (losses) | |
(1) Unrealized gains and losses are reported within AOCI.
Securities may be transferred in or out of levels within the fair value hierarchy based on the availability of observable market information and quoted prices used to determine the fair value of the security. The availability of observable market information and quoted prices varies based on market conditions and trading volume. During the three and nine months ended September 30, 2017 and 2016, there were no transfers between Level 1 and Level 2. The Company's policy is to recognize transfers between levels at the beginning of quarterly reporting periods.
Valuation Methodologies and Inputs
The following section describes the valuation methodologies and relevant inputs used to measure different financial instruments at fair value, including an indication of the level in the fair value hierarchy in which the instruments are generally classified.
Fixed Maturity Securities
Level 1 securities include highly liquid and exchange traded bonds and redeemable preferred stock, valued using quoted market prices. Level 2 securities include most other fixed maturity securities as the significant inputs are observable in the marketplace. All classes of Level 2 fixed maturity securities are valued using a methodology based on information generated by market transactions involving identical or comparable assets, a discounted cash flow methodology, or a combination of both when necessary. Common inputs for all classes of fixed maturity securities include prices from recently executed transactions of similar securities, marketplace quotes, benchmark yields, spreads off benchmark yields, interest rates and U.S. Treasury or swap curves. Specifically for asset-backed securities, key inputs include prepayment and default projections based on past performance of the underlying collateral and current market data. Fixed maturity securities are primarily assigned to Level 3 in cases where broker/dealer quotes are significant inputs to the valuation, and there is a lack of transparency as to whether these quotes are based on information that is observable in the marketplace. Level 3 securities also include private placement debt securities whose fair value is determined using internal models with inputs that are not market observable.
Equity Securities
Level 1 equity securities include publicly traded securities valued using quoted market prices. Level 2 securities are primarily non-redeemable preferred stocks and common stocks valued using pricing for similar securities, recently executed transactions and other pricing models utilizing market observable inputs. Level 3 securities are primarily priced using broker/dealer quotes and internal models with inputs that are not market observable.
23
Other Invested Assets
The fair value of Federal Home Loan Bank of Chicago (FHLBC) stock is equal to par because it can only be redeemed by the FHLBC at par or sold to another member of the FHLBC at par and is classified as Level 2.
As of September 30, 2017 and December 31, 2016, there were approximately $37 million and $31 million respectively of overseas deposits within other invested assets, which can be redeemed at net asset value in 90 days or less. Overseas deposits are excluded from the fair value hierarchy, because their fair value is recorded using the net asset value per share (or equivalent) practical expedient.
Short Term Investments
Securities that are actively traded or have quoted prices are classified as Level 1. These securities include money market funds and treasury bills. Level 2 primarily includes commercial paper, for which all inputs are market observable. Fixed maturity securities purchased within one year of maturity are classified consistent with fixed maturity securities discussed above. Short term investments as presented in the tables above differ from the amounts presented on the Condensed Consolidated Balance Sheets because certain short term investments, such as time deposits, are not measured at fair value.
Life Settlement Contracts
The Company accounts for its investment in life settlement contracts using the fair value method. Historically, the fair value of life settlement contracts was determined as the present value of the anticipated death benefits less anticipated premium payments based on contract terms that are distinct for each insured, as well as the Company's own assumptions for mortality, premium expense and the rate of return that a buyer would require on the contracts.
The entire portfolio of life settlement contracts, which is included within the Life and Group Non-Core segment, was determined to be held for sale as of December 31, 2016 as the Company reached an agreement on terms to sell the portfolio. As such, the Company adjusted the fair value to the estimated sales proceeds less cost to sell. The definitive Purchase and Sale Agreement (PSA) related to the portfolio was executed on March 7, 2017 (sale date). In connection therewith, the life settlement contracts and related sale proceeds were placed in escrow until the buyer was recognized as the owner and beneficiary of each individual life settlement contract by the life insurance company that issued the policy. All of the contracts have been released from escrow as of September 30, 2017. The Company derecognized the released contracts and recorded the consideration, including a note receivable, which is payable over three years and is carried at amortized cost less any valuation allowance. The note receivable of $45 million is included within Other assets on the September 30, 2017 Condensed Consolidated Balance Sheet and interest income is accreted to the principal balance of the note.
The fair value of the Company's investments in life settlement contracts were $0 million and $58 million as of September 30, 2017 and December 31, 2016, and are included in Other assets on the Condensed Consolidated Balance Sheets. Despite the sale, the contracts were classified as Level 3 as there is not an active market for life settlement contracts. The cash receipts and payments related to the life settlement contracts prior to the sale date are included in Cash Flows from operating activities on the Condensed Consolidated Statements of Cash Flows. Cash receipts related to the sale of the life settlement contracts, as well as principal payments on the note receivable, are included in Cash Flows from investing activities.
Derivative Financial Investments
Level 2 securities primarily include the embedded derivative on the funds withheld liability. The embedded derivative on funds withheld liability is valued using the change in fair value of the assets supporting the funds withheld liability, which are fixed maturity securities valued with observable inputs.
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Significant Unobservable Inputs
The following tables present quantitative information about the significant unobservable inputs utilized by the Company in the fair value measurements of Level 3 assets. Valuations for assets and liabilities not presented in the tables below are primarily based on broker/dealer quotes for which there is a lack of transparency as to inputs used to develop the valuations. The quantitative detail of these unobservable inputs is neither provided nor reasonably available to the Company. The valuation of life settlement contracts was based on the terms of the sale of the contracts to a third party; therefore, the contracts are not included in the table below.
September 30, 2017 | Estimated Fair Value (In millions) | Valuation Technique(s) | Unobservable Input(s) | Range (Weighted Average) | |||||
Fixed maturity securities | $ | 139 | Discounted cash flow | Credit spread | 1% - 12% (3%) | ||||
December 31, 2016 | Estimated Fair Value (In millions) | Valuation Technique(s) | Unobservable Input(s) | Range (Weighted Average) | |||||
Fixed maturity securities | $ | 106 | Discounted cash flow | Credit spread | 2% - 40% (4%) | ||||
For fixed maturity securities, an increase to the credit spread assumptions would result in a lower fair value measurement.
Financial Assets and Liabilities Not Measured at Fair Value
The carrying amount and estimated fair value of the Company's financial assets and liabilities which are not measured at fair value on the Condensed Consolidated Balance Sheets are presented in the following tables.
September 30, 2017 | Carrying Amount | Estimated Fair Value | |||||||||||||||||||
(In millions) | Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||
Assets | |||||||||||||||||||||
Mortgage loans | $ | 722 | $ | — | $ | — | $ | 731 | $ | 731 | |||||||||||
Note receivable | 45 | — | — | — | — | 46 | 46 | ||||||||||||||
Liabilities | |||||||||||||||||||||
Short term debt | $ | 150 | $ | — | $ | 152 | $ | — | $ | 152 | |||||||||||
Long term debt | 2,707 | — | 2,916 | — | 2,916 | ||||||||||||||||
December 31, 2016 | Carrying Amount | Estimated Fair Value | |||||||||||||||||
(In millions) | Level 1 | Level 2 | Level 3 | Total | |||||||||||||||
Assets | |||||||||||||||||||
Mortgage loans | $ | 591 | $ | — | $ | — | $ | 594 | $ | 594 | |||||||||
Liabilities | |||||||||||||||||||
Long term debt | $ | 2,710 | $ | — | $ | 2,952 | $ | — | $ | 2,952 | |||||||||
The following methods and assumptions were used to estimate the fair value of these financial assets and liabilities.
The fair values of mortgage loans were based on the present value of the expected future cash flows discounted at the current interest rate for origination of similar quality loans, adjusted for specific loan risk.
The fair value of the note receivable was based on the present value of the expected future cash flows discounted at the current interest rate for origination of similar notes, adjusted for specific credit risk.
The Company's senior notes and debentures were valued based on observable market prices. The fair value for other debt was estimated using discounted cash flows based on current incremental borrowing rates for similar borrowing arrangements.
The carrying amounts reported on the Condensed Consolidated Balance Sheets for Cash, Short term investments not carried at fair value, Accrued investment income and certain Other assets and Other liabilities approximate fair value due to the short term nature of these items. These assets and liabilities are not listed in the tables above.
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Note E. Claim and Claim Adjustment Expense Reserves
The Company's property and casualty insurance claim and claim adjustment expense reserves represent the estimated amounts necessary to resolve all outstanding claims, including incurred but not reported (IBNR) claims as of the reporting date. The Company's reserve projections are based primarily on detailed analysis of the facts in each case, the Company's experience with similar cases and various historical development patterns. Consideration is given to such historical patterns as claim reserving trends and settlement practices, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions, including inflation, and public attitudes. All of these factors can affect the estimation of claim and claim adjustment expense reserves.
Establishing claim and claim adjustment expense reserves, including claim and claim adjustment expense reserves for catastrophic events that have occurred, is an estimation process. Many factors can ultimately affect the final settlement of a claim and, therefore, the necessary reserve. Changes in the law, results of litigation, medical costs, the cost of repair materials and labor rates can all affect ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably estimable than long-tail claims, such as workers' compensation, general liability and professional liability claims. Adjustments to prior year reserve estimates, if necessary, are reflected in the results of operations in the period that the need for such adjustments is determined. There can be no assurance that the Company's ultimate cost for insurance losses will not exceed current estimates.
Catastrophes are an inherent risk of the property and casualty insurance business and have contributed to material period-to-period fluctuations in the Company's results of operations and/or equity. The Company reported catastrophe losses, net of reinsurance, of $269 million and $342 million for the three and nine months ended September 30, 2017. Net catastrophe losses for the three and nine months ended September 30, 2017 included $149 million related to Hurricane Harvey, $95 million related to Hurricane Irma and $20 million related to Hurricane Maria. The remaining catastrophe losses in 2017 resulted primarily from U.S. weather-related events. Catastrophe-related reinsurance reinstatement premium was $6 million for the three and nine months ended September 30, 2017. The Company reported catastrophe losses, net of reinsurance, of $16 million and $137 million for the three and nine months ended September 30, 2016. Catastrophe losses in 2016 resulted primarily from U.S. weather-related events and the Fort McMurray wildfires.
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Liability for Unpaid Claim and Claim Adjustment Expenses Rollforward
The following table presents a reconciliation between beginning and ending claim and claim adjustment expense reserves, including claim and claim adjustment expense reserves of the Life & Group Non-Core segment.
For the nine months ended September 30 | |||||||
(In millions) | 2017 | 2016 | |||||
Reserves, beginning of year: | |||||||
Gross | $ | 22,343 | $ | 22,663 | |||
Ceded | 4,094 | 4,087 | |||||
Net reserves, beginning of year | 18,249 | 18,576 | |||||
Net incurred claim and claim adjustment expenses: | |||||||
Provision for insured events of current year | 3,949 | 3,799 | |||||
Decrease in provision for insured events of prior years | (284 | ) | (332 | ) | |||
Amortization of discount | 138 | 134 | |||||
Total net incurred (1) | 3,803 | 3,601 | |||||
Net payments attributable to: | |||||||
Current year events | (560 | ) | (591 | ) | |||
Prior year events | (3,401 | ) | (3,209 | ) | |||
Total net payments | (3,961 | ) | (3,800 | ) | |||
Foreign currency translation adjustment and other | 110 | 39 | |||||
Net reserves, end of period | 18,201 | 18,416 | |||||
Ceded reserves, end of period | 4,008 | 4,256 | |||||
Gross reserves, end of period | $ | 22,209 | $ | 22,672 | |||
(1) | Total net incurred above does not agree to Insurance claims and policyholders' benefits as reflected on the Condensed Consolidated Statements of Operations due to amounts related to retroactive reinsurance deferred gain accounting, uncollectible reinsurance and loss deductible receivables, and benefit expenses related to future policy benefits, which are not reflected in the table above. |
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Net Prior Year Development
Changes in estimates of claim and allocated claim adjustment expense reserves and premium accruals, net of reinsurance, for prior years are defined as net prior year development. These changes can be favorable or unfavorable. The following tables and discussion present the net prior year development recorded for Specialty, Commercial, International and Corporate & Other Non-Core segments.
Three months ended September 30, 2017 | |||||||||||||||||||
(In millions) | Specialty | Commercial | International | Corporate & Other Non-Core | Total | ||||||||||||||
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development | $ | (109 | ) | $ | (7 | ) | $ | 1 | $ | — | $ | (115 | ) | ||||||
Pretax (favorable) unfavorable premium development | (3 | ) | (11 | ) | (5 | ) | — | (19 | ) | ||||||||||
Total pretax (favorable) unfavorable net prior year development | $ | (112 | ) | $ | (18 | ) | $ | (4 | ) | $ | — | $ | (134 | ) | |||||
Three months ended September 30, 2016 | |||||||||||||||||||
(In millions) | Specialty | Commercial | International | Corporate & Other Non-Core | Total | ||||||||||||||
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development | $ | (112 | ) | $ | (5 | ) | $ | (15 | ) | $ | — | $ | (132 | ) | |||||
Pretax (favorable) unfavorable premium development | — | (3 | ) | (2 | ) | — | (5 | ) | |||||||||||
Total pretax (favorable) unfavorable net prior year development | $ | (112 | ) | $ | (8 | ) | $ | (17 | ) | $ | — | $ | (137 | ) | |||||
Nine months ended September 30, 2017 | |||||||||||||||||||
(In millions) | Specialty | Commercial | International | Corporate & Other Non-Core | Total | ||||||||||||||
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development | $ | (163 | ) | $ | (65 | ) | $ | 1 | $ | — | $ | (227 | ) | ||||||
Pretax (favorable) unfavorable premium development | (13 | ) | 27 | (16 | ) | — | (2 | ) | |||||||||||
Total pretax (favorable) unfavorable net prior year development | $ | (176 | ) | $ | (38 | ) | $ | (15 | ) | $ | — | $ | (229 | ) | |||||
Nine months ended September 30, 2016 | |||||||||||||||||||
(In millions) | Specialty | Commercial | International | Corporate & Other Non-Core | Total | ||||||||||||||
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development | $ | (211 | ) | $ | (37 | ) | $ | (34 | ) | $ | — | $ | (282 | ) | |||||
Pretax (favorable) unfavorable premium development | (18 | ) | (7 | ) | (2 | ) | — | (27 | ) | ||||||||||
Total pretax (favorable) unfavorable net prior year development | $ | (229 | ) | $ | (44 | ) | $ | (36 | ) | $ | — | $ | (309 | ) | |||||
Premium development can occur in the property and casualty business when there is a change in exposure on auditable policies or when premium accruals differ from processed premium. Audits on policies usually occur in a period after the expiration date of the policy. See further information on the premium development in the Commercial segment for the three and nine months ended September 30, 2017 within the Small Business discussion in Note F.
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Specialty
The following table presents further detail of the net prior year claim and allocated claim adjustment expense reserve development (development) recorded for the Specialty segment.
Periods ended September 30 | Three Months | Nine Months | |||||||||||||
(In millions) | 2017 | 2016 | 2017 | 2016 | |||||||||||
Pretax (favorable) unfavorable development: | |||||||||||||||
Medical Professional Liability | $ | 1 | $ | 13 | $ | 5 | $ | (17 | ) | ||||||
Other Professional Liability and Management Liability | (27 | ) | (48 | ) | (96 | ) | (98 | ) | |||||||
Surety | (82 | ) | (63 | ) | (82 | ) | (63 | ) | |||||||
Warranty | (1 | ) | 2 | 5 | 7 | ||||||||||
Other | — | (16 | ) | 5 | (40 | ) | |||||||||
Total pretax (favorable) unfavorable development | $ | (109 | ) | $ | (112 | ) | $ | (163 | ) | $ | (211 | ) | |||
Three Months
2017
Favorable development in other professional liability and management liability was primarily due to lower than expected claim frequency in accident years 2012 through 2015, primarily for professional liability products.
Favorable development in surety coverages was primarily due to lower than expected frequency of large losses in accident years 2015 and prior.
2016
Unfavorable development for medical professional liability was largely due to higher than expected frequency in accident years 2014 and 2015 in aging services. Increased claims on a specific hospital policy in accident years 2014 and 2015 was also an unfavorable contributor although more than offset by favorable development relative to expectations in accident years 2013 and prior.
Favorable development in other professional liability and management liability was primarily related to lower than expected frequency of claims and favorable outcomes on specific claims for accident years 2010 through 2014.
Favorable development in surety coverages was primarily due to lower than expected frequency of large losses in accident years 2014 and prior.
Favorable development for other coverages was due to better than expected claim frequency in commercial lines coverages provided to Specialty customers in accident years 2010 through 2015.
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Nine Months
2017
Favorable development in other professional liability and management liability was primarily due to favorable settlements on closed claims and a lower frequency of large losses for accident years 2011 through 2016 for professional and management liability, lower than expected claim frequency in accident years 2012 through 2015 for professional liability and lower than expected severity in accident years 2014 through 2016 for professional liability.
Favorable development in surety coverages was primarily due to lower than expected frequency of large losses in accident years 2015 and prior.
2016
Favorable development for medical professional liability was primarily due to lower than expected severities for individual healthcare professionals, allied facilities and hospitals in accident years 2011 and prior. This was partially offset by unfavorable development in accident years 2012 and 2013 related to higher than expected large loss emergence in hospitals and higher than expected frequency and severity in accident years 2014 and 2015 in our aging services business.
Favorable development in other professional liability and management liability was primarily related to favorable settlements on closed claims in accident years 2011 through 2013 in professional services. Additional favorable development related to lower than expected frequency of claims and favorable outcomes on specific claims in accident years 2010 through 2014 in professional services. This was partially offset by unfavorable development related to a specific financial institutions claim in accident year 2014, higher severities in accident year 2015, and deterioration on credit crises-related claims in accident year 2009.
Favorable development in surety coverages was primarily due to lower than expected frequency of large losses in accident years 2014 and prior.
Favorable development for other coverages provided to Specialty customers was due to better than expected claim frequency in property coverages in accident year 2015 and commercial lines coverages in accident years 2010 through 2015.
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Commercial
The following table presents further detail of the development recorded for the Commercial segment.
Periods ended September 30 | Three Months | Nine Months | |||||||||||||
(In millions) | 2017 | 2016 | 2017 | 2016 | |||||||||||
Pretax (favorable) unfavorable development: | |||||||||||||||
Commercial Auto | $ | (14 | ) | $ | (12 | ) | $ | (40 | ) | $ | (47 | ) | |||
General Liability | 7 | 14 | 6 | (38 | ) | ||||||||||
Workers' Compensation | 7 | (6 | ) | (39 | ) | ||||||||||