UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
| þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended March 31, 2005
OR
| o | 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 | 36-6169860 | |
| (State or other jurisdiction of | (I.R.S. Employer | |
| incorporation or organization) | Identification No.) | |
| CNA Center | ||
| Chicago, Illinois | 60685 | |
| (Address of principal executive offices) | (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 þ No....
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes þ No....
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 May 2, 2005 | |||
Common Stock, Par value $2.50
|
255,953,958 | |||
CNA FINANCIAL CORPORATION
| March 31, | December 31, | |||||||
| 2005 | 2004 | |||||||
| Restated | ||||||||
| (In millions, except share data) | See Note Q | |||||||
Assets |
||||||||
Investments: |
||||||||
Fixed maturity securities at fair value (amortized cost of $29,501 and $30,266) |
$ | 30,114 | $ | 31,327 | ||||
Equity securities at fair value (cost of $245 and $320) |
368 | 456 | ||||||
Limited partnership investments |
1,633 | 1,549 | ||||||
Other invested assets |
43 | 36 | ||||||
Short-term investments at cost, which approximates fair value |
7,525 | 5,863 | ||||||
Total investments |
39,683 | 39,231 | ||||||
Cash |
93 | 95 | ||||||
Reinsurance receivables (less allowance for uncollectible receivables of $517 and $531) |
15,070 | 15,357 | ||||||
Insurance receivables (less allowance for doubtful accounts of $504 and $517) |
2,028 | 2,050 | ||||||
Accrued investment income |
309 | 297 | ||||||
Receivables for securities sold |
780 | 496 | ||||||
Deferred acquisition costs |
1,254 | 1,268 | ||||||
Prepaid reinsurance premiums |
1,019 | 1,128 | ||||||
Federal income taxes recoverable (includes $35 and $7 due from Loews Corporation) |
23 | — | ||||||
Deferred income taxes |
858 | 709 | ||||||
Property and equipment at cost (less accumulated depreciation of $527 and $524) |
230 | 235 | ||||||
Goodwill and other intangible assets |
145 | 162 | ||||||
Other assets |
948 | 815 | ||||||
Separate account business |
558 | 568 | ||||||
Total assets |
$ | 62,998 | $ | 62,411 | ||||
Liabilities and Stockholders’ Equity |
||||||||
Liabilities: |
||||||||
Insurance reserves: |
||||||||
Claim and claim adjustment expense |
$ | 31,113 | $ | 31,523 | ||||
Unearned premiums |
4,447 | 4,522 | ||||||
Future policy benefits |
5,978 | 5,883 | ||||||
Policyholders’ funds |
1,648 | 1,725 | ||||||
Collateral on loaned securities and derivatives |
1,111 | 918 | ||||||
Payables for securities purchased |
1,095 | 288 | ||||||
Participating policyholders’ funds |
60 | 63 | ||||||
Short term debt |
575 | 531 | ||||||
Long term debt |
1,669 | 1,726 | ||||||
Reinsurance balances payable |
2,968 | 2,980 | ||||||
Other liabilities |
2,445 | 2,231 | ||||||
Separate account business |
558 | 568 | ||||||
Total liabilities |
53,667 | 52,958 | ||||||
Commitments and contingencies (Notes F, G, I and K) |
||||||||
Minority interest |
277 | 275 | ||||||
Stockholders’ equity: |
||||||||
Preferred stock (12,500,000 shares authorized)
Series H Issue (no par value; $100,000 stated value; 7,500 shares issued; held by Loews Corporation) |
750 | 750 | ||||||
Common stock ($2.50 par value; 500,000,000 shares authorized; 258,177,285 shares issued; and
255,953,958 shares outstanding) |
645 | 645 | ||||||
Additional paid-in capital |
1,701 | 1,701 | ||||||
Retained earnings |
5,750 | 5,572 | ||||||
Accumulated other comprehensive income |
346 | 650 | ||||||
Treasury stock (2,223,327 shares), at cost |
(69 | ) | (69 | ) | ||||
| 9,123 | 9,249 | |||||||
Notes receivable for the issuance of common stock |
(69 | ) | (71 | ) | ||||
Total stockholders’ equity |
9,054 | 9,178 | ||||||
Total liabilities and stockholders’ equity |
$ | 62,998 | $ | 62,411 | ||||
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).
3
CNA FINANCIAL CORPORATION
| Three months ended March 31 | 2005 | 2004 | ||||||
| (In millions, except per share data) | Restated | |||||||
| See Note Q | ||||||||
Revenues |
||||||||
Net earned premiums |
$ | 1,899 | $ | 2,168 | ||||
Net investment income |
406 | 475 | ||||||
Realized investment losses, net of participating
policyholders’ and minority interests |
(19 | ) | (458 | ) | ||||
Other revenues |
78 | 82 | ||||||
Total revenues |
2,364 | 2,267 | ||||||
Claims, Benefits and Expenses |
||||||||
Insurance claims and policyholders’ benefits |
1,434 | 1,638 | ||||||
Amortization of deferred acquisition costs |
378 | 433 | ||||||
Other operating expenses |
274 | 332 | ||||||
Interest |
37 | 35 | ||||||
Total claims, benefits and expenses |
2,123 | 2,438 | ||||||
Income (loss) before income tax and minority interest |
241 | (171 | ) | |||||
Income tax (expense) benefit |
(56 | ) | 53 | |||||
Minority interest |
(7 | ) | (6 | ) | ||||
Net income (loss) |
$ | 178 | $ | (124 | ) | |||
Basic and Diluted Earnings (Loss) Per Share |
||||||||
Basic and diluted earnings (loss) per share
available to common stockholders |
$ | 0.63 | $ | (0.55 | ) | |||
Weighted average outstanding common stock and common
stock equivalents |
256.0 | 255.9 | ||||||
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).
4
CNA FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
| Three months ended March 31 | 2005 | 2004 | ||||||
| (In millions) | Restated | |||||||
| See Note Q | ||||||||
Cash Flows from Operating Activities |
||||||||
Net income (loss) |
$ | 178 | $ | (124 | ) | |||
Adjustments to reconcile net income (loss) to net cash flows provided by operating activities: |
||||||||
Change in bad debt provision for insurance and reinsurance receivables |
(7 | ) | 42 | |||||
Minority interest |
7 | 5 | ||||||
Loss on disposal of property and equipment |
7 | 6 | ||||||
Deferred income tax provision |
12 | (77 | ) | |||||
Realized investment losses, net of participating policyholders’ and minority interests |
19 | 458 | ||||||
Equity method income |
(80 | ) | (75 | ) | ||||
Amortization of bond (discount) premium |
(22 | ) | 1 | |||||
Depreciation |
14 | 19 | ||||||
Changes in: |
||||||||
Receivables, net |
316 | 188 | ||||||
Deferred acquisition costs |
14 | 10 | ||||||
Accrued investment income |
(12 | ) | (30 | ) | ||||
Federal income taxes payable/recoverable |
(23 | ) | 108 | |||||
Prepaid reinsurance premiums |
109 | 26 | ||||||
Reinsurance balances payable |
(13 | ) | (73 | ) | ||||
Insurance reserves |
(467 | ) | (288 | ) | ||||
Other, net |
36 | (156 | ) | |||||
Net purchases of trading securities |
36 | (3 | ) | |||||
Total adjustments |
(54 | ) | 161 | |||||
Net cash flows provided by operating activities |
124 | 37 | ||||||
Cash Flows from Investing Activities |
||||||||
Purchases of fixed maturity securities |
(12,314 | ) | (14,475 | ) | ||||
Proceeds from fixed maturity securities: |
||||||||
Sales |
12,554 | 10,867 | ||||||
Maturities, calls and redemptions |
991 | 1,443 | ||||||
Purchases of equity securities |
(22 | ) | (30 | ) | ||||
Proceeds from sales of equity securities |
101 | 36 | ||||||
Change in short-term investments |
(1,628 | ) | 1,820 | |||||
Change in collateral on loaned securities and derivatives |
193 | (71 | ) | |||||
Change in other investments |
(5 | ) | 7 | |||||
Purchases of property and equipment |
(16 | ) | (11 | ) | ||||
Dispositions |
12 | — | ||||||
Other, net |
19 | (27 | ) | |||||
Net cash flows used by investing activities |
(115 | ) | (441 | ) | ||||
Cash Flows from Financing Activities |
||||||||
Principal payments on debt |
(14 | ) | (6 | ) | ||||
Proceeds from issuance of surplus notes |
— | 346 | ||||||
Returns and deposits of policyholder account balances on investment contracts |
— | 6 | ||||||
Other |
3 | — | ||||||
Net cash flows provided (used) by financing activities |
(11 | ) | 346 | |||||
Net change in cash |
(2 | ) | (58 | ) | ||||
Cash, beginning of period |
95 | 139 | ||||||
Cash, end of period |
$ | 93 | $ | 81 | ||||
Supplemental Disclosures of Cash Flow Information: |
||||||||
Cash paid (received): |
||||||||
Interest |
$ | 14 | $ | 16 | ||||
Federal income taxes |
64 | (79 | ) | |||||
Non-cash transactions: |
||||||||
Notes receivable for the issuance of common stock |
— | — | ||||||
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).
5
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note A. Basis of Presentation
The Condensed Consolidated Financial Statements (Unaudited) include the accounts of CNA Financial Corporation (CNAF) and its controlled subsidiaries. Collectively, CNAF and its subsidiaries are referred to as CNA or the Company. CNA’s property and casualty and the remaining life and group insurance operations are primarily conducted by Continental Casualty Company (CCC), The Continental Insurance Company (CIC) and Continental Assurance Company (CAC). Loews Corporation (Loews) owned approximately 91% of the outstanding common stock and 100% of the Series H preferred stock of CNAF as of March 31, 2005.
The Company’s individual life insurance business, including its previously wholly owned subsidiary Valley Forge Life Insurance Company (VFL), was sold on April 30, 2004 to Swiss Re Life & Health America Inc. (Swiss Re). The results of the individual life insurance business sold are included in the Condensed Consolidated Statement of Operations for the three months ended March 31, 2004. See Note N for further information.
The accompanying Condensed Consolidated Financial Statements (Unaudited) have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Certain financial information that is normally included in annual financial statements, including certain financial statement notes, prepared in accordance with GAAP, 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 Form 10-K/A filed with the Securities and Exchange Commission (SEC) for the year ended December 31, 2004. Certain amounts applicable to prior periods have been conformed to the current period presentation.
The interim financial data as of March 31, 2005 and for the three months ended March 31, 2005 and 2004 is unaudited. However, in the opinion of management, the interim data includes all adjustments, consisting of normal recurring accruals, 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. All significant intercompany amounts have been eliminated.
In the second quarter of 2004, the expenses incurred related to uncollectible reinsurance receivables were reclassified from “Other operating expenses” to “Insurance claims and policyholders’ benefits” on the Condensed Consolidated Statements of Operations. Prior period amounts have been reclassified to conform to the current year presentation. This reclassification had no impact on net income (loss) in any period.
6
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)
Note B. Accounting Pronouncements
In October of 2004, the Financial Accounting Standards Board (FASB)issued FASB Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 (AJCA). AJCA introduces a special one-time dividends received deduction of 85% for the repatriation of certain foreign earnings. A number of companies are requesting that Congress or the Treasury Department provide additional clarifying language on key elements of the repatriation provision. The Company and its eligible subsidiaries (CNA Tax Group) are included in the consolidated Federal income tax return of Loews and its eligible subsidiaries. Should Loews, upon consideration of any such potential clarifying language, ultimately elect to apply the repatriation provision of the AJCA, the CNA Tax Group does not expect that the impact of such an election would be material to its results of operations or equity.
Note C. Earnings (Loss) Per Share
Earnings (loss) per share available to common stockholders is based on weighted-average outstanding shares. Basic and diluted earnings per share is computed by dividing income available to common stockholders by the weighted-average number of shares of common stock or common stock equivalents outstanding for the period. The weighted average number of shares outstanding for computing basic and diluted earnings per share was 256.0 million for the three months ended March 31, 2005 and 255.9 million for the three months ended March 31, 2004. Included in the outstanding shares in 2004 is the effect of the 32.3 million shares of CNAF common stock issued on April 20, 2004 in conjunction with the conversion of the $750 million Series I Convertible Preferred Stock issued during the fourth quarter of 2003.
The Series H Cumulative Preferred Stock Issue (Series H Issue) is held by Loews and accrues cumulative dividends at an initial rate of 8% per year, compounded annually. As of March 31, 2005, the Company had $144 million of undeclared but accumulated dividends. The Series H Issue dividend amounts for the three months ended March 31, 2005 and 2004 have been subtracted from Net Income (Loss) to determine income (loss) available to common stockholders.
Diluted earnings (loss) per share reflect 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 months ended March 31, 2005 and 2004, approximately one million shares attributable to the exercise of outstanding options were excluded from the calculation of diluted earnings (loss) per share because the exercise price of these options was greater than the average market price of CNA common stock. The computation of earnings (loss) per share was as follows.
| Earnings (Loss) Per Share | ||||||||
| For the three months ended March 31 | 2005 | 2004 | ||||||
| (In millions, except per share amounts) | ||||||||
Net income (loss) |
$ | 178 | $ | (124 | ) | |||
Less: undeclared preferred stock dividend |
(17 | ) | (16 | ) | ||||
Net income (loss) available to common stockholders |
$ | 161 | $ | (140 | ) | |||
Weighted average outstanding common stock and common
stock equivalents |
256.0 | 255.9 | ||||||
Effect of dilutive securities, employee stock options |
— | — | ||||||
Adjusted weighted average outstanding common stock
and common stock equivalents assuming conversions |
256.0 | 255.9 | ||||||
Basic and diluted earnings (loss) per share
available to common stockholders |
$ | 0.63 | $ | (0.55 | ) | |||
The Company applies the intrinsic value method under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations, in accounting for its stock-based compensation plan. Under the recognition and measurement principles of APB 25, no stock-based compensation cost has been
7
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)
recognized, as the exercise price of the granted options equaled the market price of the underlying stock at the grant date.
The following table illustrates the pro forma effect on net income (loss) and earnings (loss) per share, had the Company applied the fair value recognition provisions of Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation (SFAS 123), to stock-based employee compensation under the Company’s stock-based compensation plans.
| Pro Forma Effect of SFAS 123 on Net Income (Loss) and Earnings (Loss) Per Share | ||||||||
| For the three months ended March 31 | 2005 | 2004 | ||||||
| (In millions, except per share amounts) | ||||||||
Net income (loss) available to common stockholders |
$ | 161 | $ | (140 | ) | |||
Less: Total stock-based compensation cost determined under
the fair value method, net of tax |
(1 | ) | (1 | ) | ||||
Pro forma net income (loss) available to common stockholders |
$ | 160 | $ | (141 | ) | |||
Basic and diluted earnings (loss) per share, as reported |
$ | 0.63 | $ | (0.55 | ) | |||
Basic and diluted earnings (loss) per share, pro forma |
$ | 0.63 | $ | (0.55 | ) | |||
8
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)
Note D. Investments
The significant components of net investment income are presented in the following table.
| Net Investment Income | ||||||||
| Three months ended March 31 | 2005 | 2004 | ||||||
| (In millions) | ||||||||
Fixed maturity securities |
$ | 364 | $ | 407 | ||||
Short term investments |
32 | 16 | ||||||
Limited partnerships |
79 | 75 | ||||||
Equity securities |
4 | 4 | ||||||
Income (loss) from trading portfolio (a) |
(30 | ) | 20 | |||||
Interest on funds withheld and other deposits |
(39 | ) | (48 | ) | ||||
Other |
7 | 10 | ||||||
Gross investment income |
417 | 484 | ||||||
Investment expense |
(11 | ) | (9 | ) | ||||
Net investment income |
$ | 406 | $ | 475 | ||||
(a) The change in net unrealized gains (losses) on trading securities, included in net investment income, was $(8) million and $4 million for the three months ended March 31, 2005 and 2004.
The components of realized investment results for available-for-sale securities are presented in the following table.
| Realized Investment Gains (Losses) | ||||||||
| Three months ended March 31 | 2005 | 2004 | ||||||
| (In millions) | ||||||||
Realized investment gains (losses): |
||||||||
Fixed maturity securities: |
||||||||
U.S. Government bonds |
$ | (26 | ) | $ | 10 | |||
Corporate and other taxable bonds |
(21 | ) | 6 | |||||
Tax-exempt bonds |
7 | 73 | ||||||
Asset-backed bonds |
7 | 39 | ||||||
Redeemable preferred stock |
10 | 1 | ||||||
Total fixed maturity securities |
(23 | ) | 129 | |||||
Equity securities |
14 | 11 | ||||||
Derivative securities |
4 | (32 | ) | |||||
Impairment loss on Individual Life business, net of
participating policyholders’ interest |
— | (569 | ) | |||||
Other, including disposition of businesses |
(17 | ) | 4 | |||||
Net realized investment gains (losses) before allocation to
participating policyholders’ and minority interests |
(22 | ) | (457 | ) | ||||
Allocated to participating policyholders’ and minority interests |
3 | (1 | ) | |||||
Realized investment gains (losses) |
$ | (19 | ) | $ | (458 | ) | ||
Realized investment losses were $19 million and $458 million for the three months ended March 31, 2005 and 2004. The $439 million improvement in realized results is largely related to an impairment loss recorded in the first quarter of 2004 of $569 million related to the sale of CNA’s individual life business. This improvement was partly offset by decreased results in the fixed maturity securities portfolio and $32 million of total impairment losses recorded across various market sectors, including an impairment loss of $13 million related to loans made under a credit facility to a national contractor. See Note O for further details. For 2004, there were no impairments other than the individual life sale loss discussed above.
9
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)
Investments in the general account had a total net unrealized gain of $736 million at March 31, 2005 compared with $1,197 million at December 31, 2004. The net unrealized position at March 31, 2005 was composed of a net unrealized gain of $613 million for fixed maturities and a net unrealized gain of $123 million for equity securities. The net unrealized position at December 31, 2004 was composed of a net unrealized gain of $1,061 million for fixed maturities and a net unrealized gain of $136 million for equity securities.
The following tables summarize the unrealized gain (loss) position related to fixed maturity and equity securities.
Unrealized Gains (Losses) on Fixed Maturity and Equity Securities
| Cost or | Gross | Gross Unrealized Losses | Net | |||||||||||||||||
| Amortized | Unrealized | Less than | Greater than | Unrealized | ||||||||||||||||
| March 31, 2005 | Cost | Gains | 12 Months | 12 Months | Gain/(Loss) | |||||||||||||||
| (In millions) | ||||||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||||||
U.S. Treasury securities and obligations
of government agencies |
$ | 2,580 | $ | 115 | $ | 2 | $ | 1 | $ | 112 | ||||||||||
Asset-backed securities |
8,582 | 60 | 65 | 5 | (10 | ) | ||||||||||||||
States, municipalities and political
subdivisions – tax-exempt |
9,446 | 122 | 95 | 21 | 6 | |||||||||||||||
Corporate securities |
5,470 | 363 | 68 | 15 | ||||||||||||||||