operation of offshore oil and gas drilling rigs (Diamond Offshore Drilling, Inc. (“Diamond Offshore”), a 53% owned subsidiary);
transportation and storage of natural gas and natural gas liquids and gathering and processing of natural gas (Boardwalk Pipeline Partners, LP (“Boardwalk Pipeline”), a 51% owned subsidiary); and
Consolidated net income for 2015 was $260 million, or $0.72 per share, compared to $591 million, or $1.55 per share, in 2014. Net income in 2014 included discontinued operations reflecting the sale of HighMount Exploration & Production, LLC (“HighMount”) and CNA’s former life insurance subsidiary.
Income from continuing operations for 2015 was $260 million, or $0.72 per share, compared to $962 million, or $2.52 per share, in 2014. The decline in income from continuing operations was primarily due to a reserve charge at CNA and asset impairment charges at Diamond Offshore. In addition, parent company investment income declined as a result of lower performance of equity securities in the trading portfolio and decreased results from limited partnership investments.
CNA’s earnings decreased primarily due to a reserve charge of $177 million (after tax and noncontrolling interests) resulting from the unlocking of actuarial assumptions related to future policy benefit reserves for the long term care business. Excluding this charge, CNA’s earnings declined year-over-year primarily due to lower limited partnership results and a $38 million charge (after tax and noncontrolling interests) related to a retroactive reinsurance agreement to cede its legacy asbestos and environmental pollution liabilities. This earnings decline was partially offset by improved underwriting results driven by higher favorable net prior year development.
Boardwalk Pipeline’s earnings increase primarily stemmed from the impact of a $55 million charge (after tax and noncontrolling interests) in 2014 related to the write off of all capitalized costs associated with the terminated Bluegrass project. Absent this charge, earnings were largely consistent with the prior year as additional revenues from the settlement of the Gulf South rate case and a franchise tax refund related to settlement of prior tax periods were offset by lower natural gas storage revenues and increased depreciation and interest costs.
Book value per share decreased to $51.67 at December 31, 2015 from $51.70 at December 31, 2014. Book value per share excluding Accumulated other comprehensive income (“AOCI”) increased to $52.72 at December 31, 2015 from $50.95 at December 31, 2014.
We consider the accounting policies discussed below to be critical to an understanding of our Consolidated Financial Statements as their application places the most significant demands on our judgment. Due to the inherent uncertainties involved with these types of judgments, actual results could differ significantly from estimates, which may have a material adverse impact on our results of operations and/or equity.
Insurance reserves are established for both short and long-duration insurance contracts. Short-duration contracts are primarily related to property and casualty insurance policies where the reserving process is based on actuarial estimates of the amount of loss, including amounts for known and unknown claims. Long-duration contracts are primarily related to long term care and are estimated using actuarial estimates about morbidity and persistency as well as assumptions about expected investment returns and future premium rate increases. The reserve for unearned premiums on property and casualty contracts represents the portion of premiums written related to the unexpired terms of coverage. The reserving process is discussed in further detail in the Reserves - Estimates and Uncertainties section below.
Additionally, an exposure exists with respect to the collectibility of amounts due from customers on other receivables. An allowance for doubtful accounts is recorded on the basis of periodic evaluations of balances currently due as well as in the future, management’s experience and current economic conditions.
Future policy benefit reserves for CNA’s long term care policies are based on certain assumptions including morbidity, persistency, discount rates and future premium rate increases. The adequacy of the reserves is contingent on actual experience related to these key assumptions. If actual experience differs from these assumptions, the reserves may not be adequate, requiring CNA to add to reserves.
A prolonged period during which interest rates remain at levels lower than those anticipated in CNA’s reserving discount rate assumption could result in shortfalls in investment income on assets supporting CNA’s obligations under long term care policies, which may also require an increase to CNA’s reserves. In addition, CNA may not receive regulatory approval for the premium rate increases it requests.
In determining the expected long term rate of return on plan assets assumption, we considered the historical performance of the investment portfolio as well as the long term market return expectations based on the investment mix of the portfolio and the expected investment horizon.
The Company reviews its long-lived assets for impairment when changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company uses a probability-weighted cash flow analysis to test property and equipment for impairment based on relevant market data. If an asset is determined to be impaired, a loss is recognized to reduce the carrying amount to the fair value of the asset. Management’s cash flow assumptions are an inherent part of our asset impairment evaluation and the use of different assumptions could produce results that differ from the reported amounts.
The level of reserves CNA maintains represents its best estimate, as of a particular point in time, of what the ultimate settlement and administration of claims will cost based on CNA’s assessment of facts and circumstances known at that time. Reserves are not an exact calculation of liability but instead are complex estimates that CNA derives, generally utilizing a variety of actuarial reserve estimation techniques, from numerous assumptions and expectations about future events, both internal and external, many of which are highly uncertain. As noted below, CNA reviews its reserves for each segment of its business periodically and any such review could result in the need to increase reserves in amounts which could be material and could adversely affect its results of operations, equity, business and insurer financial strength and corporate debt ratings. Further information on reserves is provided in Note 8 of the Notes to Consolidated Financial Statements included under Item 8.
Emerging or potential claims and coverage issues include, but are not limited to, uncertainty in future medical costs in workers’ compensation. In particular, medical cost inflation could be greater than expected due to new treatments, drugs and devices, increased health care utilization and/or the future costs of health care facilities. In addition, the relationship between workers’ compensation and government and private health care providers could change, potentially shifting costs to workers’ compensation.
The loss portfolio transfer is a retroactive reinsurance contract. The cumulative amounts ceded under the loss portfolio transfer exceed the consideration paid, therefore CNA has recognized a deferred retroactive reinsurance gain. This deferred gain is recognized in earnings in proportion to actual recoveries under the loss portfolio transfer. Over the life of the contract, there is no economic impact as long as any additional losses are within the limit of the contract.
See Note 8 of the Notes to the Consolidated Financial Statements included under Item 8 for further discussion of the loss portfolio transfer, its impact on CNA’s results of operations and the deferred retroactive reinsurance gain.
Historically, CNA performed its actuarial review of A&EP claims in the fourth quarter. In 2014, CNA was unable to complete the fourth quarter review because it determined that additional information and analysis of inuring third-party reinsurance recoveries was required. The reserve review was completed in the second quarter of 2015 and CNA management adopted the second quarter of the year as the timing for all future annual A&EP claims actuarial reviews.
The detailed analyses use a variety of generally accepted actuarial methods and techniques to produce a number of estimates of ultimate loss. CNA’s actuaries determine a point estimate of ultimate loss by reviewing the various estimates and assigning weight to each estimate given the characteristics of the reserve group being reviewed. The reserve estimate is the difference between the estimated ultimate loss and the losses paid to date. The difference between the estimated ultimate loss and the case incurred loss (paid loss plus case reserve) is IBNR. IBNR calculated as such includes a provision for development on known cases (supplemental development) as well as a provision for claims that have occurred but have not yet been reported (pure IBNR).
Most of CNA’s business can be characterized as long-tail. For long-tail business, it will generally be several years between the time the business is written and the time when all claims are settled. CNA’s long-tail exposures include commercial automobile liability, workers’ compensation, general liability, medical professional liability, other professional liability and management liability coverages, assumed reinsurance run-off and products liability. Short-tail exposures include property, commercial automobile physical damage, marine, surety and warranty. Property and casualty insurance operations contain both long-tail and short-tail exposures. Other non-core operations contain long-tail exposures.
The frequency times severity method multiplies a projected number of ultimate claims by an estimated ultimate average loss for each accident or policy year to produce ultimate loss estimates. Since projections of the ultimate number of claims are often less variable than projections of ultimate loss, this method can provide more reliable results for reserve groups where loss development patterns are inconsistent or too variable to be relied on exclusively. In addition, this method can more directly account for changes in coverage that impact the number and
size of claims. However, this method can be difficult to apply to situations where very large claims or a substantial number of unusual claims result in volatile average claim sizes. Projecting the ultimate number of claims may require analysis of several factors including the rate at which policyholders report claims to CNA, the impact of judicial decisions, the impact of underwriting changes and other factors. Estimating the ultimate average loss may require analysis of the impact of large losses and claim cost trends based on changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors.
For many exposures, especially those that can be considered long-tail, a particular accident or policy year may not have a sufficient volume of paid losses to produce a statistically reliable estimate of ultimate losses. In such a case, CNA’s actuaries typically assign more weight to the incurred development method than to the paid development method. As claims continue to settle and the volume of paid loss increases, the actuaries may assign additional weight to the paid development method. For most of CNA’s products, even the incurred losses for accident or policy years that are early in the claim settlement process will not be of sufficient volume to produce a reliable estimate of ultimate losses. In these cases, CNA will not assign any weight to the paid and incurred development methods. CNA will use the loss ratio, Bornhuetter-Ferguson and frequency times severity methods. For short-tail exposures, the paid and incurred development methods can often be relied on sooner primarily because CNA’s history includes a sufficient number of years to cover the entire period over which paid and incurred losses are expected to change. However, CNA may also use the loss ratio, Bornhuetter-Ferguson and frequency times severity methods for short-tail exposures.
For other more complex reserve groups where the above methods may not produce reliable indications, CNA uses additional methods tailored to the characteristics of the specific situation.
Professional liability and management liability products and surety products include professional liability coverages provided to various professional firms, including architects, real estate agents, small and mid-sized accounting firms, law firms and other professional firms. They also include D&O, employment practices, fiduciary, fidelity and surety coverages, as well as insurance products serving the health care delivery system. The most significant factor affecting reserve estimates for these liability coverages is claim severity. Claim severity is driven by the cost of medical care, the cost of wage replacement, legal fees, judicial decisions, legislative changes and other factors. Underwriting and claim handling decisions such as the classes of business written and individual claim settlement decisions can also impact claim severity. If the estimated claim severity increases by 9%, CNA estimates that the net reserves would increase by approximately $500 million. If the estimated claim severity decreases by 3%, CNA estimates that net reserves would decrease by approximately $150 million. CNA’s net reserves for these products were approximately $5.4 billion as of December 31, 2015.
For general liability, the most significant factor affecting reserve estimates is claim severity. Claim severity is driven by changes in the cost of repairing or replacing property, the cost of medical care, the cost of wage replacement, judicial decisions, legislation and other factors. If the estimated claim severity for general liability increases by 6%, CNA estimates that its net reserves would increase by approximately $200 million. If the estimated claim severity for general liability decreases by 3%, CNA estimates that its net reserves would decrease by approximately $100 million. Net reserves for general liability were approximately $3.6 billion as of December 31, 2015.
Given the factors described above, it is not possible to quantify precisely the ultimate exposure represented by claims and related litigation. As a result, CNA regularly reviews the adequacy of its reserves and reassesses its reserve estimates as historical loss experience develops, additional claims are reported and settled and additional information becomes available in subsequent periods. In reviewing CNA’s reserve estimates, CNA makes adjustments in the period that the need for such adjustments is determined. These reviews have resulted in CNA’s
identification of information and trends that have caused CNA to change its reserves in prior periods and could lead to the identification of a need for additional material increases or decreases in claim and claim adjustment expense reserves, which could materially affect our results of operations and equity and CNA’s business and insurer financial strength and corporate debt ratings positively or negatively. See the Ratings section of this MD&A for further information regarding CNA’s financial strength and corporate debt ratings.
CNA maintains both claim and claim adjustment expense reserves as well as future policy benefit reserves for policyholder benefits for the Life & Group Non-Core business. Claim and claim expense reserves consist of estimated reserves for long term care policyholders that are currently receiving benefits, including claims that have been incurred but are not yet reported. In developing the claim and claim adjustment expense reserve estimates for CNA’s long term care policies, its actuaries perform a detailed claim experience study on an annual basis. The study reviews the sufficiency of existing reserves for policyholders currently on claim and includes an evaluation of expected benefit utilization and claim duration. CNA’s recorded claim and claim adjustment expense reserves reflect its best estimate after incorporating the results of the most recent study. In addition, claim and claim adjustment reserves are also maintained for structured settlement obligations that are not funded by annuities related to certain property and casualty claimants. Future policy benefit reserves represent the active life reserves related to CNA’s long term care policies and are the present value of expected future benefit payments and expenses less expected future premiums. The determination of these reserves is fundamental to its financial results and requires management to make estimates and assumptions about expected investment and policyholder experience over the life of the contract. Since many of these contracts may be in force for several decades, these assumptions are subject to significant estimation risk.
While the structured settlement obligations arise under short duration contracts, long duration contract principles and actuarial methods are used to determine management’s best estimate of the required claim and claim adjustment reserve.
Annually, management assesses the adequacy of its GAAP long term care future policy benefit reserves as well as the claim and claim adjustment expense reserves for unfunded structured settlement obligations by performing a gross premium valuation (“GPV”) to determine if there is a premium deficiency. Under the GPV, management estimates required reserves using best estimate assumptions, including anticipated future premium rate increases, as of the date of the assessment without provisions for adverse deviation. The GPV reserves are then compared to the recorded reserves. If the GPV reserves are greater than the existing net GAAP reserves (i.e. reserves net of any deferred acquisition costs asset), the existing net GAAP reserves are unlocked and are increased to the greater amount. Any such increase is reflected in CNA’s results of operations in the period in which the need for such adjustment is determined, and could materially adversely affect our results of operations and equity and CNA’s business and insurer financial strength and corporate debt ratings.
primarily due to changes in future interest rate assumptions, contemplating both near-term market indications and long-term normative assumptions. Changes in expenses and other assumptions had a small adverse impact on the premium deficiency.
The following table summarizes policyholder reserves for Life & Group Non-Core:
The following table summarizes the results of operations for CNA for the years ended December 31, 2015, 2014 and 2013 as presented in Note 21 of the Notes to Consolidated Financial Statements included under Item 8. For further discussion of Net investment income and Net realized investment results, see the Investments section of this MD&A.
The following table summarizes the results of CNA’s property and casualty operations for the years ended December 31, 2015, 2014 and 2013.
Net operating income decreased $42 million in 2015 as compared with 2014. The decrease in net operating income was due to lower net investment income and less favorable underwriting results in International, partially offset by improved underwriting results in Commercial. Catastrophe losses were $85 million (after tax and noncontrolling interests) in 2015 as compared to catastrophe losses of $92 million (after tax and noncontrolling interests) in 2014.
Commercial’s combined ratio improved 7.8 points in 2015 as compared with 2014. The loss ratio improved 10.2 points, due to favorable net prior year development for 2015 as compared to unfavorable net prior year development for 2014 and an improved current accident year loss ratio. The expense ratio increased 2.4 points in 2015 as compared with 2014, due to higher expenses including increased commissions, the favorable impact in 2014 of recoveries on insurance receivables written off in prior years and the unfavorable effect of lower net earned premiums.
Net operating income decreased $157 million in 2014 as compared to 2013, primarily due to lower net investment income, less favorable net prior year development and a legal settlement benefit of $28 million (after tax and noncontrolling interests) in 2013 for Commercial, partially offset by improved current accident year underwriting results in Specialty and Commercial. Catastrophe losses were $92 million (after tax and noncontrolling interests) in 2014 as compared to $100 million (after tax and noncontrolling interests) in 2013.
International’s combined ratio improved 0.7 points in 2014 as compared with 2013. The loss ratio increased 0.1 points, due to the higher current accident year loss ratio, substantially offset by the impact of commutations. The expense ratio improved 0.8 points in 2014 as compared with 2013, primarily due to decreased acquisition expenses.
Net loss from continuing operations increased $264 million in 2015 as compared with 2014, driven by a $296 million charge related to recognition of a premium deficiency and a $9 million deficiency in claim reserves in CNA’s long term care business. The impact of both of these items was $177 million (after-tax and noncontrolling interests), as further discussed in the Reserves - Estimates and Uncertainties section of this MD&A. As a result of recognizing the premium deficiency, the actuarial assumptions used to determine long term care Future policy benefit reserves were unlocked. The December 31, 2015 Future policy benefit reserves for long term care are based on CNA’s best estimate assumptions with no margin for adverse deviation. Since there is no margin in the carried reserves, CNA may have to unlock its reserve assumptions in the future. Factors that could affect the need to unlock reserve assumptions include the significance and persistence of variances between actual experience and the expected results contemplated in the best estimate reserves as well as changes in CNA’s outlook of the future. The periodic operating results for this business in 2016 will reflect any variance between actual experience and the expected results contemplated in CNA’s best estimate reserves.
Results in 2015 were also negatively impacted by an increase in gross A&EP claim reserves. While all of this reserve development is reinsured under the loss portfolio transfer, only a portion of the reinsurance recovery is currently recognized because of the application of retroactive reinsurance accounting. As a result, the comparison with 2014 was negatively affected by $78 million ($46 million after tax and noncontrolling interests), as further discussed in Note 8 of the Notes to Consolidated Financial Statements included under Item 8. Additionally, results in 2015 benefited from lower interest expense due to the maturity of higher coupon debt in the fourth quarter of 2014.
Results from continuing operations increased $107 million in 2014 as compared with 2013, primarily driven by the prior year impact of a $111 million (after tax and noncontrolling interests) deferred gain under retroactive reinsurance accounting related to the loss portfolio transfer. Results in 2014 included a $50 million (after tax and noncontrolling interests) benefit related to a postretirement plan curtailment, substantially offset by a $49 million (after tax and noncontrolling interests) lump sum pension plan settlement, as further discussed in Note 14 of the Notes to Consolidated Financial Statements included under Item 8.
Results in CNA’s long term care and life settlement business improved in 2014, but that improvement was substantially offset by the $31 million (after tax and noncontrolling interests) loss on the coinsurance transaction related to the sale of CNA’s former life insurance subsidiary and results for CNA’s remaining structured settlements. The improved results in long term care were driven by higher net investment income attributable to a higher invested asset base and portfolio allocation of tax-exempt bonds, rate increase actions and the slightly more favorable net morbidity and persistency.
Operating expenses represent all direct and indirect costs associated with the operation and maintenance of Diamond Offshore’s drilling equipment. The principal components of Diamond Offshore’s operating costs are, among other things, direct and indirect costs of labor and benefits, repairs and maintenance, freight, regulatory inspections, boat and helicopter rentals and insurance. Labor and repair and maintenance costs represent the most significant components of Diamond Offshore’s operating expenses. In general, labor costs increase primarily due to higher salary levels, rig staffing requirements and costs associated with labor regulations in the geographic regions in which Diamond Offshore’s rigs operate. In addition, the costs associated with training new and seasoned employees can be significant. Costs to repair and maintain equipment fluctuate depending upon the type of activity the drilling rig is performing, as well as the age and condition of the equipment and the regions in which Diamond Offshore’s rigs are working.
Pretax income is negatively impacted when Diamond Offshore performs certain regulatory inspections, which it refers to as a 5-year survey, or special survey, that are due every five years for each of Diamond Offshore’s rigs. Operating revenue decreases because these special surveys are generally performed during scheduled downtime in a shipyard. Operating expenses increase as a result of these special surveys due to the cost to mobilize the rigs to a shipyard, inspection costs incurred and repair and maintenance costs which are recognized as incurred. Repair and
maintenance activities may result from the special survey or may have been previously planned to take place during this mandatory downtime. The number of rigs undergoing a 5-year survey will vary from year to year, as well as from quarter to quarter.
In addition, pretax income may also be negatively impacted by intermediate surveys, which are performed at interim periods between 5-year surveys. Intermediate surveys are generally less extensive in duration and scope than a 5-year survey. Although an intermediate survey may require some downtime for the drilling rig, it normally does not require dry-docking or shipyard time, except for rigs, generally older than 15 years that are located in the United Kingdom (“U.K.”) sector of the North Sea.
Market fundamentals in the oil and gas industry deteriorated further in the fourth quarter of 2015 and have continued to decline in 2016. In early January 2016, oil prices fell to a 12-year low below $30 per barrel, with some industry analysts predicting even lower commodity prices before any market recovery. Oil markets continue to be volatile due to a number of geopolitical and economic factors. These factors, combined with significant operating losses incurred during the fourth quarter of 2015 by some independent and national oil companies and exploration and production companies, have caused most of these companies to announce additional cuts to their already reduced 2016 capital spending plans, reflecting delays in planned drilling or exploration projects, and, in some cases, termination of projects altogether. Rig tenders are infrequent and have generally been limited to short-term or well-to-well work not commencing until 2017 or later. There have been very few rig tenders thus far in 2016.
As a result of the depressed market conditions and continued pessimistic outlook for the near term, certain of Diamond Offshore’s customers, as well as those of its competitors, have attempted to renegotiate or terminate existing drilling contracts. Such renegotiations could include requests to lower the contract dayrate, lowering of a dayrate in exchange for additional contract term, shortening the term on one contracted rig in exchange for additional term on another rig, early termination of a contract in exchange for a lump sum margin payout and many other possibilities. In addition to the potential for renegotiations, some of Diamond Offshore’s drilling contracts permit the customer to terminate the contract early after specified notice periods, sometimes resulting in no payment to Diamond Offshore or sometimes resulting in a contractually specified termination amount, which may not fully compensate it for the loss of the contract. During depressed market conditions, certain customers have utilized such contract clauses to seek to renegotiate or terminate a drilling contract or claim that Diamond Offshore has breached provisions of its drilling contracts in order to avoid their obligations to Diamond Offshore under circumstances where it believes it is in compliance with the contracts. Particularly during depressed market conditions, the early termination of a contract may result in a rig being idle for an extended period of time, which could adversely affect Diamond Offshore’s business. When a customer terminates a contract prior to the contract’s scheduled expiration, Diamond Offshore’s contract backlog is also adversely impacted.
As of February 16, 2016, 17 of Diamond Offshore’s rigs were not subject to a drilling contract with a customer, including 14 rigs that have been cold stacked. Of the cold stacked rigs, four jack-up rigs are currently being marketed for sale. A previously cold stacked jack-up rig was sold in February of 2016.
Globally, the ultra-deepwater and deepwater floater markets continue to be depressed. Diminished or nonexistent demand, combined with an oversupply of rigs has caused floater dayrates to decline significantly. Offshore drilling contractors have been approached by customers with binding contracts, who have sought to and have successfully renegotiated such contracts at lower rates to obtain some financial relief in the current market, and, in some cases, have terminated contracts with and without compensation to the associated drilling contractor. Industry analysts expect offshore drillers to continue to scrap older, lower specification rigs; however, newer and higher specification rigs have not been immune to the recycling trend. In addition, industry analysts predict that the number of uncontracted floaters may more than double by the end of 2016.
Diamond Offshore operates through various subsidiaries in a number of countries throughout the world. As a result, it is subject to highly complex tax laws, treaties and regulations in the jurisdictions in which it operates, which may change and are subject to interpretation. Changes in laws, treaties and regulations and the interpretation of such laws, treaties and regulations may put Diamond Offshore at risk for future tax assessments and liabilities which could be substantial and could have a material adverse effect on its financial condition and our results of operations and cash flows. Further information is provided in Notes 10 and 18 of the Notes to Consolidated Financial Statements included under Item 8.
The following table reflects the amount of Diamond Offshore’s contract drilling backlog by year as of February 16, 2016:
(a) Ultra-deepwater floaters includes (i) $90 million for the year 2016, (ii) $214 million in the aggregate for each of the years 2017 to 2018 and (iii) $123 million for the year 2019 attributable to future work for the Ocean GreatWhite, which is under construction.
The following table reflects the percentage of rig days committed by year as of February 16, 2016. The percentage of rig days committed is calculated as the ratio of total days committed under contracts, as well as scheduled shipyard, survey and mobilization days for all rigs in Diamond Offshore’s fleet, to total available days (number of rigs multiplied by the number of days in a particular year). Total available days have been calculated based on the expected final commissioning date for the Ocean GreatWhite, which is under construction.
(a) Includes approximately 535 currently known, scheduled shipyard days for rig commissioning, contract preparation, surveys and extended maintenance projects, as well as rig mobilization days for 2016.
(b) Utilization is calculated as the ratio of total revenue earning days divided by the total calendar days in the period for all rigs in Diamond Offshore’s fleet (including cold stacked rigs, but excluding rigs under construction). As of December 31, 2015, Diamond Offshore’s cold stacked rigs included one ultra-deepwater semisubmersible, two deepwater submersibles, and four mid-water semisubmersible rigs. In addition, Diamond Offshore had five cold stacked jack-up rigs which are being marketed for sale. As of December 31, 2014, six of Diamond Offshore’s mid-water semisubmersible rigs were cold stacked, all of which were sold for scrap in 2015.
(c) Utilization for Diamond Offshore’s deepwater floaters in 2015 included 365 total calendar days for the Ocean Apex, which was placed in service in December 2014.
(d) Average daily revenue is defined as total contract drilling revenue for all of the specified rigs in Diamond Offshore’s fleet per revenue earning day.
The following table summarizes the results of operations for Diamond Offshore for the years ended December 31, 2015, 2014 and 2013 as presented in Note 21 of the Notes to Consolidated Financial Statements included under Item 8:
Revenue generated by ultra-deepwater floaters increased $352 million in 2015 as compared with 2014 primarily as a result of an increase in utilization of $248 million and higher average daily revenue earned of $104 million. Total revenue earning days increased primarily due to incremental revenue days for Diamond Offshore’s newbuild drillships, the Ocean Endeavor, offshore Romania, and the Ocean Monarch, offshore Australia, partially offset by fewer revenue earning days for Diamond Offshore’s other ultra-deepwater floaters, including the early termination of drilling contracts for the Ocean Baroness and Ocean Clipper. Average daily revenue increased in 2015 primarily due to revenue associated with the operation of three additional drillships and the Ocean Endeavor, including higher amortized mobilization and contract preparation revenue and a favorable dayrate adjustment for the Ocean Courage.
Revenue generated by mid-water floaters decreased $689 million in 2015 as compared with 2014 primarily due to a decrease in utilization of $688 million. The decrease in revenue earning days resulted from the cold stacking or retirement of 12 mid-water rigs and the idling of the Ocean Guardian and Ocean Quest between contracts, partially offset by incremental revenue earning days for the Ocean Patriot, operating in the North Sea, and the Ocean Ambassador, which is expected to complete its contract offshore Mexico in the first quarter of 2016.
A net loss of $156 million in 2015 and net income of $183 million in 2014 resulted in a change of $339 million due to the impact of a $341 million asset impairment charge (after tax and noncontrolling interests) in 2015 related to the carrying value of 17 drilling rigs, as compared to the prior year when Diamond Offshore recorded a $55 million asset impairment charge (after tax and noncontrolling interests) related to the carrying values of six drilling rigs. Results in 2015 also include the recognition of a $20 million impairment charge to write off all goodwill associated with the Company’s investment in Diamond Offshore as well as higher depreciation and interest expense.
Contract drilling revenue decreased $107 million in 2014 as compared with 2013. Contract drilling revenue decreased primarily due to fewer overall revenue earning days, partially offset by higher average daily revenue primarily earned by ultra-deepwater floaters.
Diamond Offshore’s effective tax rate decreased in 2014 as compared with 2013 primarily due to differences in the mix of Diamond Offshore’s domestic and international pretax earnings and losses. Also contributing to the lower 2014 effective tax rate was the reversal of $55 million ($27 million after noncontrolling interests) of reserves for uncertain tax positions in various foreign jurisdictions which were settled in Diamond Offshore’s favor or for which the statute of limitations had expired. The 2013 period was negatively impacted by a provision of $57 million ($27 million after noncontrolling interests) related to an uncertain tax position in Egypt, partially offset by the impact of The American Taxpayer Relief Act of 2012, which reduced income tax expense by $28 million ($13 million after noncontrolling interests).
Boardwalk Pipeline derives revenues primarily from the transportation and storage of natural gas and natural gas liquids (“NGLs”) and gathering and processing of natural gas for third parties. Transportation services consist of firm natural gas transportation, where the customer pays a capacity reservation charge to reserve pipeline capacity at receipt and delivery points along pipeline systems, plus a commodity and fuel charge on the volume of natural gas actually transported, and interruptible natural gas transportation, where the customer pays to transport gas only when capacity is available and used. Boardwalk Pipeline offers firm natural gas storage services in which the customer reserves and pays for a specific amount of storage capacity, including injection and withdrawal rights, and interruptible storage and parking and lending (“PAL”) services where the customer receives and pays for capacity only when it is available and used. Boardwalk Pipeline also transports and stores NGLs. Boardwalk Pipeline’s NGL contracts for most of its services are fee based or based on minimum volume requirements, while others are dependent on actual volumes transported. Boardwalk Pipeline’s NGL storage rates are market-based and contracts are typically fixed price arrangements with escalation clauses. Boardwalk Pipeline is not in the business of buying and selling natural gas and NGLs other than for system management purposes, but changes in natural gas and NGLs prices may impact the volumes of natural gas or NGLs transported and stored by customers on its systems. Due to the capital intensive nature of its business, Boardwalk Pipeline’s operating costs and expenses typically do not vary significantly based upon the amount of products transported, with the exception of fuel consumed at its compressor stations and not included in a fuel tracker.
Transportation rates that Boardwalk Pipeline is able to charge customers are heavily influenced by longer term trends in, for example, the amount and geographical location of natural gas production and demand for gas by end users such as power plants, petrochemical facilities and liquefied natural gas (“LNG”) export facilities. Changes in certain longer term trends such as the development of gas production from the Marcellus and Utica production areas located in the northeastern U.S. and changes to related pipeline infrastructure have resulted in a sustained narrowing of basis differentials corresponding to traditional flow patterns on Boardwalk Pipeline’s natural gas pipeline systems (generally south to north and west to east), reducing the transportation rates and adversely impacting other contract terms that Boardwalk Pipeline can negotiate with its customers for available transportation capacity and for contracts due for renewal for Boardwalk Pipeline’s transportation services. These conditions have had, and Boardwalk Pipeline expects will continue to have, a material adverse effect on Boardwalk Pipeline’s revenues, earnings and distributable cash flows. Further, during 2015, the prices of oil and natural gas declined significantly
The value of Boardwalk Pipeline’s storage and PAL services (comprised of parking gas for customers and/or lending gas to customers) is affected by natural gas price differentials between time periods, such as winter to summer (time period price spreads), price volatility of natural gas and other factors. Boardwalk Pipeline’s storage and parking services have greater value when the natural gas futures market is in contango (a positive time period price spread, meaning that current price quotes for delivery of natural gas further in the future are higher than in the nearer term), while its lending service has greater value when the futures market is backwardated (a negative time period price spread, meaning that current price quotes for delivery of natural gas in the nearer term are higher than further in the future). The value of both storage and PAL services may also be favorably impacted by increased volatility in the price of natural gas, which allows Boardwalk Pipeline to optimize the value of its storage and PAL capacity.
Maintenance costs may be capitalized or expensed, depending on the nature of the activities. For any given reporting period, the mix of projects that Boardwalk Pipeline undertakes will affect the amounts it records as property, plant and equipment on its balance sheet or recognize as expenses, which impacts Boardwalk Pipeline’s earnings. In 2016, Boardwalk Pipeline expects to incur approximately $330 million to maintain its pipeline systems, of which approximately $130 million is expected to be maintenance capital. In 2015, these costs were $352 million, of which $143 million was recorded as maintenance capital. The projected decrease of approximately $22 million is primarily driven by the completion, in 2015, of maintenance activities associated with certain brine facilities. The maintenance capital amounts discussed above reflect pipeline integrity upgrades associated with certain segments of Boardwalk Pipeline’s natural gas pipelines which will be completed over the ensuing three years.
Credit risk relates to the risk of loss resulting from the nonperformance by a customer of its contractual obligations. Boardwalk Pipeline actively monitors its customers’ credit profiles, as well as, the portion of its revenues generated from investment-grade and non-investment-grade customers. Approximately $1.0 billion of operating revenues in 2015 were earned from Boardwalk Pipeline’s top 50 customers. While almost all of these customers are rated investment-grade by at least one of the major credit rating agencies, many oil and gas producers have recently had their ratings placed under review.
The following table summarizes the results of operations for Boardwalk Pipeline for the years ended December 31, 2015, 2014 and 2013 as presented in Note 21 of the Notes to Consolidated Financial Statements included under Item 8:
Net income for 2014 decreased $60 million as compared to 2013 period primarily reflecting the Bluegrass Project related charge and higher operations, maintenance and depreciation expense, partially offset by the prior year goodwill impairment charge of $16 million (after tax and noncontrolling interests) discussed further below.
The following table summarizes the results of operations for Loews Hotels for the years ended December 31, 2015, 2014 and 2013 as presented in Note 21 of the Notes to Consolidated Financial Statements included under Item 8:
Operating and depreciation expenses increased $116 million and $17 million in 2015 as compared with 2014 primarily due to the acquisition of two hotels during 2015 and three hotels during 2014.
Interest expense increased $7 million in 2015 as compared with 2014 primarily due to higher debt levels, including refinancings and new property-level debt incurred to fund acquisitions.
Equity income from joint venture properties increased $12 million in 2014 as compared to 2013. The increase was primarily due to improved performance of the Universal Orlando properties, including the addition of Universal’s Cabana Bay Beach Resort.
Losses from discontinued operations (after tax and noncontrolling interests) were $371 million and $554 million for the years ended December 31, 2014 and 2013. Results for the year ended December 31, 2014 reflect an impairment charge of $138 million related to the sale of HighMount, a ceiling test impairment charge of $19 million and losses from HighMount operations of $37 million, including exit and disposal costs related to the sale. Results for the year ended December 31, 2013 include a goodwill impairment charge of $382 million and a ceiling test impairment charge of $186 million.
For 2015, net cash provided by operating activities was $1.4 billion for each of 2015 and 2014. In 2015, cash provided by operating activities reflected lower premiums collected and decreased receipts relating to returns on limited partnerships, offset by lower net claim payments. In 2014, cash provided by operating activities reflected increased receipts relating to returns on limited partnerships and lower net claim payments, substantially offset by increased tax payments. Net cash provided by operating activities was $1.2 billion in 2013. In 2013, CNA contributed $75 million to the CNA Retirement Plan.
Ratings are an important factor in establishing the competitive position of insurance companies. CNA’s insurance company subsidiaries are rated by major rating agencies and these ratings reflect the rating agency’s opinion of the insurance company’s financial strength, operating performance, strategic position and ability to meet its obligations to policyholders. Agency ratings are not a recommendation to buy, sell or hold any security and may be revised or withdrawn at any time by the issuing organization. Each agency’s rating should be evaluated independently of any other agency’s rating. One or more of these agencies could take action in the future to change the ratings of CNA’s insurance subsidiaries.
The table below reflects the various group ratings issued by A.M. Best Company (“A.M. Best”), Moody’s Investors Service, Inc. (“Moody’s”) and Standard & Poor’s (“S&P”). The table also includes the ratings for CNA senior debt.
Cash and investments totaled $130 million at December 31, 2015, compared to $250 million at December 31, 2014. In 2015, Diamond Offshore paid regular cash dividends totaling $69 million. On February 8, 2016, Diamond Offshore announced that its Board of Directors was discontinuing its quarterly regular cash dividend.
Cash provided by operating activities was $736 million in 2015, compared to $993 million in 2014, a decrease of $257 million, primarily due to a decrease in cash receipts from contract drilling services of $445 million, partially offset by a $144 million net decrease in cash payments for contract drilling and general and administrative expenses, including personnel-related, maintenance, mobilization and other rig operating costs and lower income taxes paid, net of refunds of $44 million. The decline in cash receipts from and cash payments related to contract drilling services both reflect an aggregate decline in Diamond Offshore’s contract drilling operations as well as its efforts to control costs. The $73 million decrease in cash provided by operating activities in 2014 compared to 2013 was primarily due to higher cash payments related to contract drilling expenses of $77 million and higher interest payments of $51 million on senior notes.
As of December 31, 2015, Diamond Offshore had $287 million in commercial paper notes outstanding with a weighted average interest rate of 0.86% and a weighted average remaining term of 5.8 days that was repaid in January of 2016. As of February 16, 2016, Diamond Offshore had no commercial paper notes outstanding.
In January of 2016, Moody’s Investor Service, Inc. (“Moody’s”) announced that it would be reviewing Diamond Offshore’s long-term corporate credit and unsecured debt rating and short-term credit rating for commercial paper, which are currently Baa2 and Prime-2, for possible downgrade. Diamond Offshore’s current corporate credit rating is BBB+ and its short-term credit rating is A2 for Standard & Poor’s (“S&P”). Market conditions and other factors, many of which are outside of Diamond Offshore’s control, could cause its credit ratings to be lowered. A downgrade in Diamond Offshore’s credit ratings could adversely impact its cost of issuing additional debt and the amount of additional debt that it could issue and could restrict Diamond Offshore’s access to its commercial paper program and capital markets and its ability to raise additional debt or rollover existing maturities. As a consequence, Diamond Offshore may not be able to issue additional debt in amounts and/or with terms that it considers to be reasonable. One or more of these occurrences could limit Diamond Offshore’s ability to pursue other business opportunities.
Certain of Diamond Offshore’s international rigs are owned and operated, directly or indirectly, by Diamond Foreign Asset Company (“DFAC”), and as a result of Diamond Offshore’s intention to indefinitely reinvest the earnings of DFAC and its foreign subsidiaries to finance Diamond Offshore’s foreign activities, Diamond Offshore does not expect such earnings to be available for distribution to its stockholders or to finance its domestic activities. To the extent available, Diamond Offshore expects to utilize the operating cash flows generated by and cash reserves of DFAC, and the operating cash flows available to and cash reserves of Diamond Offshore Drilling, Inc. to meet each entity’s respective working capital requirements and capital commitments. Diamond Offshore, may, from time to time, issue debt or equity securities, or a combination thereof, to finance capital expenditures, the acquisition of assets and businesses or for general corporate purposes. Diamond Offshore’s ability to access the capital markets by issuing debt or equity securities will be dependent on its results of operations, current financial condition, current credit ratings, current market conditions and other factors beyond its control.
Boardwalk Pipeline anticipates that for 2016 its existing capital resources, including the revolving credit facility, a subordinated loan agreement with a subsidiary of the Company and cash flows from operating activities will be adequate to fund its operations, including its planned capital expenditures. The subordinated loan agreement provides borrowings of up to $300 million with a draw period through December 31, 2016 and matures in July of 2024, subject to certain mandatory pre-payment requirements. Boardwalk Pipeline may seek to access the capital markets to fund some or all capital expenditures for future growth projects or acquisitions, or to repay or refinance all or a portion of its indebtedness, a significant amount of which matures in the next five years.
Most of Boardwalk Pipeline’s senior unsecured debt is rated by independent credit rating agencies. Boardwalk Pipeline’s credit ratings affect its ability to access the public and private debt markets, as well as the terms and the cost of borrowings. The ability to satisfy financing requirements or fund planned growth capital expenditures will depend upon Boardwalk Pipeline’s future operating performance and the ability to access the capital markets, which are affected by economic factors in its industry as well as other financial and business factors, some of which are beyond Boardwalk Pipeline’s control. The table below reflects the various group ratings issued by S&P, Moody’s and Fitch Ratings, Inc. (“Fitch”) for Boardwalk Pipeline’s senior unsecured notes and that of its operating subsidiaries having outstanding rated debt as of February 17, 2016.
Cash and investments totaled $93 million at December 31, 2015, as compared to $84 million at December 31, 2014.
In 2015 and January of 2016, Loews Hotels purchased three hotel properties and a joint venture equity interest in a hotel property for approximately $445 million, funded with capital contributions from us and property level debt. In 2015, Loews Hotels received proceeds of $177 million from mortgage loan agreements in connection with one of the 2015 acquisitions and refinancing of $83 million in existing debt. Funds for future capital expenditures, including acquisitions of new properties, renovations and working capital requirements are expected to be provided from operations, newly incurred debt, existing cash balances and advances or capital contributions from us.
During 2016, Loews Hotels plans on making capital improvements of approximately $75 million in connection with extensive renovations to several hotel properties, during which time the revenues and earnings of Loews Hotels are expected to be adversely affected.
Parent Company cash and investments, net of receivables and payables at December 31, 2015 totaled $4.3 billion, as compared to $5.1 billion at December 31, 2014. In 2015, we received $816 million in dividends from our subsidiaries, including a special dividend from CNA of $485 million. Cash outflows included, among other corporate overhead costs, the payment of $1.3 billion to fund treasury stock purchases, $29 million to purchase shares of Diamond Offshore, $90 million of cash dividends to our shareholders and net cash contributions of approximately $260 million to our subsidiaries, primarily Loews Hotels.
(b) Claim and claim adjustment expense reserves are not discounted and represent CNA’s estimate of the amount and timing of the ultimate settlement and administration of gross claims based on its assessment of facts and circumstances known as of December 31, 2015. See the Reserves - Estimates and Uncertainties section of this MD&A for further information.
We enter into short sales and invest in certain derivative instruments that are used for asset and liability management activities, income enhancements to our portfolio management strategy and to benefit from anticipated future movements in the underlying markets. If such movements do not occur as anticipated, then significant losses may occur. Monitoring procedures include senior management review of daily detailed reports of existing positions and valuation fluctuations to ensure that open positions are consistent with our portfolio strategy.
Net investment income after tax and noncontrolling interests decreased $131 million in 2015 as compared with 2014. The decrease was driven by limited partnership investments, which returned 3.0% in 2015 as compared with 9.7% in the prior year. Income from fixed maturity securities decreased by $30 million, after tax and noncontrolling interests, driven by a $22 million, after tax and noncontrolling interests, change in estimate effected by a change in accounting principle to better reflect the yield on fixed maturity securities that have call provisions. Additionally, income from fixed maturity securities decreased due to lower reinvestment rates, partially offset by favorable changes in estimates for prepayments for asset-backed securities. Additional information on the accounting change is included in Note 1 of the Notes to Consolidated Financial Statements included under Item 8.
As of December 31, 2015 and 2014, only 1% of CNA’s fixed maturity portfolio was rated internally.
A primary objective in the management of the investment portfolio is to optimize return relative to corresponding liabilities and respective liquidity needs. CNA’s views on the current interest rate environment, tax regulations, asset class valuations, specific security issuer and broader industry segment conditions and the domestic and global economic conditions, are some of the factors that enter into an investment decision. CNA also continually monitors exposure to issuers of securities held and broader industry sector exposures and may from time to time adjust such exposures based on its views of a specific issuer or industry sector.
A further consideration in the management of the investment portfolio is the characteristics of the corresponding liabilities and the ability to align the duration of the portfolio to those liabilities and to meet future liquidity needs, minimize interest rate risk and maintain a level of income sufficient to support the underlying insurance liabilities. For portfolios where future liability cash flows are determinable and typically long term in nature, CNA segregates investments for asset/liability management purposes. The segregated investments support the long term care and structured settlement liabilities in the Life & Group Non-Core business.
The effective durations of fixed maturity securities and short term investments are presented in the following table. Amounts presented are net of accounts payable and receivable amounts for securities purchased and sold, but not yet settled.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for us. Our internal control system was designed to provide reasonable assurance to our management and Board of Directors regarding the preparation and fair presentation of published financial statements.
We have audited the internal control over financial reporting of Loews Corporation and subsidiaries (the “Company”) as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying management’s report on internal control over financial reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2015 of the Company and our report dated February 19, 2016 expressed an unqualified opinion on those consolidated financial statements and financial statement schedules.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Loews Corporation and subsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Basis of presentation - Loews Corporation is a holding company. Its subsidiaries are engaged in the following lines of business: commercial property and casualty insurance (CNA Financial Corporation (“CNA”), a 90% owned subsidiary); the operation of offshore oil and gas drilling rigs (Diamond Offshore Drilling, Inc. (“Diamond Offshore”), a 53% owned subsidiary); transportation and storage of natural gas and natural gas liquids and gathering and processing of natural gas (Boardwalk Pipeline Partners, LP (“Boardwalk Pipeline”), a 51% owned subsidiary); and the operation of a chain of hotels (Loews Hotels Holding Corporation (“Loews Hotels”), a wholly owned subsidiary). Unless the context otherwise requires, the terms “Company,” “Loews” and “Registrant” as used herein mean Loews Corporation excluding its subsidiaries and the term “Net income (loss) attributable to Loews Corporation” as used herein means Net income (loss) attributable to Loews Corporation shareholders.
Investments - The Company classifies its fixed maturity securities and equity securities as either available-for-sale or trading, and as such, they are carried at fair value. Short term investments are carried at fair value. Changes in fair value of trading securities are reported within Net investment income on the Consolidated Statements of Income. Changes in fair value related to available-for-sale securities are reported as a component of Other comprehensive income. Losses may be recognized within the Consolidated Statements of Income when a decline in value is determined by the Company to be other-than-temporary.
To the extent that unrealized gains on fixed income securities supporting long term care products and structured settlements not funded by annuities would result in a premium deficiency if those gains were realized, a related decrease in Deferred acquisition costs and/or increase in Insurance reserves are recorded, net of tax and noncontrolling interests, as a reduction of net unrealized gains through Other comprehensive income (“Shadow Adjustments”). Shadow Adjustments decreased $159 million (after tax and noncontrolling interests) and increased $679 million (after tax and noncontrolling interests) for the years ended December 31, 2015 and 2014. As of December 31, 2015 and 2014, net unrealized gains on investments included in Accumulated other comprehensive income (“AOCI”) were correspondingly reduced by $996 million and $1.2 billion (after tax and noncontrolling interests).
For asset-backed securities included in fixed maturity securities, the Company recognizes income using an effective yield based on anticipated prepayments and the estimated economic life of the securities. When estimates of prepayments change, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The amortized cost of high credit quality fixed rate securities is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the securities. Such adjustments are reflected in Net investment income on the Consolidated Statements of Income. Interest income on lower rated and variable rate securities is determined using the prospective yield method.
Significant judgment is required in the determination of whether an OTTI loss has occurred for a security. CNA follows a consistent and systematic process for determining and recording an OTTI loss. CNA has established a committee responsible for the OTTI process referred to as the Impairment Committee. The Impairment Committee is responsible for evaluating all securities in an unrealized loss position on at least a quarterly basis.
Workers’ compensation lifetime claim reserves are calculated using mortality assumptions determined through statutory regulation and economic factors. Accident and health claim reserves are calculated using mortality and morbidity assumptions based on CNA and industry experience. Workers’ compensation lifetime claim reserves and accident and health claim reserves are discounted at interest rates ranging from 3.5% to 6.8% at December 31, 2015 and 2014. At December 31, 2015 and 2014, such discounted reserves totaled $2.6 billion and $2.5 billion, net of discount of $653 million and $654 million.
Future policy benefits reserves - Future policy benefit reserves represent the active life reserves related to CNA’s long term care policies and are computed using the net level premium method, which incorporates actuarial assumptions as to morbidity, persistency, discount rate and expenses. Expense assumptions primarily relate to claim adjudication. Actuarial assumptions generally vary by plan, age at issue and policy duration. The initial assumptions are determined at issuance, include a margin for adverse deviation and are locked in throughout the life of the contract unless a premium deficiency develops. If a premium deficiency emerges, the assumptions are unlocked and deferred acquisition costs, if any, and the future policy benefit reserves are adjusted. The December 31, 2015 gross premium valuation indicated a premium deficiency of $296 million. The indicated premium deficiency necessitated a charge to income that was effected by the write off of the entire long term care deferred acquisition cost asset of $289 million and an increase to active life reserves of $7 million. As a result, the long term care active life reserves carried as of December 31, 2015 represent management’s best estimate assumptions at that date with no margin for adverse deviation. Interest rates for long term care products range from 6.6% to 7.0% at December 31, 2015 and 4.5% to 7.9% as of December 31, 2014.
Reinsurance contracts that do not effectively transfer the economic risk of loss on the underlying policies are recorded using the deposit method of accounting, which requires that premium paid or received by the ceding company or assuming company be accounted for as a deposit asset or liability. CNA had $3 million recorded as deposit assets at December 31, 2015 and 2014, and $8 million and $9 million recorded as deposit liabilities as of December 31, 2015 and 2014. Income on reinsurance contracts accounted for under the deposit method is recognized using an effective yield based on the anticipated timing of payments and the remaining life of the contract. When the anticipated timing of payments changes, the effective yield is recalculated to reflect actual payments to date and the estimated timing of future payments. The deposit asset or liability is adjusted to the amount that would have existed had the new effective yield been applied since the inception of the contract.
Deferred acquisition costs - Deferrable acquisition costs include commissions, premium taxes and certain underwriting and policy issuance costs which are incremental direct costs of successful contract acquisitions. Deferred acquisition costs related to long term care contracts issued prior to January 1, 2004 include costs which vary with and are primarily related to the acquisition of business.
As noted under Future policy benefit reserves, all of the long term care deferred acquisition costs of $289 million were written off as of December 31, 2015 in recognition of a premium deficiency. Deferred acquisition costs related to long term care contracts are amortized over the premium-paying period of the related policies using assumptions consistent with those used for computing future policy benefit reserves for such contracts. Assumptions are made at the date of policy issuance or acquisition and are consistently applied during the lives of the contracts. Deviations from estimated experience are included in results of operations when they occur. For these contracts, the amortization period is typically the estimated life of the policy.
CNA evaluates deferred acquisition costs for recoverability. Anticipated investment income is considered in the determination of the recoverability of deferred acquisition costs. Adjustments, if necessary, are recorded in current period results of operations.
The increase (decrease) in fair value recognized for the years ended December 31, 2015, 2014 and 2013 on contracts still held was $1 million, $8 million and $(2) million. The gains recognized during the years ended December 31, 2015, 2014 and 2013 on contracts that settled were $24 million, $25 million and $15 million.
Income taxes - The Company and its eligible subsidiaries file a consolidated tax return. Deferred income taxes are recognized for temporary differences between the financial statement and tax return bases of assets and liabilities, based on enacted tax rates and other provisions of the tax law. The effect of a change in tax laws or rates on deferred tax assets and liabilities is recognized in income in the period in which such change is enacted. Future tax benefits are recognized to the extent that realization of such benefits is more likely than not, and a valuation allowance is established for any portion of a deferred tax asset that management believes may not be realized.
The Company recognizes uncertain tax positions that it has taken or expects to take on a tax return. The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information. See Note 10 for additional information on the provision for income taxes.
Pension and postretirement benefits - The Company recognizes the overfunded or underfunded status of its defined benefit plans in Other assets or Other liabilities in the Consolidated Balance Sheets. Changes in funded status related to prior service costs and credits and actuarial gains and losses are recognized in the year in which the changes occur through Accumulated other comprehensive income (loss). The Company measures its benefit plan assets and obligations at December 31. Annual service cost, interest cost, expected return on plan assets, amortization of prior service costs and credits and amortization of actuarial gains and losses are recognized in the Consolidated Statements of Income.
The Company recognized compensation expense that decreased net income by $14 million, $12 million and $11 million for the years ended December 31, 2015, 2014 and 2013. Several of the Company’s subsidiaries also maintain their own stock option plans. The amounts reported above include the Company’s share of expense related to its subsidiaries’ plans.
In January of 2016, the FASB issued ASU 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 primary change for the Company is expected 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. The updated guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the effect the updated guidance will have on its consolidated financial statements.
In connection with the sale of CAC, CNA entered into a 100% coinsurance agreement on a separate small block of annuity business outside of CAC. The coinsurance agreement required the transfer of assets with a book value equal to the ceded reserves on the inception date of the contract. Because a substantial portion of the assets supporting these liabilities are held in trust for the benefit of the original cedant, those assets were transferred on a funds withheld basis. Under this approach CNA maintains legal ownership of the assets, but the investment income and realized gains and losses on those assets inure to the reinsurer. As a result, the $31 million (after tax and noncontrolling interests) difference between market value and book value of the funds withheld assets at the coinsurance contract’s inception was recognized in Other operating expenses in 2014.
(a) Includes net unrealized gains (losses) related to changes in fair value on trading securities still held of $(46), $42 and $(2) for the years ended December 31, 2015, 2014 and 2013.
As of December 31, 2015, the Company held $54 million of non-income producing fixed maturity securities. As of December 31, 2014, the Company held no non-income producing fixed maturity securities. As of December 31, 2015 and 2014, no investments in a single issuer exceeded 10% of shareholders’ equity other than investments in securities issued by the U.S. Treasury and obligations of government-sponsored enterprises.
Net change in unrealized gains (losses) on available-for-sale investments is as follows:
The following table presents available-for-sale fixed maturity securities by contractual maturity.
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 include: (i) the review of pricing service or broker pricing methodologies, (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) detailed analysis, 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.
The tables below present reconciliations for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2015 and 2014:
In 2014, Diamond Offshore took delivery of three ultra-deepwater drillships and two deepwater floaters. The aggregate net book value of these newly constructed rigs was $2.7 billion at December 31, 2014, of which $1.3 billion was reported in Construction in process at December 31, 2013. At December 31, 2014, Construction in process included $439 million related to two rigs still under construction.
At December 31, 2015, $14 million net book value of five jack-up rigs held for sale was included in Other assets on the Consolidated Balance Sheets. One of these jack-up rigs held for sale was sold in February 2016 for $8 million. In addition, during 2015, nine rigs with an aggregate net book value of $5 million were sold at a nominal gain.
Diamond Offshore utilizes an undiscounted projected probability-weighted cash flow analysis in testing an asset for potential impairment. A matrix of assumptions is developed for each rig under evaluation using multiple utilization/dayrate scenarios, to each of which Diamond Offshore assigns a probability of occurrence. Diamond Offshore arrives at a projected probability-weighted cash flow for each rig based on the respective matrix and compares such amount to the carrying value of the asset to assess recoverability.
The underlying assumptions and assigned probabilities of occurrence for utilization and dayrate scenarios are developed using a methodology that examines historical data for each rig, which considers the rig’s age, rated water depth and other attributes and then assesses its future marketability in light of the current and projected market environment at the time of assessment. Other assumptions, such as operating, maintenance and inspection costs, are estimated using historical data adjusted for known developments and future events that are anticipated by management at the time of the assessment.
Diamond Offshore estimated the fair value of 16 of the impaired rigs utilizing a market approach, which required it to estimate the value that would be received for each rig in the principal or most advantageous market for that rig in an orderly transaction between market participants. Such estimates were based on various inputs, including historical contracted sales prices for similar rigs in the fleet, nonbinding quotes from rig brokers and/or indicative bids, where applicable. The fair value of the one remaining rig impaired in 2015 is estimated using an income approach, as Diamond Offshore has determined that the most likely use for this rig would be to cold stack the rig and reintroduce it into the market at a later date. The fair value of this rig was determined by discounting its future cash flows and includes assumptions which utilize significant unobservable inputs, including those related to estimated dayrate revenue, rig utilization, estimated equipment upgrade and regulatory survey costs, as well as estimated proceeds that may be received on ultimate disposition of the rig. The fair value estimates are representative of Level 3 fair value measurements due to the significant level of estimation involved and the lack of transparency as to the inputs used.
In the third quarter of 2014, Diamond Offshore determined it would retire and scrap six rigs, including a rig upon completion of its contract term in 2015. Diamond Offshore performed an impairment analysis to determine whether the carrying amount of these assets was recoverable. Based on this analysis, an impairment loss was recognized aggregating $109 million ($55 million after tax and noncontrolling interests) for the year ended December 31, 2014. The fair value was determined through discussions and a quote from a rig broker, and for the rig under contract using an internally developed income approach, which are Level 3 inputs of the fair value hierarchy. In the fourth quarter of 2014, two of the rigs were scrapped and at December 31, 2014, the carrying value of the remaining rigs amounted to $9 million. The remaining rigs impaired in 2014 were sold in 2015.
The impairment losses recorded during the years ended December 31, 2015 and 2014 are reported within Other operating expenses on the Consolidated Statements of Income. No impairment loss was recorded during the year ended December 31, 2013.
CNA’s property and casualty insurance claim and claim adjustment expense reserves represent the estimated amounts necessary to resolve all outstanding claims, including claims that are incurred but not reported (“IBNR”) as of the reporting date. CNA’s reserve projections are based primarily on detailed analysis of the facts in each case, CNA’s experience with similar cases and various historical development patterns. Consideration is given to such historical patterns as field reserving trends and claims 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
Catastrophes are an inherent risk of the property and casualty insurance business and have contributed to material period-to-period fluctuations in CNA’s results of operations and/or equity. CNA reported catastrophe losses, net of reinsurance, of $141 million, $156 million and $169 million for the years ended December 31, 2015, 2014 and 2013. Catastrophe losses in 2015 related primarily to U.S. weather-related events.
The following table and discussion presents further detail of the net prior year claim and allocated claim adjustment expense reserve development (“development”) recorded for the Specialty segment:
Favorable development for general liability was primarily due to favorable settlements on claims in accident years 2010 through 2013.
Favorable development for property and other was primarily due to better than expected claim emergence from 2012 and 2014 catastrophe events and better than expected frequency of large claims in accident year 2014.
Favorable development of $26 million was recorded in accident years 1996 and prior related to the commutation of a workers’ compensation reinsurance pool.
Unfavorable development for commercial auto coverages was primarily due to higher than expected frequency in accident years 2011 and 2012 and large loss emergence in accident years 2009 and 2010.
Unfavorable development for workers’ compensation includes CNA’s response to legislation enacted during 2013 related to the New York Fund for Reopened Cases. The law change necessitated an increase in reserves as re-opened workers’ compensation claims can no longer be turned over to the state for handling and payment after December 31, 2013. Additional unfavorable development was recorded in accident year 2012 related to increased frequency and severity on claims related to DBA contractors and in accident year 2010 due to higher than expected large losses and increased severity in the state of California.
Favorable development in liability was due to better than expected large loss emergence in accident years 2012 and prior.
Favorable development for property and marine coverages primarily related to better than expected frequency of large claims in accident years 2012 and prior.
Through December 31, 2013, CNA recorded $0.9 billion of additional amounts ceded under the LPT. As a result, the cumulative amounts ceded under the loss portfolio transfer exceeded the $2.2 billion consideration paid, resulting in a deferred retroactive reinsurance gain. This deferred gain is recognized in earnings in proportion to actual recoveries under the loss portfolio transfer. Over the life of the contract, there is no economic impact as long
as any additional losses are within the limit under the contract. In a period in which the estimate of ceded losses is changed, the required change to the deferred gain is cumulatively recognized in earnings as if the revised estimate was available at the inception of the LPT. The effect of the deferred retroactive reinsurance benefit is recorded in Insurance claims and policyholders’ benefits in the Consolidated Statements of Income.
The fourth quarter of 2014 A&EP reserve review was not completed in 2014 because additional information and analysis on inuring third party reinsurance recoveries were needed to finalize the review. The review was finalized in the second quarter of 2015. Unfavorable development was due to a decrease in anticipated future reinsurance recoveries related to asbestos claims and higher than expected severity on pollution claims. CNA adopted the second quarter of the year as the timing for all future annual A&EP claims actuarial reviews.
Leases cover office facilities, machinery and computer equipment. The Company’s hotels in some instances are constructed on leased land. Rent expense amounted to $85 million, $94 million and $83 million for the years ended December 31, 2015, 2014 and 2013. The table below presents the future minimum lease payments to be made under non-cancelable operating leases along with lease and sublease minimum receipts to be received on owned and leased properties.
For 2013 through 2015, the Internal Revenue Service (“IRS”) has accepted the Company into the Compliance Assurance Process (“CAP”), which is a voluntary program for large corporations. Under CAP, the IRS conducts a real-time audit and works contemporaneously with the Company to resolve any issues prior to the filing of the tax return. The Company believes this approach should reduce tax-related uncertainties, if any. Although the outcome of tax audits is always uncertain, the Company believes that any adjustments resulting from audits will not have a material impact on its results of operations, financial position and cash flows. The Company and/or its subsidiaries also file income tax returns in various state, local and foreign jurisdictions. These returns, with few exceptions, are no longer subject to examination by the various taxing authorities before 2011.
Provision has been made for the expected U.S. federal income tax liabilities applicable to undistributed earnings of subsidiaries, except for certain subsidiaries for which the Company intends to invest the undistributed earnings indefinitely to finance foreign activities, or recover such undistributed earnings tax-free. The determination of the amount of the unrecognized deferred tax liability on approximately $2.0 billion of undistributed earnings related to foreign subsidiaries is not practicable.
(a) Includes $19 and $14 of deferred tax assets reflected in Other assets in the Consolidated Balance Sheets at December 31, 2015 and 2014.
Federal net operating loss carryforwards of $138 million expire in 2034 and 2035. Net operating loss carryforwards in foreign tax jurisdictions of $66 million expire between 2020 and 2025 and $32 million can be carried forward indefinitely. Federal tax credit carryforwards of $83 million have indefinite lives and $46 million of foreign tax credit carryforwards expire in 2024 and 2025.
During the third quarter of 2015, CNA entered into a new credit agreement with a syndicate of banks and simultaneously terminated the previous credit agreement. The new credit agreement established a five-year $250 million senior unsecured revolving credit facility which may be used for general corporate purposes. At CNA’s election, the commitments under the new credit agreement may be increased from time to time up to an additional aggregate amount of $100 million and the new credit agreement includes two optional one-year extensions prior to the first and second anniversary of the closing date, subject to applicable consents. As of December 31, 2015 and 2014, there were no outstanding borrowings under the credit agreements and CNA was in compliance with all covenants.
Dividends of $0.25 per share on the Company’s common stock were declared and paid in 2015, 2014 and 2013.
Boardwalk Pipeline sold 7.1 million common units under an equity distribution agreement with certain broker-dealers during 2015 and received net proceeds of $115 million, including a $2 million contribution from the Company to maintain its 2% general partner interest. The Company’s percentage ownership interest in Boardwalk Pipeline declined as a result of this transaction, from 53% to 51%. The Company’s carrying value exceeded the issuance price of the common units, resulting in a decrease to APIC of $2 million and an increase to AOCI of $1 million.
The long term care premium deficiency discussed in Note 1 was recorded on a GAAP basis. There was no premium deficiency for statutory accounting purposes. Statutory accounting principles requires the use of prescribed discount rates in calculating the reserves for long term care future policy benefits which are lower than the discount rates used on a GAAP basis and results in higher carried reserves relative to GAAP reserves.
Dividends from CCC are subject to the insurance holding company laws of the State of Illinois, the domiciliary state of CCC. Under these laws, ordinary dividends, or dividends that do not require prior approval by the Illinois Department of Insurance (“Department”) are determined based on the greater of the prior year’s statutory net income or 10% of statutory surplus as of the end of the prior year, as well as timing and amount of dividends paid in the preceding 12 months. Additionally, ordinary dividends may only be paid from earned surplus, which is calculated by removing unrealized gains from unassigned surplus. As of December 31, 2015, CCC is in a positive earned surplus position. The maximum allowable dividend CCC could pay during 2016 that would not be subject to the Department’s prior approval is $1.1 billion, less dividends paid during the preceding 12 months measured at that point in time. CCC paid dividends of $900 million in 2015. The actual level of dividends paid in any year is determined after an assessment of available dividend capacity, holding company liquidity and cash needs as well as the impact the dividends will have on the statutory surplus of the applicable insurance company.
In 2015, CNA eliminated future benefit accruals associated with the CNA Retirement Plan effective June 30, 2015. This amendment resulted in a $55 million curtailment which is a decrease in the plan benefit obligation liability and a reduction of the unrecognized actuarial losses included in AOCI. In connection with the curtailment, CNA remeasured the plan benefit obligation which resulted in an increase in the discount rate used to determine the benefit obligation from 3.9% to 4.0%.
The accumulated benefit obligation for all defined benefit pension plans was $3.2 billion and $3.4 billion at December 31, 2015 and 2014.
The table below presents the estimated amounts to be recognized from AOCI into net periodic cost (benefit) during 2016.
Savings Plans - The Company and its subsidiaries have several contributory savings plans which allow employees to make regular contributions based upon a percentage of their salaries. Matching contributions are made up to specified percentages of employees’ contributions. The contributions by the Company and its subsidiaries to these plans amounted to $115 million, $125 million and $120 million for the years ended December 31, 2015, 2014 and 2013.
The following table summarizes information about the Company’s stock options and SARs outstanding in connection with the Loews Plan at December 31, 2015:
The Company recorded stock based compensation expense of $6 million, $6 million and $7 million related to the Loews Plan for the years ended December 31, 2015, 2014 and 2013. The related income tax benefits recognized were $2 million for each year. At December 31, 2015, the compensation cost related to nonvested awards not yet recognized was $9 million, and the weighted average period over which it is expected to be recognized is 2.4 years.
CNA has established an allowance for doubtful accounts on reinsurance receivables. CNA reviews the allowance quarterly and adjusts the allowance as necessary to reflect changes in estimates of uncollectible balances. The allowance may also be reduced by write-offs of reinsurance receivable balances.
CNA’s largest recoverables from a single reinsurer, including ceded unearned premium reserves as of December 31, 2015 were approximately $2.4 billion from subsidiaries of Berkshire Hathaway Group, $284 million from the Gateway Rivers Insurance Company and $207 million from subsidiaries of the Hartford Insurance Group. The recoverable from the Berkshire Hathaway Group includes amounts related to third party reinsurance for which NICO has assumed the credit risk under the terms of the loss portfolio transfer as discussed in Note 8.
Insurance claims and policyholders’ benefits reported on the Consolidated Statements of Income are net of reinsurance recoveries of $2.6 billion, $1.4 billion and $1.5 billion for the years ended December 31, 2015, 2014 and 2013, including $2.3 billion, $1.5 billion and $712 million related to the significant third party captive program discussed above. Reinsurance recoveries in 2014 were unfavorably affected by the commutation of a workers’ compensation reinsurance pool.
The sum of the quarterly per share amounts may not equal per share amounts reported for year-to-date periods. This is due to changes in the number of weighted average shares outstanding and the effects of rounding for each period.
(a) Net loss for the fourth quarter of 2015 includes the impact of a $177 million charge related to recognition of a premium deficiency in CNA’s long term care business and a $182 million asset impairment charge at Diamond Offshore.
In addition, CNA has agreed to provide indemnification to third-party purchasers for certain losses associated with sold business entities or assets that are not limited by a contractual monetary amount. As of December 31, 2015, CNA had outstanding unlimited indemnifications in connection with the sales of certain of its business entities or assets that included tax liabilities arising prior to a purchaser’s ownership of an entity or asset, defects in title at the time of sale, employee claims arising prior to closing and in some cases losses arising from certain litigation and
In February of 2016, Diamond Offshore entered into a ten-year agreement with GE Oil & Gas (“GE”) to provide services with respect to certain blowout preventer and related well control equipment on its four newbuild drillships. Such services include management of maintenance, certification and reliability with respect to such equipment. In connection with the services agreement with GE, Diamond Offshore will sell the equipment to a GE affiliate for an aggregate $210 million and will lease back such equipment over separate ten-year operating leases. Diamond Offshore does not expect to realize any gain or loss on these sale and leaseback transactions. Future commitments for the full term under the services agreement and leases are estimated to aggregate approximately $650 million.
Diamond Offshore owns and operates offshore drilling rigs that are chartered on a contract basis for fixed terms by companies engaged in exploration and production of hydrocarbons. Offshore rigs are mobile units that can be relocated based on market demand. Diamond Offshore’s fleet consists of 32 drilling rigs, including one newbuild rig which is under construction, and four jack-up rigs which are being marketed for sale. On December 31, 2015, Diamond Offshore’s drilling rigs were located offshore of seven countries in addition to the United States.
Boardwalk Pipeline is engaged in the interstate transportation and storage of natural gas and NGLs and gathering and processing of natural gas. This segment consists of interstate natural gas pipeline systems originating in the Gulf Coast region, Oklahoma and Arkansas, and extending north and east through the midwestern states of Tennessee, Kentucky, Illinois, Indiana and Ohio, natural gas storage facilities in four states and NGL pipelines and storage facilities in Louisiana and Texas, with approximately 14,525 miles of pipeline.
Loews Hotels operates a chain of 24 hotels, 23 of which are in the United States and one of which is in Canada.
The following schedules present the Company’s consolidating balance sheet information at December 31, 2015 and 2014, and consolidating statements of income information for the years ended December 31, 2015, 2014 and 2013. These schedules present the individual subsidiaries of the Company and their contribution to the consolidated financial statements. Amounts presented will not necessarily be the same as those in the individual financial statements of the Company’s subsidiaries due to adjustments for purchase accounting, income taxes and noncontrolling interests. In addition, many of the Company’s subsidiaries use a classified balance sheet which also leads to differences in amounts reported for certain line items.
The Corporate and other column primarily reflects the parent company’s investment in its subsidiaries, invested cash portfolio and corporate long term debt. The elimination adjustments are for intercompany assets and liabilities, interest and dividends, the parent company’s investment in capital stocks of subsidiaries, and various reclasses of debit or credit balances to the amounts in consolidation. Purchase accounting adjustments have been pushed down to the appropriate subsidiary.