Boardwalk Pipeline’s earnings decreased primarily due to a $55 million charge (after tax and noncontrolling interests) related to the write-off of all previously capitalized costs incurred by the Company and Boardwalk Pipeline for the proposed Bluegrass project as well as higher operations, maintenance and depreciation expense in 2014. The prior year included a goodwill impairment charge of $16 million (after tax and noncontrolling interests) partially offset by a gain on the sale of storage gas of $13 million (after tax and noncontrolling interests).
Discontinued operations in 2014 include impairment charges related to the sale of HighMount and CNA’s annuity and pension deposit business as well as the operations of those businesses. Additionally, discontinued operations in 2013 included a goodwill impairment charge of $382 million (after tax), a ceiling test impairment charge of $186 million (after tax) and an impairment charge of $22 million (after tax) related to gathering pipelines at HighMount.
We are a holding company and derive substantially all of our cash flow from our subsidiaries. We rely upon our invested cash balances and distributions from our subsidiaries to generate the funds necessary to meet our obligations and to declare and pay any dividends to our shareholders. The ability of our subsidiaries to pay dividends is subject to, among other things, the availability of sufficient earnings and funds in such subsidiaries, applicable state laws, including in the case of the insurance subsidiaries of CNA, laws and rules governing the payment of dividends by regulated insurance companies (see Note 14 of the Notes to Consolidated Financial Statements included under Item 8) and compliance with covenants in their respective loan agreements. Claims of creditors of our subsidiaries will generally have priority as to the assets of such subsidiaries over our claims and those of our creditors and shareholders.
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 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.
If actual experience differs from the estimates made by management in determining the allowances for doubtful accounts on reinsurance and other receivables, net receivables as reflected on our Consolidated Balance Sheets may not be collected. Therefore, our results of operations and/or equity could be materially adversely affected.
We classify fixed maturity securities and equity securities as either available-for-sale or trading which are both carried at fair value. Fair value represents the price that would be received in a sale of an asset in an orderly transaction between market participants on the measurement date, the determination of which requires us to make a significant number of assumptions and judgments. Securities with the greatest level of subjectivity around valuation are those that rely on inputs that are significant to the estimated fair value and that are not observable in the market or cannot be derived principally from or corroborated by observable market data. These unobservable inputs are based on assumptions consistent with what we believe other market participants would use to price such securities. Further information on fair value measurements is included in Note 4 of the Notes to Consolidated Financial Statements included under Item 8.
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 rate increases it requests.
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 9 of the Notes to Consolidated Financial Statements included under Item 8.
government and private health care providers could change, potentially shifting costs to workers’ compensation;
increased uncertainty related to medical professional liability, medical products liability and workers’ compensation coverages resulting from the Patient Protection and Affordable Care Act;
To mitigate the risks posed by CNA’s exposure to A&EP claims and claim adjustment expenses, as further discussed in Note 9 of the Notes to Consolidated Financial Statements included under Item 8, on August 31, 2010, CNA completed a transaction with National Indemnity Company (“NICO”), under which substantially all of CNA’s legacy A&EP liabilities were ceded to NICO effective January 1, 2010 (“Loss Portfolio Transfer” or “LPT”).
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. Specialty, Commercial and International contain both long-tail and short-tail exposures. Other contains long-tail exposures.
The reserve analyses performed by CNA’s actuaries result in point estimates. Each quarter, the results of the detailed reserve reviews are summarized and discussed with CNA’s senior management to determine the best estimate of reserves. CNA’s senior management considers many factors in making this decision. The factors include, but are not limited to, the historical pattern and volatility of the actuarial indications, the sensitivity of the actuarial indications to changes in paid and incurred loss patterns, the consistency of claims handling processes, the consistency of case reserving practices, changes in CNA’s pricing and underwriting, pricing and underwriting trends in the insurance market and legal, judicial, social and economic trends.
CNA’s recorded reserves reflect its best estimate as of a particular point in time based upon known facts, consideration of the factors cited above and its judgment. The carried reserve may differ from the actuarial point estimate as the result of CNA’s consideration of the factors noted above as well as the potential volatility of the projections associated with the specific product being analyzed and other factors affecting claims costs that may not be quantifiable through traditional actuarial analysis. This process results in management’s best estimate which is then recorded as the loss reserve.
Currently, CNA’s recorded reserves are modestly higher than the actuarial point estimate. For Commercial, Specialty and International, the difference between CNA’s reserves and the actuarial point estimate is primarily driven by uncertainty with respect to immature accident years, claim cost inflation, changes in claims handling, changes to the tort environment which may adversely impact claim costs and the effects from the economy. For CNA’s legacy A&EP liabilities, the difference between CNA’s reserves and the actuarial point estimate is primarily driven by the potential tail volatility of run-off exposures.
For workers’ compensation, since many years will pass from the time the business is written until all claim payments have been made, claim cost inflation on claim payments is the most significant factor affecting workers’ compensation reserve estimates. Workers’ compensation claim cost inflation is driven by the cost of medical care, the cost of wage replacement, expected claimant lifetimes, judicial decisions, legislative changes and other factors. If estimated workers’ compensation claim cost inflation increases by 100 basis points for the entire period over which claim payments will be made, CNA estimates that its net reserves would increase by approximately $400 million. If estimated workers’ compensation claim cost inflation decreases by 100 basis points for the entire period over which claim payments will be made, CNA estimates that its net reserves would decrease by approximately $400 million. Net reserves for workers’ compensation were approximately $4.5 billion at December 31, 2014.
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 $3.7 billion at December 31, 2014.
CNA calculates and maintains reserves for policyholder benefits for Life & Group Non-Core, which primarily includes long term care, based on actuarial assumptions. The determination of these reserves is fundamental to its financial results and requires management to make 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.
Long term care policies provide benefits for nursing home, assisted living and home health care subject to various daily and lifetime caps. Policyholders must continue to make periodic premium payments to keep the policy in force. Generally CNA has the ability to increase policy premiums, subject to state regulatory approval.
The actuarial assumptions that management believes are subject to the most variability are discount rate, morbidity and persistency. Persistency can be affected by policy lapses and death. Discount rate is influenced by the investment yield on assets supporting long term care reserves which is subject to interest rate and market volatility. There is limited historical company and industry data available to CNA for long term care morbidity and mortality, as only a small portion of the policies written to date are in claims paying status. As a result of this variability, CNA’s long term care reserves may be subject to material increases if actual experience develops adversely to its expectations.
Annually, management assesses the adequacy of its GAAP reserves by product group 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 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 would be 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.
The level of margin in CNA’s long term care reserves at December 31, 2014 was approximately $100 million, a decrease of approximately $250 million from the prior year end. A summary of the changes in the margin is presented in the table below:
The following table summarizes the results of operations for CNA for the years ended December 31, 2014, 2013 and 2012 as presented in Note 22 of the Notes to Consolidated Financial Statements included under Item 8.
Income from continuing operations decreased $27 million in 2014 as compared with 2013 due to lower net investment income of $215 million, primarily driven by reduced limited partnership results, lower favorable net prior year development and a $31 million (after tax and noncontrolling interests) loss on the coinsurance transaction related to the sale of CNA’s annuity and pension deposit business. These decreases were partially offset by an increase of $38 million ($22 million after tax and noncontrolling interests) in investment gains, improved current accident year underwriting results and 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. See the Investments section of this MD&A for further discussion of net realized investment results and net investment income. Further information on net prior year development for 2014 and 2013 is included in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.
Income from continuing operations increased $295 million in 2013 as compared with 2012. Net investment income increased $172 million, primarily driven by a significant increase in limited partnership results. This increase was partially offset by a decrease of $35 million ($20 million after tax and noncontrolling interests) in investment gains. See the Investments section of this MD&A for further discussion of net realized investment results and net investment income. Insurance premiums increased $390 million, including an increase of $241 million related to Hardy, which was acquired in July of 2012. Insurance claims and policyholders’ benefits increased $77 million, primarily due to the impact of the $111 million (after tax and noncontrolling interests) deferred gain under retroactive reinsurance accounting related to the Loss Portfolio Transfer and lower aggregate favorable net prior year development, partially offset by lower catastrophe impacts. Further information on net prior year development for 2013 and 2012 is included in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.
As a result of realigned management responsibilities at CNA, we revised the CNA related segments in the fourth quarter of 2014 to Specialty, Commercial, International and Other Non-Core. Results of CNA Europe and Canada that were previously included in the Specialty and Commercial segments and results of Hardy that were previously included in the Other Non-Core segment are now included in the International segment. Prior period segment disclosures have been conformed to the current year presentation.
The following table summarizes the results of CNA’s property and casualty operations for the years ended December 31, 2014, 2013 and 2012.
Specialty’s average rate increased 3% in 2014 as compared with an increase of 6% in 2013, for the policies that renewed in each period. Retention of 86% and 85% was achieved in each period. Commercial’s average rate increased 5% in 2014 as compared with an increase of 9% in 2013, for the policies that renewed in each period. Retention of 74% was achieved in each period. International’s average rate decreased 1% in 2014 as compared with an increase of 1% in 2013, for the policies that renewed in each period. Retention of 74% and 79% was achieved in each period.
Favorable net prior year development decreased by $105 million, from $155 million in 2013 to $50 million in 2014. Further information on net prior year development is included in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.
Commercial’s combined ratio and loss ratio in 2014 were largely consistent with 2013. The expense ratio improved 0.3 points in 2014 as compared with 2013, primarily due to the favorable impact of recoveries on insurance receivables written off in prior years.
Net written premiums increased $385 million in 2013 as compared with 2012, including an increase of $279 million in International related to Hardy. Excluding Hardy, the increase in net written premiums was primarily driven by increased rate, partially offset by underwriting actions taken in certain business classes in Commercial. Net earned premiums increased $391 million in 2013 as compared with 2012, including $241 million in International related to Hardy. Excluding Hardy, the increase in net earned premiums was consistent with increases in net written premiums.
Specialty’s average rate increased 6% in 2013 as compared with an increase of 5% in 2012, for the policies that renewed in each period. Retention of 85% and 86% was achieved in each period. Commercial’s average rate increased 9% in 2013 as compared with an increase of 7% in 2012, for the policies that renewed in each period. Retention of 74% and 77% was achieved in each period. International’s average rate increased 1% in 2013 as compared with an increase of 2% in 2012 for the policies that renewed in each period. Retention of 79% and 80% was achieved in each period.
Net operating income increased $383 million in 2013 as compared to 2012, primarily due to improved underwriting results, higher net investment income and a legal settlement benefit of $28 million (after tax and noncontrolling interests) in 2013 for Commercial. These favorable impacts were partially offset by unfavorable net prior year development in 2013 for Commercial. Catastrophe losses were $100 million (after tax and noncontrolling interests) in 2013 as compared to $243 million (after tax and noncontrolling interests) in 2012.
Other Non-Core primarily includes the results of CNA’s individual and group long term care businesses, which are in run-off and also includes certain CNA corporate expenses, including interest on corporate debt and the results of certain property and casualty business in run-off, including CNA Re and A&EP. CNA’s group long term care business, while considered non-core, currently continues to accept new employees in existing groups.
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 annuity and pension deposit business 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.
CNA’s long term care business was positively impacted in 2013 by the effect of rate increase actions and long term care claim reserve strengthening in 2012, partially offset by unfavorable morbidity.
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.”) and Norwegian sectors of the North Sea.
Diamond Offshore is self-insured for physical damage to rigs and equipment caused by named windstorms in the U.S. Gulf of Mexico (“GOM”). If a named windstorm in the GOM causes significant damage to Diamond Offshore’s rigs or equipment, it could have a material adverse effect on its financial condition, results of operations and cash flows. Under its insurance policy that expires on May 1, 2015, Diamond Offshore carries physical damage insurance for certain losses other than those caused by named windstorms in the GOM for which its deductible for physical damage is $25 million per occurrence. Diamond Offshore does not typically retain loss-of-hire insurance policies to cover its rigs.
In declining markets, rig tenders by Diamond Offshore’s customers may be for shorter terms or on a well-to-well basis and increased competition for the tenders may drive down contract dayrates. It is also not unusual for adverse market conditions to result in the migration of some ultra-deepwater rigs to work in deepwater and, likewise, some deepwater rigs to compete against mid-water rigs, or even ultra-deepwater rigs to work in some mid-water markets. This has had and could continue to have an adverse impact on Diamond Offshore’s fleet, and particularly lower specification mid-water rigs, as indicated by the retirement of six of Diamond Offshore’s mid-water semisubmersible rigs during 2014, three of which have since been scrapped.
The impact of the depressed market conditions in the offshore drilling industry has materially impacted Diamond Offshore’s results of operations and cash flows in 2014. Diamond Offshore currently expects that these adverse conditions will continue through 2015 and likely into 2016 or even longer. The continuation of these conditions could result in more of Diamond Offshore’s rigs being without contracts and/or cold stacked and could further materially and adversely affect its business. When Diamond Offshore cold stacks a rig, they evaluate the rig for impairment.
Conditions in the mid-water market have varied by region, but have generally been adversely impacted by lower demand, the waterfall effect of declining dayrates in the ultra-deepwater and deepwater markets, the challenges experienced by lower specification rigs in this segment as a result of growing regulatory demands and more complex customer specifications, and the intensified competition resulting from the migration of some deepwater and ultra-deepwater rigs to compete against mid-water rigs. As higher specification rigs take the place of lower specification rigs, some lower specification rigs are expected to be cold stacked or ultimately scrapped.
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 11 and 19 of the Notes to Consolidated Financial Statements included under Item 8.
The following table reflects Diamond Offshore’s contract drilling backlog as of February 9, 2015, October 21, 2014 (the date reported in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2014) and February 5, 2014 (the date reported in our Annual Report on Form 10-K for the year ended December 31, 2013). Contract drilling backlog as presented below includes only firm commitments (typically represented by signed
(a) As of February 9, 2015, ultra-deepwater floaters includes (i) $1.3 billion attributable to contracted operations offshore Brazil for the years 2015 to 2018; (ii) $584 million attributable to future work for the Ocean BlackLion for the years 2015 to 2019, which is under construction; and (iii) $641 million for the years 2016 to 2019 attributable to future work for the semisubmersible Ocean GreatWhite, which is under construction.
(c) As of February 9, 2015, deepwater floaters includes $196 million attributable to contracted operations offshore Brazil for the years 2015 to 2016.
(d) As of October 21, 2014, mid-water floaters excludes $107 million in backlog attributable to contracted work for the Ocean Vanguard that is included in the February 5, 2014 backlog. As previously reported, in the second quarter of 2014, Statoil ASA (“Statoil”), the customer for the Ocean Vanguard, terminated its drilling contract, which was estimated to conclude in accordance with its terms in February of 2015. Diamond Offshore does not believe that Statoil had a valid basis for terminating the contract and it has filed a lawsuit against Statoil in Norway to collect damages resulting from the unlawful termination.
(f) As of February 9, 2015, mid-water floaters excludes $209 million attributable to the Ocean Ambassador and the Ocean Lexington. See Recent Developments above.
(g) As of February 9, 2015, jack-ups excludes $49 million attributable to the Ocean Nugget and the Ocean Summit. See Recent Developments above.
(a) As of February 9, 2015, ultra-deepwater floaters includes (i) $452 million, $333 million, $332 million and $159 million for the years 2015, 2016, 2017 and 2018, attributable to contracted operations offshore Brazil; (ii) $25 million, $146 million and $146 million for the years 2015, 2016 and 2017 and $267 million in the aggregate for the years 2018 to 2019, attributable to future work for the Ocean BlackLion, which is under construction; and (iii) $90 million for the year 2016, $214 million for the year 2017 and $337 million in the aggregate for the years 2018 to 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 9, 2015. 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 dates for both rigs under construction.
(b) Revenue earning days for the year ended December 31, 2012 included approximately 87 days earned by Diamond Offshore’s jack-up rigs during the period prior to being sold in 2012.
(c) 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, 2014, six mid-water semisubmersible drilling rigs were cold stacked, three of which Diamond Offshore plans to scrap.
(d) Utilization for Diamond Offshore’s jack-up rigs would have been 87% for the year ended December 31, 2012, excluding revenue earning days and total calendar days associated with rigs that were sold in 2012.
Revenue generated by jack-up rigs increased $4 million in 2014 as compared with 2013 primarily due to an increase in average daily revenue of $14 million as a result of higher dayrates earned by several jack-up rigs during 2014, partially offset by lower utilization of $9 million compared to the prior year period.
Revenue generated by deepwater floaters increased $19 million in 2013 as compared with 2012, as a result of higher average daily revenue of $47 million, partially offset by a decrease in utilization of $28 million. Average daily revenue increased in 2013 primarily due to the Ocean Valiant and Ocean Victory both working at significantly higher dayrates than those rigs earned in 2012, partially offset by lower amortized mobilization revenue of $5 million. The decline in revenue earning days is due to incremental unscheduled downtime for repairs, scheduled shipyard projects and mobilization of the Ocean America.
Revenue generated by mid-water floaters decreased $77 million in 2013 as compared with 2012, as a result of decreased utilization of $124 million, partially offset by higher average daily revenue of $47 million. Revenue earning days decreased primarily due to an increase in planned downtime for shipyard inspections and projects, cold stacking of a rig and non-revenue earning days associated with two customer contracts, partially offset by fewer days for the mobilization of rigs. The increase in average daily revenue is primarily due to new contracts and contract renewals for four rigs at higher dayrates than previously earned.
Revenue generated by jack-up rigs increased $14 million in 2013 as compared with 2012, primarily due to utilization of a rig which was warm stacked in 2012 earning $26 million of revenue in 2013, partially offset by the absence of revenue attributable to six jack-up rigs that Diamond Offshore sold in 2012. These rigs earned aggregate revenue of $5 million in 2012. Revenues in 2013 were further reduced by scheduled downtime for repairs for two jack-up rigs.
Diamond Offshore’s effective tax rate in 2013 increased as compared with 2012. The higher effective tax rate in 2013 is primarily the result of differences in the mix of Diamond Offshore’s domestic and international pretax earnings and losses, as well as the international jurisdictions in which Diamond Offshore operates and a $57 million ($27 million after noncontrolling interests) charge related to an uncertain tax position for Egyptian operations. The increase in the effective rate is partially offset by the recognition of the impact of The American Taxpayer Relief Act of 2012, which reduced 2013 income tax expense by $28 million ($13 million after noncontrolling interests). The Act, which was signed into law on January 2, 2013, extended through 2013 several expired temporary business provisions, commonly referred to as “extenders” which were retroactively extended to the beginning of 2012.
Boardwalk Pipeline provides natural gas transportation services to customers that are directly connected to its pipeline system and, through interconnects with third-party pipelines, to customers that are not directly connected to its system. 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. As a result of changes in 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, basis differentials corresponding to traditional flow patterns on Boardwalk Pipeline’s natural gas pipeline systems (generally south to north and west to east) have narrowed significantly in recent years, reducing the transportation rates and adversely impacting other contract terms that can be negotiated with customers for available transportation capacity and for contracts due for renewal for Boardwalk Pipeline’s transportation services. These conditions have had and are expected to continue to have a material adverse affect on Boardwalk Pipeline’s revenues, earnings and distributable cash flow.
In the second half of 2014, oil prices declined significantly and the outlook for oil prices indicated that prices could remain depressed for the foreseeable future. In 2014, approximately 51% of Boardwalk Pipeline’s revenues were generated from contracts with natural gas producers, a significant number of which are integrated oil companies. Further, several of Boardwalk Pipeline’s growth projects are supported by contracts with oil companies. Should the price of oil remain at its current level for a sustained period of time, Boardwalk Pipeline could be exposed to increased credit risk associated with the producer customer group.
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 has seen the value of its storage and PAL services adversely impacted by some of the market factors discussed above which have contributed to a narrowing of time period price spreads, which in turn has reduced the rates Boardwalk Pipeline can charge and the capacity it can sell under storage and PAL services. 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 Boardwalk Pipeline’s 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). During the first half of 2014, the futures market was significantly backwardated, partly reflecting the harsh weather conditions in late 2013 and early 2014 and Boardwalk Pipeline earned revenues from lending gas to customers under PAL services. Since then, the futures market has reverted to a contango market, although time period price spreads remain relatively narrow. Storage market fundamentals can be volatile in a relatively short period of time. Based on the current narrowing of time period price spreads and fewer market participants due to a decrease in the number of marketers taking storage positions, Boardwalk Pipeline is currently experiencing weakened demand for its storage and PAL services.
Boardwalk Pipeline incurs substantial costs for ongoing maintenance of its pipeline systems and related facilities, including those incurred for pipeline integrity management activities, equipment overhauls, general upkeep and repairs. These costs are not dependent on the amount of revenues earned from Boardwalk Pipeline’s natural gas transportation services. The Pipeline and Hazardous Materials Safety Administration (“PHMSA”) has developed regulations that require transportation pipeline operators to implement integrity management programs to comprehensively evaluate certain areas along pipelines and take additional measures to protect pipeline segments located in highly populated areas. These regulations have resulted in an overall increase in Boardwalk Pipeline’s ongoing maintenance costs, including maintenance capital and maintenance expense. PHMSA has proposed more stringent regulations, which if implemented, could require Boardwalk Pipeline to incur significant additional costs.
In January of 2015, Boardwalk Pipeline experienced a pipeline rupture on its Gulf South pipeline in a remote area north of Jackson, Mississippi. As a result, Boardwalk Pipeline took that pipeline out of service and reduced operating pressures on certain other pipeline sections. The ruptured pipeline has been repaired, though it will not be returned to service until approval has been received from PHMSA. The pipeline rupture occurred at a time when Boardwalk Pipeline was beginning to reassess its pipeline integrity plans, particularly in light of new project opportunities. To accommodate these opportunities and otherwise ensure the integrity of Boardwalk Pipeline’s pipeline systems, over the next four years, Boardwalk Pipeline will upgrade sections of its pipeline systems, resulting in additional capital expenditures.
In October of 2014, Boardwalk Pipeline’s Gulf South subsidiary filed a rate case with the Federal Energy Regulatory Commission (“FERC”) pursuant to Section 4 of the Natural Gas Act of 1938 (Docket No. RP15-65), requesting, among other things, a reconfiguration of the transportation rate zones on its system and, in general, an increase in its tariff rates. The new tariff rates are expected to become effective May 1, 2015, subject to refund, which means that Boardwalk Pipeline will be responsible for refunds if the FERC later finds that the proposed rates are not just and reasonable. The rate case is in the initial stages, therefore, the ultimate outcome and impacts on Boardwalk Pipeline’s earnings and cash flows for 2015 and beyond cannot be predicted at this time.
Total revenues increased $48 million in 2013 as compared with 2012. This increase is primarily due to $63 million of revenues earned from Boardwalk Louisiana Midstream LLC (“Louisiana Midstream”), acquired in October of 2012, a $30 million gain from the sale of storage gas and an increase in fuel revenues of $9 million primarily due to higher natural gas prices. The increase in revenues was partially offset by the market conditions discussed above, resulting in lower transportation revenues, excluding fuel, of $53 million and $4 million of reduced storage and PAL revenues.
Boardwalk Pipeline recognized a goodwill impairment charge of $52 million ($16 million after tax and noncontrolling interests) for the year ended December 31, 2013, representing the carrying value of goodwill related to its reporting unit which included goodwill associated with the acquisition of Petal Gas Storage, LLC (formerly referred to as Boardwalk HP Storage Company, LLC) in December of 2011. The fair value of the reporting unit declined from the amount determined in 2012 primarily due to the recent narrowing of time period price spreads and reduced volatility which negatively affects the value of Boardwalk Pipeline’s storage and PAL services and the cumulative effect of reduced basis spreads on the value of Boardwalk Pipeline’s transportation services.
Net income decreased $31 million in 2013 as compared with 2012 reflecting higher revenues offset by increased expenses as discussed above. The percentage of income attributable to noncontrolling interests increased as a result of equity offerings in 2012 and 2013 by Boardwalk Pipeline, decreasing our ownership percentage from 59% in 2012 to 54% in 2013.
The following table summarizes the results of operations for Loews Hotels for the years ended December 31, 2014, 2013 and 2012 as presented in Note 22 of the Notes to Consolidated Financial Statements included under Item 8:
Operating revenues increased $75 million in 2014 as compared to 2013, primarily due to current year acquisitions and the reopening in January of 2014 of the Loews Regency Hotel in New York, which was closed for renovation in 2013. These increases were partially offset by the reduction in revenue recognized by Loews Hotels as a result of the sale of equity interests in two hotels in July of 2013. For periods following the sale of these equity interests, Loews Hotels’ share of earnings or losses for these hotels is included in Equity income from joint ventures.
Reimbursable expenses relate mainly to payroll incurred by Loews Hotels on behalf of the owners of joint venture and managed hotel properties.
Operating expenses increased $52 million in 2014 as compared to 2013 primarily due to the addition of three hotels and the reopening of the Loews Regency Hotel, partially offset by a reduction in expenses as a result of the sale of equity interests in two hotels.
Interest expense increased $5 million in 2014 as compared to 2013, primarily due to the refinancing of a $125 million mortgage loan for a new $300 million mortgage loan and incremental interest expense from property-level debt incurred to fund acquisitions. These increases were partially offset by the reduction in interest expense as a result of the sale of equity interests in two hotels.
Operating expenses decreased $40 million in 2013 as compared to 2012, primarily due to the closure of the Loews Regency Hotel, partially offset by higher corporate expenses related to hotels recently acquired and under development. In addition, expenses were reduced by $3 million and $7 million in 2013 and 2012 related to recoveries of a loan guarantee payment.
The following table summarizes the results of operations for Corporate and Other for the years ended December 31, 2014, 2013 and 2012 as presented in Note 22 of the Notes to Consolidated Financial Statements included under Item 8:
Net investment income increased by $80 million in 2013 as compared to 2012, primarily due to improved performance of the equity and fixed income investments in the trading portfolio and improved performance of limited partnership investments for 2013.
Cash flows from investing activities include the purchase and disposition of available-for-sale financial instruments and may include the purchase and sale of businesses, land, buildings, equipment and other assets not generally held for resale.
Net cash used by investing activities was $918 million for 2014, as compared with $898 million and $934 million for 2013 and 2012. The cash flow from investing activities is affected by various factors such as the anticipated payment of claims, financing activity, asset/liability management and individual security buy and sell decisions made in the normal course of portfolio management.
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”) as of December 31, 2014. The table also includes the ratings for CNA senior debt.
Hardy benefits from the collective financial strength of the Lloyd’s market, which is rated A+ by S&P with a stable outlook and A by A.M. Best with a positive outlook.
Cash provided by operating activities in 2014 was $993 million, compared to $1.1 billion in 2013, a decrease of $73 million, primarily due to higher cash payments related to contract drilling expenses of $77 million and higher interest payments of $51 million on senior notes. The increase in cash outflows for 2014 was partially offset by lower cash income taxes paid in the U.S. Federal Jurisdiction and a slight increase in cash receipts from contract drilling services of $7 million.
(a) Represents expected delivery date of vessel from shipyard and does not include additional non-operating days for commissioning, contract preparation and mobilization to initial area of operation, which will occur prior to the rig being placed in service.
In September of 2014, Diamond Offshore repaid at maturity the entire $250 million principal amount of its 5.2% senior notes.
During the third quarter of 2014, S&P revised its outlook on Diamond Offshore to negative from stable and in December of 2014, lowered its corporate credit and unsecured debt ratings from A to A-. In February of 2015, Moody’s and S&P assigned short-term credit ratings of Prime-2 and A2 to Diamond Offshore’s commercial paper program. Concurrently, Moody’s and S&P affirmed Diamond Offshore’s long term corporate credit rating of A3 and
In November of 2014, Boardwalk Pipeline issued $350 million in aggregate principal amount of 5.0% Senior Notes due December 15, 2024. Boardwalk Pipeline used a portion of the $343 million in net proceeds to retire all of the outstanding $275 million aggregate principal amount of 5.1% notes due 2015 on February 2, 2015, and the remainder of the net proceeds was used to reduce outstanding borrowings under the revolving credit facility.
On September 30, 2014, we received proceeds of $787 million from the sale of HighMount, of which $480 million was used to repay indebtedness of HighMount.
We continue to pursue conservative financial strategies while seeking opportunities for responsible growth. These include the expansion of existing businesses, full or partial acquisitions and dispositions, and opportunities for efficiencies and economies of scale.
(c) Future policy benefits and policyholders’ funds reserves are not discounted and represent CNA’s estimate of the ultimate amount and timing of the settlement of benefits based on its assessment of facts and circumstances known as of December 31, 2014. Additional information on future policy benefits and policyholders’ funds reserves is included in Note 1 of the Notes to Consolidated Financial Statements included under Item 8.
(d) Does not include expected contribution of approximately $22 million to the Company’s pension and postretirement plans in 2015.
Net investment income after tax and noncontrolling interests decreased $95 million in 2014 as compared with 2013. The decrease was primarily driven by limited partnerships, which produced a rate of return of 9.7% as compared with 18.3% in the prior year. This was partially offset by an increase in fixed maturity securities investment income, after tax and noncontrolling interests, due to additional investments in tax-exempt securities.
Net investment income after tax and noncontrolling interests increased $111 million in 2013 as compared with 2012. The increase was driven by a significant increase in limited partnership investment income. Limited partnership results were positively affected by more favorable equity market returns.
Net realized investment gains increased $22 million in 2014 as compared with 2013, driven by higher net realized investment gains on sales of securities. Net realized investment gains decreased $20 million in 2013 as compared with 2012, driven by lower net realized investment gains on sales of securities, partially offset by lower other-than-temporary impairment (“OTTI”) losses recognized in earnings. Further information on CNA’s realized gains and losses, including CNA’s OTTI losses and impairment decision process, is set forth in Notes 1 and 3 of the Notes to Consolidated Financial Statements included under Item 8.
Non-investment grade fixed maturity securities, as presented in the table below, include securities rated below BBB- by bond rating agencies and other unrated securities that, according to CNA’s analysis, are below investment grade. Non-investment grade securities generally involve a greater degree of risk than investment grade securities. The amortized cost of CNA’s non-investment grade fixed maturity securities was $2.8 billion and $3.1 billion at December 31, 2014 and 2013. The following table summarizes the ratings of these securities at fair value:
There are inherent limitations to the effectiveness of any control system, however well designed, including the possibility of human error and the possible circumvention or overriding of controls. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Management must make judgments with respect to the relative cost and expected benefits of any specific control measure. The design of a control system also is based in part upon assumptions and judgments made by management about the likelihood of future events, and there can be no assurance that a control will be effective under all potential future conditions. As a result, even an effective system of internal control over financial reporting can provide no more than reasonable assurance with respect to the fair presentation of financial statements and the processes under which they were prepared.
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, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014, 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.
Loews segments are CNA Financial, including Specialty, Commercial, International and Other Non-Core; Diamond Offshore; Boardwalk Pipeline; Loews Hotels; and Corporate and other. See Note 21 for additional information on segments.
The Impairment Committee’s assessment of whether an OTTI loss has occurred incorporates both quantitative and qualitative information. Fixed maturity securities that CNA intends to sell, or it more likely than not will be required to sell before recovery of amortized cost, are considered to be other-than-temporarily impaired and the entire difference between the amortized cost basis and fair value of the security is recognized as an OTTI loss in earnings. The remaining fixed maturity securities in an unrealized loss position are evaluated to determine if a credit loss exists. The factors considered by the Impairment Committee include: (i) the financial condition and near term prospects of the issuer, (ii) whether the debtor is current on interest and principal payments, (iii) credit ratings of the securities and (iv) general market conditions and industry or sector specific outlook. CNA also considers results and analysis of cash flow modeling for asset-backed securities, and when appropriate, other fixed maturity securities.
CNA applies the same impairment model as described above for the majority of non-redeemable preferred stock securities on the basis that these securities possess characteristics similar to debt securities and that the issuers maintain their ability to pay dividends. For all other equity securities, in determining whether the security is other-
Joint venture investments - The Company has 20% to 50% interests in operating joint ventures related to hotel properties and had joint venture interests in the Bluegrass Project, as discussed in Note 2, that are accounted for under the equity method. The Company’s investment in these entities was $158 million and $242 million for the years ended December 31, 2014 and 2013 and reported in Other assets on the Company’s Consolidated Balance Sheets. Equity income (loss) for these investments was $(62) million, $12 million and $24 million for the years ended December 31, 2014, 2013 and 2012 and reported in Other operating expenses on the Company’s Consolidated Statements of Income. Some of these investments are variable interest entities (“VIE”) as defined in the accounting guidance because the entities will require additional funding from each equity owner throughout the development and construction phase and are accounted for under the equity method since the Company is not the primary beneficiary. The maximum exposure to loss for the VIE investments is $252 million, consisting of the amount of the investment and debt guarantees.
Hedging - The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedging transactions. The Company also formally assesses (both at the hedge’s inception and on an ongoing basis) whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in fair value or cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. When it is determined that a derivative for which hedge accounting has been designated is not (or ceases to be) highly effective, the Company discontinues hedge accounting prospectively. See Note 5 for additional information on the Company’s use of derivatives.
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, 2014 and 3.0% to 6.8% at December 31, 2013. At December 31, 2014 and 2013, such discounted reserves totaled $2.5 billion and $2.4 billion, net of discount of $654 million and $617 million.
Future policy benefits reserves - Reserves for long term care policies and payout annuity contracts 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. Interest rates for long term care products range from 4.5% to 7.9% at December 31, 2014 and 2013. Interest rates for payout annuity contracts ranged from 5.0% to 8.7% at December 31, 2013.
Guaranty fund and other insurance-related assessments - Liabilities for guaranty fund and other insurance-related assessments are accrued when an assessment is probable, when it can be reasonably estimated and when the event obligating the entity to pay an imposed or probable assessment has occurred. Liabilities for guaranty funds and other insurance-related assessments are not discounted and are included as part of Other liabilities on the Consolidated Balance Sheets. As of December 31, 2014 and 2013, the liability balances were $131 million and $143 million.
Amounts are considered past due based on the reinsurance contract terms. Reinsurance receivables related to paid losses and any related allowance are written off after collection efforts have been exhausted or a negotiated settlement is reached with the reinsurer. Reinsurance receivables related to paid losses from insolvent insurers are written off when the settlement due from the estate can be reasonably estimated. At the time reinsurance receivables
related to paid losses are written off, any required adjustment to reinsurance receivables related to unpaid losses is recorded as a component of Insurance claims and policyholders’ benefits on the Consolidated Statements of Income.
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, 2014 and 2013, and $9 million and $130 million recorded as deposit liabilities at December 31, 2014 and 2013. 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.
A loss portfolio transfer is a retroactive reinsurance contract. If the cumulative claim and allocated claim adjustment expenses ceded under a loss portfolio transfer exceed the consideration paid, the resulting gain from such excess is deferred and amortized into earnings in future periods in proportion to actual recoveries under the loss portfolio transfer. In the period in which an excess arises, a portion of the deferred gain is cumulatively recognized in earnings as if the revised estimate was available at the inception date of the loss portfolio transfer.
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. At December 31, 2014 and 2013, deferred acquisition costs were presented net of Shadow Adjustments of $314 million and $342 million.
Deferred acquisition costs are presented net of ceding commissions and other ceded acquisition costs. Unamortized deferred acquisition costs relating to contracts that have been substantially changed by a modification in benefits, features, rights or coverages that were not anticipated in the original contract are not deferred and are included as a charge to operations in the period during which the contract modification occurred.
The following table details the values for life settlement contracts. The determination of fair value is discussed in Note 4.
Separate account business - Separate account assets and liabilities on the Consolidated Balance Sheet as of December 31, 2013 represented contract holder funds related to investment and annuity products for which the policyholder assumes substantially all the risk and reward. The assets were segregated into accounts with specific underlying investment objectives and are legally segregated from CNA. All assets of the separate account business were carried at fair value with an equal amount recorded for separate account liabilities.
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 11 for additional information on the provision for income taxes.
Updated accounting guidance not yet adopted - In April of 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” Under the new accounting guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. The update also requires new disclosures for discontinued operations and disposals that do not meet the definition of a discontinued operation. The new accounting guidance is to be applied prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2014, and will not have a material impact on the Company’s consolidated financial statements.
In May of 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” The core principle of the new accounting guidance is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The new accounting guidance provides a five-step analysis of transactions to determine when and how revenue is recognized and requires enhanced disclosures about revenue. This update is effective for annual reporting periods beginning after December 15, 2016, including interim periods, and can be adopted either retrospectively or as a cumulative effect adjustment at the date of adoption. The Company is currently evaluating the effect that adopting this new accounting guidance will have on its consolidated financial statements.
In October of 2014, Boardwalk Pipeline acquired Boardwalk Petrochemical, formerly known as Chevron Petrochemical Pipeline, LLC, which owns the Evangeline ethylene pipeline system for $295 million in cash, subject to customary adjustments. This acquisition was made as part of Boardwalk Pipeline’s long term growth and diversification strategy and to complement existing natural gas liquids (“NGLs”) and ethylene midstream assets. The purchase price was funded through borrowings under Boardwalk Pipeline’s revolving credit facility. Boardwalk Pipeline recorded $20 million of identifiable finite-lived intangible assets and $22 million of goodwill.
On October 1, 2012, a joint venture between Boardwalk Pipeline and Boardwalk Pipeline Holding Corp. (“BPHC”) acquired Boardwalk Louisiana Midstream LLC, a company that provides salt dome storage, pipeline transportation, fractionation and brine supply services, from PL Logistics LLC for approximately $620 million. The acquisition was funded with proceeds from a $225 million five-year variable rate term loan and equity contributions by BPHC of $269 million for a 65% equity interest and of $148 million by Boardwalk Pipeline for a 35% equity interest. The joint venture recorded $25 million of identifiable finite-lived intangible assets and $52 million of goodwill. On October 15, 2012, Boardwalk Pipeline acquired BPHC’s 65% equity interest in the joint venture for $269 million, which did not result in any significant adjustments to the Consolidated Financial Statements.
(a) Includes net unrealized gains (losses) related to changes in fair value on trading securities still held of $42, $(2) and $6 for the years ended December 31, 2014, 2013 and 2012.
As of December 31, 2014 and 2013, the Company held no non-income producing fixed maturity securities. As of December 31, 2014 and 2013, 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.
(a) Includes gross realized gains of $178, $198 and $241 and gross realized losses of $136, $179 and $187 on available-for-sale securities for the years ended December 31, 2014, 2013 and 2012.
The following table summarizes available-for-sale fixed maturity securities by contractual maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid with or without call or prepayment penalties. Securities not due at a single date are allocated based on weighted average life.
The carrying value of limited partnerships as of December 31, 2014 and 2013 was approximately $3.7 billion and $3.4 billion which includes undistributed earnings of $1.3 billion and $1.2 billion. Limited partnerships comprising 72.4% of the total carrying value are reported on a current basis through December 31, 2014 with no reporting lag, 12.6% are reported on a one month lag and the remainder are reported on more than a one month lag. As of December 31, 2014 and 2013, the Company had 92 and 93 active limited partnership investments. The number of limited partnerships held and the strategies employed provide diversification to the limited partnership portfolio and the overall invested asset portfolio.
Of the limited partnerships held, 78.6% and 79.2% at December 31, 2014 and 2013 employ hedge fund strategies that generate returns through investing in marketable securities in the public fixed income and equity markets. Limited partnerships representing 18.6% and 17.8% at December 31, 2014 and 2013 were invested in private debt and equity, and the remaining limited partnerships were primarily invested in real estate strategies. Hedge fund strategies include both long and short positions in fixed income, equity and derivative instruments. These hedge fund strategies may seek to generate gains from mispriced or undervalued securities, price differentials between securities, distressed investments, sector rotation or various arbitrage disciplines. Within hedge fund strategies, approximately 57.2% were equity related, 28.3% pursued a multi-strategy approach, 10.7% were focused on distressed investments and 3.8% were fixed income related at December 31, 2014.
As of December 31, 2014, the Company had committed approximately $327 million to future capital calls from various third party limited partnership investments in exchange for an ownership interest in the related partnerships.
Securities with carrying values of approximately $3.0 billion and $3.3 billion were deposited by CNA’s insurance subsidiaries under requirements of regulatory authorities and others as of December 31, 2014 and 2013.
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, 2014 and 2013:
Assets and liabilities of discontinued operations relate to HighMount, as discussed in Notes 2 and 20. These balances represent short term investments and derivative assets and liabilities, which are valued using the methodologies and inputs for these asset and liability types described above.
The carrying amount, estimated fair value and the level of the fair value hierarchy of the Company’s financial instrument assets and liabilities which are not measured at fair value on the Consolidated Balance Sheets are listed in the tables below. The carrying amounts and estimated fair values of short term debt and long term debt exclude capital lease obligations. The carrying amounts reported on the Consolidated Balance Sheets for cash and short term investments not carried at fair value and certain other assets and liabilities approximate fair value due to the short term nature of these items.
Premium deposits and annuity contracts were valued based on cash surrender values or estimated fair values of policyholder liabilities, net of amounts ceded related to sold business.
In connection with the sale of HighMount, as discussed in Note 2, cash flow hedge accounting treatment was discontinued for all of HighMount’s commodity and interest rate swaps in 2014 and a loss of $4 million after tax was reclassified from AOCI into Discontinued operations, net for those hedges where the original forecasted transactions are no longer probable of occurring. In addition, mark-to-market losses of $2 million after tax were recognized on these derivatives in 2014.
Capitalized interest related to the construction and upgrade of qualifying assets amounted to approximately $80 million, $92 million and $43 million for the years ended December 31, 2014, 2013 and 2012.
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 $156 million, $169 million and $391 million for the years ended December 31, 2014, 2013 and 2012. Catastrophe losses in 2012 included Storm Sandy.
The table below provides a reconciliation between beginning and ending claim and claim adjustment expense reserves, including claim and claim adjustment expense reserves of the life company as of and for the years ended December 31, 2014, 2013 and 2012.
(a) Total net incurred above does not agree to Insurance claims and policyholders’ benefits as reflected in the Consolidated Statements of Income due to amounts related to retroactive reinsurance deferred gain accounting, uncollectible reinsurance and loss deductible receivables and benefit expenses related to future policy benefits and policyholders’ funds, which are not reflected in the table above.
Favorable net prior year development of $14 million, $9 million and $11 million was recorded in Life & Group Non-Core for the years ended December 31, 2014, 2013 and 2012.
Overall, favorable development for medical professional liability reflects favorable experience in accident years 2009 and prior. Unfavorable development was recorded for accident years 2010 and 2011 due to higher than expected large loss activity.
Favorable development for surety coverages was primarily due to better than expected large loss emergence in accident years 2011 and prior.
Favorable development for surety coverages was primarily due to better than expected loss emergence in accident years 2010 and prior.
The following table and discussion provide further detail of the development recorded for the Commercial segment:
Unfavorable development for commercial auto was primarily related to higher than expected frequency in accident years 2012 and 2013 and higher than expected severity for liability coverages in accident years 2010 through 2013. Favorable development was recorded related to fewer large claims than expected in accident years 2008 and 2009.
Overall, unfavorable development for workers’ compensation was primarily due to increased medical severity in accident years 2010 and prior, higher than expected severity related to Defense Base Act (“DBA”) contractors in accident years 2010 through 2013 and the recognition of losses related to favorable premium development in accident year 2013. Favorable development of $26 million was recorded in accident years 1996 and prior related to the commutation of a workers’ compensation reinsurance pool.
Favorable development for property and other first party coverages was recorded in accident years 2013 and prior, primarily related to fewer claims than expected and favorable individual claim settlements.
Unfavorable development for general liability coverages was primarily related to increased incurred loss severity in accident years 2010 through 2012.
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 for liability was primarily related to better than expected frequency and severity in accident years 2009 and subsequent.
Favorable development for other coverages was a result of better than expected frequency in Hardy, primarily in financial institution coverages.
Favorable development for other coverages was largely a result of better than expected severity in Hardy in accident year 2012.
In 2010, Continental Casualty Company (“CCC”) together with several of CNA’s insurance subsidiaries completed a transaction with National Indemnity Company (“NICO”), a subsidiary of Berkshire Hathaway Inc., under which substantially all of CNA’s legacy A&EP liabilities were ceded to NICO (“Loss Portfolio Transfer” or “LPT”). Under the terms of the NICO transaction, CNA ceded approximately $1.6 billion of net A&EP claim and allocated claim adjustment expense reserves to NICO under a retroactive reinsurance agreement with an aggregate limit of $4.0 billion. The $1.6 billion of claim and allocated claim adjustment expense reserves ceded to NICO was net of $1.2 billion of ceded claim and allocated claim adjustment expense reserves under existing third party reinsurance contracts. The NICO aggregate reinsurance limit also covers credit risk on the existing third party reinsurance related to these liabilities. CNA paid NICO a reinsurance premium of $2.0 billion and transferred to NICO billed third party reinsurance receivables related to A&EP claims with a net book value of $215 million, resulting in total consideration of $2.2 billion.
During 2013 and 2012, unfavorable development was recorded for accident years 2000 and prior related to A&EP claims due to an increase in ultimate claim severity and higher than anticipated claim reporting, as well as increased defense costs. Additionally, in 2013 CNA recognized a provision for uncollectible third party reinsurance which increased the expected recovery from NICO. The fourth quarter 2014 A&EP reserve review was not completed. Additional information and analysis on inuring third party reinsurance recoveries are needed to finalize the review. CNA expects to complete the review in the first half of 2015.
Diamond Offshore, which is not included in the Company’s consolidated federal income tax return, files income tax returns in the U.S. federal, various state and foreign jurisdictions. Tax years that remain subject to examination by the various other jurisdictions include years 2008 to 2014.
At December 31, 2014, 2013 and 2012, $51 million, $76 million and $48 million of unrecognized tax benefits related to Diamond Offshore would affect the effective tax rate if recognized.
The Company recognizes interest accrued related to: (i) unrecognized tax benefits in Interest expense and (ii) tax refund claims in Other revenues on the Consolidated Statements of Income. The Company recognizes penalties in Income tax expense on the Consolidated Statements of Income. Interest amounts recorded by the Company were insignificant for the years ended December 31, 2014, 2013 and 2012. The Company recorded income tax benefit of $22 million and $1 million for the years ended December 31, 2014 and 2012 and income tax expense of $38 million for the year ended December 31, 2013 related to penalties.
During 2013, Diamond Offshore received notification from the Egyptian tax authorities proposing a $1.2 billion increase in taxable income for the years 2006 to 2008. In December of 2013, Diamond Offshore accrued an additional $57 million of expense for uncertain tax positions in Egypt for all open years. During the first quarter of 2014, Diamond Offshore settled certain disputes for the years 2006 through 2008 with the Egyptian tax authorities, resulting in a net reduction to income tax expense of $17 million.
During the second quarter of 2014, the Appeals Committee in Egypt issued a decision regarding one remaining open item for the years 2006 to 2008. Diamond Offshore has filed an objection with the Egyptian courts and continues to dispute the matter, believing that its position will, more likely than not, be sustained. However, if Diamond Offshore’s position is not sustained, tax expense and related penalties would increase by approximately $50 million related to this issue for the 2006 through 2008 tax years as of December 31, 2014.
In July of 2014, the United Kingdom Finance Act (“Finance Act”) was enacted, with an effective date retroactive to April 1, 2014. Certain provisions of the Finance Act will limit the amount of tax deductions available with respect to rigs operating in the United Kingdom (“U.K.”) under bareboat charter arrangements, which has caused Diamond Offshore’s tax expense for the full year of 2014 to increase by approximately $22 million.
Federal net operating loss carryforwards of $281 million expire in 2034 and $28 million of net operating loss carryforwards in foreign tax jurisdictions can be carried forward indefinitely. Federal tax credit carryforwards of $47 million have indefinite lives and $46 million of foreign tax credit carryforwards expire in 2024.
CNA has a $250 million revolving credit agreement. The credit agreement, which matures on April 19, 2016, bears interest at London Interbank Offered Rate (“LIBOR”) plus an applicable margin. At CNA’s election the commitments under the unsecured credit facility may be increased from time to time up to an additional aggregate amount of $100 million. As of December 31, 2014, there were no borrowings under the credit facility and CNA was in compliance with all covenants.
Diamond Offshore has a $1.5 billion revolving credit agreement with a maturity date of 2019. The credit agreement bears interest at Diamond Offshore’s option on either an alternate base rate or Eurodollar rate, as defined in the credit agreement, plus an applicable margin. As of December 31, 2014, there were no borrowings under the credit facility and Diamond Offshore was in compliance with all covenants.
In August of 2014, Loews Hotels refinanced a $125 million 4.8% mortgage loan and entered into a new $300 million 4.1% mortgage loan due in September of 2024.
Dividends of $0.25 per share on the Company’s common stock were declared and paid in 2014, 2013 and 2012.
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 Department, are determined based on statutory net income and surplus as well as timing of dividends paid in the
The statutory capital and surplus presented above for CCC was approximately 270% and 265% of company action level RBC at December 31, 2014 and 2013. Company action level RBC is the level of RBC which triggers a heightened level of regulatory supervision. The statutory capital and surplus of CCC’s foreign insurance subsidiaries, which is not significant to the overall statutory capital and surplus, also met or exceeded their respective regulatory and other capital requirements.
The Hardy entities are not owned by CCC, therefore their regulatory capital is not included in the Statutory Capital and Surplus of the Combined Continental Casualty Companies presented in the table above. At December 31, 2014, Hardy’s capital requirement included $105 million of capital provided by CCC which is included in Combined Continental Casualty Companies’ Statutory Capital and Surplus above.
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. An increase or decrease in the assumed health care cost trend rate of 1% in each year would not have a significant impact on the Company’s service and interest cost as of December 31, 2014. An increase of 1% in each year would increase the Company’s accumulated postretirement benefit obligation as of December 31, 2014 by $3 million and a decrease of 1% in each year would decrease the Company’s accumulated postretirement benefit obligation as of December 31, 2014 by $3 million.
In the second quarter of 2014, CNA eliminated certain postretirement medical benefits associated with the CNA Health and Group Benefits Program. This change was a negative plan amendment which resulted in an $86 million curtailment gain reported in Other operating expenses in the Consolidated Statements of Income. In connection with the plan amendment, CNA remeasured the plan benefit obligation which resulted in a decrease to the discount rate used to determine the benefit obligation from 3.6% to 3.1%.
The Company employs a total return approach whereby a mix of equity and fixed maturity securities are used to maximize the long term return of plan assets for a prudent level of risk and to manage cash flows according to plan requirements. The target allocation of plan assets is 40% to 60% invested in equity securities and limited partnerships, with the remainder primarily invested in fixed maturity securities. The intent of this strategy is to minimize the Company’s expenses by generating investment returns that exceed the growth of the plan liabilities over the long run. Risk tolerance is established after careful consideration of the plan liabilities, plan funded status and corporate financial conditions. The investment portfolio contains a diversified blend of fixed maturity, equity and short term securities. Alternative investments, including limited partnerships, are used to enhance risk adjusted long term returns while improving portfolio diversification. At December 31, 2014, the Company had committed $115 million to future capital calls from various third party limited partnership investments in exchange for an ownership interest in the related partnerships. Investment risk is monitored through annual liability measurements, periodic asset/liability studies and quarterly investment portfolio reviews.
In 2015, it is expected that contributions of approximately $17 million will be made to pension plans and $5 million to postretirement health care and life insurance benefit plans.
The limited partnership investments are recorded at fair value, which represents the plans’ share of the net asset value of each partnership. The share of the net asset value of each partnership is determined by the General Partner and is based upon the fair value of the underlying investments, which are valued using varying market approaches. Level 2 includes limited partnership investments which can be redeemed at net asset value in 90 days or less. Level 3 includes limited partnership investments with withdrawal provisions greater than 90 days, or for which withdrawals are not permitted until the termination of the partnership. Within hedge fund strategies, approximately 58% are equity related, 37% pursue a multi-strategy approach and 5% are focused on distressed investments at December 31, 2014.
The tables below present reconciliations for all pension plan assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2014 and 2013:
CNA attempts to mitigate its credit risk related to reinsurance by entering into reinsurance arrangements with reinsurers that have credit ratings above certain levels and by obtaining collateral. On a limited basis, CNA may enter into reinsurance agreements with reinsurers that are not rated, primarily captive reinsurers. The primary methods of obtaining collateral are through reinsurance trusts, letters of credit and funds withheld balances. Such collateral was approximately $3.4 billion and $3.9 billion at December 31, 2014 and 2013.
CNA’s largest recoverables from a single reinsurer at December 31, 2014, including ceded unearned premium reserves were approximately $2.6 billion from subsidiaries of Berkshire Hathaway Group, $244 million from subsidiaries of the Hartford Insurance Group and $185 million from subsidiaries of Wilton Re. 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 9.
(a) Income from continuing operations for the fourth quarter of 2013 includes the impact of a $111 million deferred gain under retroactive reinsurance accounting at CNA and a $16 million goodwill impairment charge at Boardwalk Pipeline.
(b) Discontinued operations, net for the fourth quarter of 2013 includes a ceiling test impairment charge of $52 million at HighMount related to the carrying value of its natural gas and oil properties and a $382 million goodwill impairment charge.
In the normal course of business, CNA also provided guarantees, if the primary obligor fails to perform, to holders of structured settlement annuities provided by a previously owned subsidiary, which are estimated to mature through 2120. The potential amount of future payments CNA could be required to pay under these guarantees was approximately $1.9 billion at December 31, 2014. CNA does not believe a payable is likely under these guarantees, as CNA is the beneficiary of a trust that must be maintained at a level that approximates the discounted reserves for these annuities.
Diamond Offshore is financially obligated under a contract with Hyundai for the construction of an ultra-deepwater drillship, with expected delivery in the first quarter of 2015. The total cost of the drillship including shipyard costs, commissioning, capital spares and project management costs is estimated to be $655 million. The remaining contractual payment of $395 million is due upon delivery of the rig.
In July of 2014, Diamond Offshore was notified by Petróleo Brasileiro S.A., (“Petrobras”) that it is challenging assessments by Brazilian tax authorities of withholding taxes associated with the provision of drilling rigs for its operations in Brazil during the years 2008 and 2009. If Petrobras is ultimately assessed such withholding taxes, it will seek reimbursement from Diamond Offshore for the portion allocable to its drilling rigs. Diamond Offshore disputes any basis for Petrobras to obtain such reimbursement and has notified Petrobras of its position and intends to pursue all legal remedies available to defend any reimbursement claims against it vigorously. Diamond Offshore is currently unable to estimate the range of loss, if any, that it would incur if Petrobras is ultimately assessed such taxes and if it is determined that Petrobras is entitled to obtain reimbursement from Diamond Offshore. However, if Diamond Offshore’s position is not sustained, the amount of such reimbursement could have a material adverse effect on its financial condition and the Company’s results of operations and cash flows.
CNA’s results are reported in four business segments: Specialty, Commercial, International and Other Non-Core. Specialty provides a broad array of professional, financial and specialty property and casualty products and services, through a network of independent agents, brokers and managing general underwriters. Commercial includes property and casualty coverages sold to small businesses and middle market entities and organizations primarily through an independent agency distribution system. Commercial also includes commercial insurance and risk management products sold to large corporations primarily through insurance brokers. International provides management and professional liability coverages as well as a broad range of other property and casualty insurance products and services abroad through a network of brokers, independent agencies and managing general underwriters, as well as the Lloyd’s marketplace. Other Non-Core primarily includes the results of CNA’s individual and group long term care businesses that are in run-off and also includes corporate expenses, including interest on corporate debt, and the results of certain property and casualty business in run-off, including CNA Re and A&EP.
The Corporate and other column primarily reflects the parent company’s investment in its subsidiaries, invested cash portfolio and corporate long term debt and assets and liabilities of discontinued operations of HighMount. 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.