operation of a chain of hotels (Loews Hotels Holding Corporation (“Loews Hotels”), a wholly owned subsidiary).
Diamond Offshore’s results for 2015 include asset impairment charges totaling $341 million (after tax and noncontrolling interests) related to the carrying value of 17 drilling rigs, as well as lower rig utilization. In addition, earnings were impacted by a $20 million impairment charge to write off all goodwill associated with the Company’s investment in Diamond Offshore as well as increased depreciation and interest expense. In 2014, Diamond Offshore recognized an asset impairment charge of $55 million (after tax and noncontrolling interests).
Loews Hotels’ earnings increased slightly as compared to the prior year as higher income from Universal Orlando joint venture properties was partially offset by higher interest expense and increased tax expense due to an adjustment for prior years’ estimates and higher Florida state income taxes, reflecting increased profits at the Universal Orlando and Miami properties.
An exposure exists with respect to the collectibility of ceded property and casualty and life reinsurance to the extent that any reinsurer is unable to meet its obligations or disputes the liabilities CNA has ceded under reinsurance agreements. An allowance for doubtful accounts on reinsurance receivables is recorded on the basis of periodic evaluations of balances due from reinsurers, reinsurer solvency, CNA’s past experience and current economic
conditions. Further information on CNA’s reinsurance receivables is included in Note 15 of the Notes to Consolidated Financial Statements included under Item 8.
CNA’s investment portfolio is subject to market declines below amortized cost that may be other-than-temporary and therefore result in the recognition of impairment losses in earnings. Factors considered in the determination of whether or not a decline is other-than-temporary include a current intention or need to sell the security or an indication that a credit loss exists. Significant judgment exists regarding the evaluation of the financial condition and expected near-term and long term prospects of the issuer, the relevant industry conditions and trends, and whether CNA expects to receive cash flows sufficient to recover the entire amortized cost basis of the security. Further information on CNA’s process for evaluating impairments is included in Note 1 of the Notes to Consolidated Financial Statements included under Item 8.
We make a significant number of assumptions in order to estimate the liabilities and costs related to our pension and postretirement benefit obligations under our benefit plans. The assumptions that have the most impact on pension costs are the discount rate and the expected long term rate of return on plan assets. These assumptions are evaluated relative to current market factors such as inflation, interest rates and broader capital market expectations. Changes in these assumptions can have a material impact on pension obligations and pension expense.
Further information on our pension and postretirement benefit obligations is in Note 14 of the Notes to Consolidated Financial Statements included under Item 8.
Deferred income taxes are recognized for temporary differences between the financial statement and tax return bases of assets and liabilities. Any resulting future tax benefits are recognized to the extent that realization of such benefits is more likely than not, and a valuation allowance is established for any portion of a deferred tax asset that management believes may not be realized. The assessment of the need for a valuation allowance requires management to make estimates and assumptions about future earnings, reversal of existing temporary differences and available tax planning strategies. If actual experience differs from these estimates and assumptions, the recorded deferred tax asset may not be fully realized, resulting in an increase to income tax expense in our results of operations. In addition, the ability to record deferred tax assets in the future could be limited resulting in a higher effective tax rate in that future period.
CNA maintains loss reserves to cover its estimated ultimate unpaid liability for claim and claim adjustment expenses, including the estimated cost of the claims adjudication process, for claims that have been reported but not yet settled (case reserves) and claims that have been incurred but not reported (“IBNR”). Claim and claim adjustment expense reserves are reflected as liabilities and are included on the Consolidated Balance Sheets under the heading “Insurance Reserves.” Adjustments to prior year reserve estimates, if necessary, are reflected in results of operations in the period that the need for such adjustments is determined. The carried case and IBNR reserves as of each balance sheet date are provided in the discussion that follows and in Note 8 of the Notes to Consolidated Financial Statements included under Item 8.
CNA is subject to the uncertain effects of emerging or potential claims and coverage issues that arise as industry practices and legal, judicial, social, economic and other environmental conditions change. These issues have had, and may continue to have, a negative effect on CNA’s business by either extending coverage beyond the original underwriting intent or by increasing the number or size of claims.
To mitigate the risks posed by CNA’s exposure to A&EP claims and claim adjustment expenses, CNA completed a transaction with National Indemnity Company (“NICO”), under which substantially all of CNA’s legacy A&EP liabilities were ceded to NICO effective January 1, 2010 (loss portfolio transfer or “LPT”).
In developing claim and claim adjustment expense (“loss” or “losses”) reserve estimates, CNA’s actuaries perform detailed reserve analyses that are staggered throughout the year. The data is organized at a reserve group level. A reserve group can be a line of business covering a subset of insureds such as commercial automobile liability for small or middle market customers, it can encompass several lines of business provided to a specific set of customers such as dentists, or it can be a particular type of claim such as construction defect. Every reserve group is reviewed at least once during the year. The analyses generally review losses gross of ceded reinsurance and apply the ceded reinsurance terms to the gross estimates to establish estimates net of reinsurance. In addition to the detailed analyses, CNA reviews actual loss emergence for all products each quarter.
For many reserve groups, paid loss data for recent periods may be too immature or erratic for accurate predictions. This situation often exists for long-tail exposures. In addition, changes in the factors described above may result in inconsistent payment patterns. Finally, estimating the paid loss pattern subsequent to the most mature point available in the data analyzed often involves considerable uncertainty for long-tail products such as workers’ compensation.
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 reserve group 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.
Under GAAP, reserves for long term care future policy benefits and the unfunded structured settlement annuity claim and claim adjustment expense reserves were first established based on CNA’s actuarial best estimate assumptions at the date the contract was issued plus a margin for adverse deviation. Actuarial assumptions include estimates of morbidity, persistency, discount rates and expenses over the life of the contracts. These assumptions are locked in throughout the life of the contract unless a premium deficiency develops. The impact of differences between the actuarial assumptions and actual experience is reflected in results of operations each period.
The actuarial assumptions that management believes are subject to the most variability are morbidity, persistency and discount rate. 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 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.
Prior to December 31, 2015, the active life reserves for long term care were based on actuarial assumptions established at policy issuance. The December 31, 2014 GPV indicated the carried reserves included a margin of approximately $100 million. The December 31, 2015 GPV indicated a premium deficiency of $296 million. A summary of the changes in the GPV results is presented in the table below:
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. 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 table below summarizes the estimated pretax impact on CNA’s results of operations from various hypothetical revisions to its assumptions. CNA has assumed that revisions to such assumptions would occur in each policy type, age and duration within each policy group and would occur absent any changes, mitigating or otherwise, in the other assumptions. Although such hypothetical revisions are not currently required or anticipated, CNA believes they could occur based on past variances in experience and its expectations of the ranges of future experience that could reasonably occur. The hypothetical revisions have been updated from the disclosures in prior periods to be reflective of CNA’s updated best estimate assumptions as of December 31, 2015 in support of its active life reserves. As a result, in some cases the scenarios described below are not directly comparable to prior periods. Persistency now reflects active life mortality and lapse whereas prior periods reflected total lives. Discount rates now reflect future interest rates only whereas prior periods reflected future interest rates and changes in CNA’s existing investment portfolio yield. The hypothetical scenarios for morbidity and premium rate actions are comparable to prior periods.
To the extent that unrealized gains on fixed income securities supporting long term care products and annuity contracts would result in a premium deficiency if those gains were realized, 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”). The Shadow Adjustments presented above as of December 31, 2014 do not include $314 million related to Deferred acquisition costs.
Income from continuing operations decreased $411 million in 2015 as compared with 2014. Results in 2015 were negatively impacted by a $177 million charge (after tax and noncontrolling interests) related to recognition of a premium deficiency and a small deficiency in claim reserves in CNA’s long term care business as further discussed in the Reserves - Estimates and Uncertainties section of this MD&A. In addition, results in 2015 decreased $78 million ($46 million after tax and noncontrolling interests) as compared to 2014 as a result of the application of retroactive reinsurance accounting to adverse reserve development ceded under the 2010 A&EP loss portfolio transfer, as further discussed in Note 8 of the Notes to Consolidated Financial Statements included under Item 8. In addition, results in 2015 included lower net investment income and investment losses driven by lower limited partnership results and higher other than temporary impairment (“OTTI”) losses, partially offset by improved underwriting results. Results in 2014 were impacted by a $31 million (after tax and noncontrolling interests) loss on a coinsurance transaction related to the sale of CNA’s former life insurance subsidiary.
In evaluating the results of the property and casualty businesses, CNA utilizes the loss ratio, the expense ratio, the dividend ratio and the combined ratio. These ratios are calculated using GAAP financial results. The loss ratio is the percentage of net incurred claim and claim adjustment expenses to net earned premiums. The expense ratio is the percentage of insurance underwriting and acquisition expenses, including the amortization of deferred acquisition costs, to net earned premiums. The dividend ratio is the ratio of policyholders’ dividends incurred to net earned premiums. The combined ratio is the sum of the loss, expense and dividend ratios. In addition, CNA also utilizes rate, retention and new business in evaluating operating trends. Rate represents the average change in price on policies that renew excluding exposure change. Retention represents the percentage of premium dollars renewed in comparison to the expiring premium dollars from policies available to renew. New business represents premiums from policies written with new customers and additional policies written with existing customers.
Net written premiums decreased $115 million in 2015 as compared with 2014. This decrease was driven by the unfavorable effect of foreign currency exchange rates, the 2014 termination of a specialty product managing general underwriter relationship in Canada and unfavorable premium development at Hardy, for International, lower new business in Specialty and the residual effect of previous underwriting actions undertaken in certain business classes, offset by positive rate, higher retention and new business in Commercial. Net earned premiums decreased $283 million in 2015 as compared with 2014, consistent with the trend in net written premiums.
Favorable net prior year development of $218 million and $50 million was recorded in 2015 and 2014. Further information on net prior year development is included in Note 8 of the Notes to Consolidated Financial Statements included under Item 8.
Specialty’s combined ratio increased 1.1 points in 2015 as compared with 2014. The loss ratio increased 0.1 point due to deterioration in the current accident year loss ratio, primarily offset by higher net favorable prior year development. The expense ratio increased 1.0 point in 2015 as compared with 2014, driven by increased underwriting expenses and the unfavorable effect of lower net earned premiums.
Net written premiums decreased $263 million in 2014 as compared with 2013. The decrease in net written premiums was primarily driven by a lower level of new business, reflecting competitive market conditions in Commercial and Specialty, underwriting actions taken in certain business classes in Commercial and a 2013 commutation by Hardy, partially offset by continued rate increases in Commercial. Net earned premiums decreased $58 million in 2014 as compared with 2013, consistent with decreases in net written premiums.
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 8 of the Notes to Consolidated Financial Statements included under Item 8.
Other Non-Core primarily includes the results of CNA’s long term care business that is 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. Long term care policies were sold on both an individual and group basis. While considered non-core, new enrollees in existing groups were accepted through February 1, 2016.
The following table summarizes the results of CNA’s Other Non-Core operations for the years ended December 31, 2015, 2014 and 2013.
Diamond Offshore’s pretax income is primarily a function of contract drilling revenue earned less contract drilling expenses incurred or recognized. The two most significant variables affecting Diamond Offshore’s contract drilling revenues are dayrates earned and rig utilization rates achieved by its rigs, each of which is a function of rig supply and demand in the marketplace. These factors are not within Diamond Offshore’s control and are difficult to predict. Diamond Offshore generally recognizes revenue from dayrate drilling contracts as services are performed, consequently, when a rig is idle, no dayrate is earned and revenue will decrease as a result. Revenues can also be affected as a result of the acquisition or disposal of rigs, rig mobilizations, required surveys and shipyard projects. In connection with certain drilling contracts, Diamond Offshore may receive fees for the mobilization of equipment. In addition, some of Diamond Offshore’s drilling contracts require downtime before the start of the contract to prepare the rig to meet customer requirements for which it may or may not be compensated.
During 2016, Diamond Offshore expects to spend approximately 535 days for the mobilization of rigs and contract acceptance testing, including days associated with mobilization and acceptance testing for the Ocean GreatWhite, which is under construction and expected to be delivered in mid-2016 and rig modifications and acceptance testing for the Ocean BlackRhino, which is scheduled to begin operating under a new contract in January of 2017. Diamond Offshore expects the Ocean Endeavor to be unavailable through mid-2016 as it demobilizes out of the Black Sea. Diamond Offshore can provide no assurance as to the exact timing and/or duration of downtime associated with regulatory inspections, planned rig mobilizations and other shipyard projects.
In April 2015, the Bureau of Safety and Environmental Enforcement (an agency established by the U.S. Department of the Interior that governs the offshore drilling industry on the Outer Continental Shelf) announced proposed rules that, when enacted, will include more stringent design requirements for well control equipment used in offshore drilling operations. Based on Diamond Offshore’s assessment of the proposed rules, it believes that it may need to incur significant capital costs to comply with the additional design requirements to enable its cold-stacked mid-water semisubmersibles to return to work in U.S. waters.
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, 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 addition, under its current insurance policy, Diamond Offshore carries marine liability insurance covering certain legal liabilities, including coverage for certain personal injury claims, and generally covering liabilities arising out of or relating to pollution and/or environmental risk. Diamond Offshore believes that the policy limit for its marine liability insurance is within the range that is customary for companies of its size in the offshore drilling industry and is appropriate for Diamond Offshore’s business. Diamond Offshore’s deductibles for marine liability coverage, including for personal injury claims, are $25 million for the first occurrence and vary in amounts ranging between $5 million and, if aggregate claims exceed certain thresholds, up to $100 million for each subsequent occurrence, depending on the nature, severity and frequency of claims that might arise during the policy year.
The offshore floater market is currently faced with an oversupply of drilling rigs, which thus far has only been slightly abated by the cold stacking and retirement of rigs. The number of available rigs continues to grow as contracted rigs come off contract and newbuilds are delivered, increasing competition. Competition for the limited number of
drilling jobs continues to be intense with some operators bidding multiple rigs on the same job, in some cases, bidding rigs of both higher and lower specifications. Operators are also continuing to attempt to sublet previously contracted rigs for which capital spending programs have been delayed or canceled. Industry analysts have predicted that the offshore contract drilling market may remain depressed with further declines in dayrates and utilization likely in 2016 and 2017.
Diamond Offshore’s results of operations and cash flows for the year ended December 31, 2015 have been materially impacted by depressed market conditions in the offshore drilling industry. Diamond Offshore currently expects that these adverse market conditions will continue for the foreseeable future. The continuation of these conditions for an extended period could result in more of its rigs being without contracts and/or cold stacked or scrapped and could further materially and adversely affect Diamond Offshore’s business. When Diamond Offshore cold stacks or elects to scrap a rig, they evaluate the rig for impairment. During 2015, Diamond Offshore recognized an aggregate impairment loss of $861 million, including an impairment loss of $499 million recognized in the fourth quarter of 2015.
While conditions in the mid-water market vary slightly by region, mid-water rigs have been adversely impacted by (i) lower demand, (ii) declining dayrates, (iii) increased regulatory requirements, including more stringent design requirements for well control equipment, which could significantly increase the capital needed to comply with design requirements that would permit such rigs to work in U.S. waters, (iv) the challenges experienced by lower specification units in this segment as a result of more complex customer specifications, and (v) the intensified competition resulting from the migration of some deepwater and ultra-deepwater units to compete against mid-water units. To date, the mid-water market has seen the highest number of cold-stacked and scrapped rigs. Since 2012, Diamond Offshore has sold 12 of its mid-water rigs for scrap. As market conditions remain challenging, Diamond Offshore expects higher specification rigs to take the place of lower specification units, where possible, leading to additional lower specification rigs being cold stacked or ultimately scrapped.
The following table reflects Diamond Offshore’s contract drilling backlog as of February 16, 2016 (based on contract information known at that time), October 1, 2015 (the date reported in our Quarterly Report on Form 10-Q for quarter ended September 30, 2015) and February 9, 2015 (the date reported in our Annual Report on Form 10-K for the year ended December 31, 2014). Contract drilling backlog as presented below includes only firm commitments (typically represented by signed contracts) and is calculated by multiplying the contracted operating dayrate by the firm contract period and adding one-half of any potential rig performance bonuses. Diamond Offshore’s calculation also assumes full utilization of its drilling equipment for the contract period (excluding scheduled shipyard and survey days); however, the amount of actual revenue earned and the actual periods during which revenues are earned will be different than the amounts and periods shown in the tables below due to various factors. Utilization rates, which generally approach 92% - 98% during contracted periods, can be adversely impacted by downtime due to various operating factors including, but not limited to, weather conditions and unscheduled repairs and maintenance. Contract drilling backlog excludes revenues for mobilization, demobilization, contract preparation and customer reimbursables. No revenue is generally earned during periods of downtime for regulatory surveys. Changes in Diamond Offshore’s contract drilling backlog between periods are generally a function of the performance of work on term contracts, as well as the extension or modification of existing term contracts and the execution of additional contracts. In addition, under certain circumstances, Diamond Offshore’s customers may seek to terminate or renegotiate its contracts.
(a) Ultra-deepwater floaters includes $641 million attributable to future work for the semisubmersible Ocean GreatWhite, which is under construction.
Contract drilling revenue decreased $377 million in 2015 as compared with 2014, and contract drilling expense decreased $296 million during the same period. Contract drilling revenue decreased primarily due to a decrease in revenue earned by both mid-water and jack-up fleets, partially offset by an increase in revenue earned by both ultra-deepwater and deepwater floaters. The decrease in contract drilling revenue also reflects a decrease in revenue earning days primarily due to cold stacking, rig sales and incremental downtime between contracts for several rigs, partially offset by incremental revenue earning days for newly constructed and upgraded or enhanced rigs.
Revenue generated by deepwater floaters increased $54 million in 2015 as compared with 2014 primarily due to an increase in utilization of $55 million. The increase in revenue earning days resulted from incremental operating days for four rigs after prolonged periods of nonproductive time for planned upgrades and surveys, as well as warm stacking between contracts, partially offset by fewer revenue earning days due to the cold stacking of the Ocean Star and additional non-revenue earning days for rig mobilization and repairs.
Revenue generated by jack-up rigs decreased $94 million in 2015 as compared with 2014, primarily due to reduced utilization for five rigs that were under contract in 2014, but were cold stacked and marketed for sale at the end of 2015. In addition, revenue for 2015 was negatively impacted by a negotiated dayrate reduction for the remaining actively marketed jack-up rig, the Ocean Scepter.
Revenue generated by ultra-deepwater floaters increased $133 million in 2014 as compared with 2013 as a result of higher average daily revenue of $219 million, including the recognition of incremental mobilization and contract preparation fees of $51 million, partially offset by a decrease in utilization of $86 million. Average daily revenue increased primarily due to several rigs operating under higher dayrates as compared to 2013. The reduction in revenue earning days is primarily due to incremental downtime for inspections and shipyard projects, including the Ocean Confidence life-extension project, downtime in between contracts and rig mobilizations, partially offset by a reduction in unscheduled downtime for repairs and incremental revenue earning days for the Ocean BlackHawk which was placed in service in 2014.
Revenue generated by deepwater floaters decreased $123 million in 2014 as compared with 2013 primarily due to lower utilization of $131 million, partially offset by higher average daily revenue of $8 million which reflected an increase in amortized mobilization and contract preparation revenue. The decrease in revenue earning days was the result of unplanned downtime associated with the warm stacking of rigs between contracts and incremental scheduled downtime for surveys and shipyard projects and rig mobilizations, partially offset by incremental revenue earning days for the Ocean Onyx which was placed into service during 2014.
Net income decreased $74 million in 2014 as compared with 2013 primarily reflecting the decrease in revenue, the impact of a $109 million impairment loss ($55 million after tax and noncontrolling interests) related to the carrying value of Diamond Offshore’s semisubmersible rigs, higher general and administrative expense and depreciation expense, as well as an increase in interest expense related to the $1.0 billion of senior unsecured notes issued in November of 2013. General and administrative costs for 2014 include higher employee compensation and termination benefits paid to certain current and former key executives. These increases were partially offset by a $9 million gain ($3 million after tax and noncontrolling interests) recognized on the sale of the previously held for sale jack-up rig Ocean Spartan in the second quarter of 2014. Diamond Offshore recognized a charge for an uncollectible receivable of $23 million ($9 million after tax and noncontrolling interests) in 2013.
from an increase in supplies mainly from shale production areas in the U.S. which has adversely impacted the businesses of certain of Boardwalk Pipeline’s producer customers. If the recent declines in prices were to continue for a sustained period of time, the businesses of other members of Boardwalk Pipeline’s producer customer group could be adversely affected which, in turn, would reduce the demand for Boardwalk Pipeline’s services and could result in the non-renewal of contracted capacity, or the renewal of capacity at lower rates when existing contracts expire.
A substantial portion of Boardwalk Pipeline’s transportation capacity is contracted for under firm transportation agreements. Actual revenues recognized from capacity reservation and minimum bill charges in 2015 were $940 million. Approximate projected revenues from capacity reservation and minimum bill charges under committed firm transportation agreements in place as of December 31, 2015, for each of the full years 2016 and 2017 are $1,010 million and $1,030 million. The amounts shown for 2015 and 2016 increased approximately $30 million and $110 million from what was previously reported in our 2014 10-K. Approximately half of the increase in each year is due to contract renewals during 2015 and new contracts that were entered into in 2015. The remainder is due to the settled Gulf South rate case, which resulted in a general increase in rates, and the extension to 2023 of certain NNS contracts. Included in these revenues are approximately $25 million for 2017 that are anticipated under executed precedent transportation agreements for projects that are subject to regulatory approval to commence construction. Additional revenues Boardwalk Pipeline has recognized and may receive under firm transportation agreements based on actual utilization of the contracted pipeline facilities or any expected revenues for periods after the expiration dates of the existing agreements or execution of precedent agreements associated with growth projects or events that occurred subsequent to December 31, 2015 are not included in these amounts.
Each year a portion of Boardwalk Pipeline’s firm transportation agreements expire and need to be renewed or replaced. Over the past several years, Boardwalk Pipeline has renewed many expiring transportation contracts at lower rates and for shorter terms than in the past, or not renewed the contracts at all which has materially adversely impacted transportation revenues. Capacity not renewed and available for sale on a short term basis has been and continues to be sold under short term firm or interruptible contracts at rates reflective of basis spreads, which generally have been lower than historical rates, or in some cases not sold at all. Rates for short term and interruptible transportation services are influenced by the factors discussed above but can be more heavily affected by shorter term conditions such as current and forecasted weather.
Demand has increased to transport gas from north to south, instead of south to north as had been the traditional flow pattern. This demand is being driven primarily by increases in gas production from the Marcellus and Utica production areas and growing demand for natural gas in the Gulf Coast area from new and planned power plants, petrochemical facilities and LNG export facilities. This flow pattern has resulted in growth opportunities for Boardwalk Pipeline that require significant capital expenditures, among other things, to make parts of Boardwalk Pipeline’s system bi-directional, and in many instances, will utilize existing pipeline capacity that has been turned back to Boardwalk Pipeline by customers that have not renewed expiring contracts. These projects have lengthy planning and construction periods and as a result, will not contribute to Boardwalk Pipeline’s earnings and cash flows until they are placed into service over the next several years. In some instances the projects remain subject to regulatory approval to commence construction. These projects are also subject to the risk that they may not be completed, may be impacted by significant cost overruns or may be materially changed prior to completion as a result of future developments or circumstances that Boardwalk Pipeline cannot predict at this time.
Boardwalk Pipeline has seen the value of its storage and PAL services adversely impacted by some of the market factors discussed above, as well as there being fewer market participants from a decrease in the number of marketers taking storage positions, which has contributed to a narrowing of time period price spreads. Although in recent months, Boardwalk Pipeline has seen an increase in volatility that has allowed it to lock in favorable price spreads, generally, these factors have reduced the rates it can charge and the capacity it can sell under its storage and PAL services.
Credit risk also exists in relation to Boardwalk Pipeline’s growth projects, both because the foundation shippers have made long-term commitments to it for capacity on such projects and certain of the foundation shippers have agreed to provide credit support as construction progresses. A large majority of these foundation shippers are rated investment-grade by at least one of the major credit rating agencies. As discussed elsewhere in this filing, Boardwalk Pipeline had one customer fail to post the required credit support on the contractually required date.
Natural gas producers comprise a significant portion of Boardwalk Pipeline’s revenues. For example, in 2015, approximately 50% of its revenues were generated from contracts with natural gas producers. During 2015, the prices of oil and natural gas declined significantly due to an increase in supplies mainly from shale production areas in the U.S. Should the prices of natural gas and oil remain at current levels for a sustained period of time, or decline further, Boardwalk Pipeline could be exposed to increased credit risk associated with its producer customer group. Boardwalk Pipeline continues to monitor its credit risk carefully, especially as it relates to customers that may be affected by the current oil and natural gas markets.
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), in which Gulf South requested, among other things, a reconfiguration of the transportation rate zones on the Gulf South system and, in general, an increase in its tariff rates. In 2015, an uncontested settlement was reached with Gulf South’s customers and approved by the FERC. The settlement will become effective March 1, 2016.
The settled rates were moved into effect on November 1, 2015. Refunds for the difference between the rates as filed and as settled are required to be paid to customers by May 1, 2016. For 2015, Boardwalk Pipeline recognized $20 million of additional operating revenues as a result of the rate case. Based on current, contracted capacity, and the elections made by Gulf South’s NNS customers, Boardwalk Pipeline expects to recognize approximately $30 million in net revenues as a result of the rate case in 2016.
Total revenues increased $18 million in 2015 as compared with 2014. This increase is primarily due to higher transportation revenues of $39 million resulting from growth projects recently placed into service and includes $20 million of additional revenues from the Gulf South rate case. The recently acquired Evangeline pipeline contributed an additional $11 million and Boardwalk Pipeline received $8 million of proceeds related to a business interruption claim. These increases were partially offset by the comparably warm weather experienced in the early part of the 2015 period in Boardwalk Pipeline’s market areas, a decrease in fuel retained due to lower natural gas prices and the effects of market and contract renewal conditions discussed above. Storage and PAL revenues were lower by $20 million primarily as a result of the effects of unfavorable market conditions on time period price spreads.
Operating expenses decreased $80 million for 2015 as compared with 2014. This decrease is primarily due to a $94 million prior year charge to write off all capitalized costs associated with the terminated Bluegrass project, a $10 million franchise tax refund related to settlement of prior tax periods and a decrease in fuel and transportation expense due to lower natural gas prices. These decreases were partially offset by higher depreciation expense of $35 million from an increase in the asset base, including the Evangeline acquisition and a change in the estimated lives of certain older, low-pressure assets. Maintenance expense increased by $15 million primarily due to pipeline system maintenance activities as discussed above and the Evangeline acquisition. Interest expense increased $11 million primarily due to higher average debt balances as compared with 2014, lower capitalized interest related to capital projects and the expensing of previously deferred costs related to the refinancing of the revolving credit facility.
Total revenues increased $4 million in 2014, compared with 2013. This increase is primarily due to a $27 million increase in transportation and other revenues generally due to the colder than normal winter weather in Boardwalk Pipeline’s market areas and growth projects which were recently placed into service, partially offset by lower firm transportation revenues due to the effects of the market and contract renewal conditions discussed above. Additionally, revenues increased $13 million from fuel retained primarily due to higher natural gas prices and $15 million from gas sales associated with the Flag City processing plant, which were offset by gas purchases recorded in Operating expenses. Storage and parking and lending revenues were lower by $22 million primarily as a result of the effects of unfavorable market conditions on natural gas time period price spreads. The 2013 period was favorably impacted by a $30 million gain from the sale of storage gas.
Equity income increased $18 million in 2015 as compared with 2014 primarily due to improved performance of the Universal Orlando joint ventures, partially offset by a $5 million impairment of a joint venture equity interest in a hotel property.
Net income increased slightly as compared to the prior year as higher income from Universal Orlando joint venture properties was partially offset by the negative impact of transaction and transition costs for hotels acquired during the year and higher interest expense. In addition, the effective tax rate increased due to an adjustment for prior years’ estimate and a higher state tax accrual for an increase in the ratio of Florida based income.
Operating revenues increased $75 million in 2014 as compared to 2013, primarily due to acquisitions in 2014 and the reopening in January of 2014 of the Loews Regency New York Hotel, 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.
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 New York Hotel, partially offset by a reduction in expenses as a result of the sale of equity interests in two hotels.
Corporate and Other operations consist primarily of investment income at the Parent Company, corporate interest expenses and other corporate administrative costs. Investment income includes earnings on cash and short term investments held at the Parent Company level to meet current and future liquidity needs, as well as results of limited partnership investments and the trading portfolio.
The following table summarizes the results of operations for Corporate and Other 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 results decreased $42 million in 2014 as compared to 2013, primarily due to the change in revenues and expenses discussed above.
Cash flows from financing activities may include proceeds from the issuance of debt and equity securities, outflows for shareholder dividends or repayment of debt and outlays to reacquire equity instruments. Net cash used by financing activities was $807 million, $519 million and $264 million for 2015, 2014 and 2013. Cash used by financing activities reflected an increased special shareholder dividend in 2015 as compared to 2014. Additionally, in 2014, CNA issued $550 million of senior notes.
CNA believes that its present cash flows from operations, investing activities and financing activities are sufficient to fund its current and expected working capital and debt obligation needs and CNA does not expect this to change in the near term. There are currently no amounts outstanding under CNA’s $250 million senior unsecured revolving credit facility and no borrowings outstanding through CNA’s membership in the Federal Home Loan Bank of Chicago (“FHLBC”).
A.M. Best, Moody’s and S&P each maintain a stable outlook on CNA.
Hardy through Syndicate 382, 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.
Diamond Offshore is currently obligated under a construction agreement for the ultra-deepwater semisubmersible, the Ocean GreatWhite. Construction continues with delivery expected in mid-2016. The estimated total project cost, including shipyard costs, capital spares, commissioning, project management and shipyard supervision, but excluding capitalized interest, is $764 million, of which $242 million has been incurred as of December 31, 2015.
For 2016, Diamond Offshore has budgeted approximately $675 million for capital expenditures of which approximately $525 million is expected to be spent on completion of the construction of the Ocean GreatWhite. Diamond Offshore’s 2016 capital spending program also includes an estimated $150 million for ongoing capital maintenance and replacement programs.
Depending on market and other conditions, Diamond Offshore may purchase shares of its outstanding common stock in the open market or otherwise. Diamond Offshore did not purchase any shares of its outstanding common stock in 2015. During 2014, Diamond Offshore purchased 1.9 million shares of its outstanding common stock at an aggregate cost of $88 million.
During February of 2016, Diamond Offshore borrowed $305 million in Eurodollar loans under the credit agreement, which bear interest at 1.6% and will mature on February 29, 2016. As of February 16, 2016, Diamond Offshore had an additional $1.2 billion available under the credit agreement.
As of December 31, 2015, Diamond Offshore had an aggregate $2.0 billion in long-term, unsecured senior notes outstanding, of which $500 million will mature in 2019 and the remainder will mature at various times beginning in 2023.
At December 31, 2015 and 2014, cash and investments amounted to $4 million and $8 million. Funds from operations for 2015 amounted to $576 million, compared to $514 million in 2014. In 2015 and 2014, Boardwalk Pipeline’s capital expenditures were $375 million and $404 million, consisting of a combination of growth and maintenance capital. In 2015 and 2014, Boardwalk Pipeline paid cash distributions of $102 million and $99 million to its partners. Boardwalk Pipeline expects total capital expenditures to be approximately $850 million in 2016, primarily related to growth projects discussed further in Item 1 and increased pipeline system maintenance expenditures. A summary of the estimated total costs of the growth projects and inception to date spending, as of December 31, 2015, are as follows:
In May 2015, Boardwalk Pipeline entered into an amended credit facility which increased the borrowing capacity of the revolving credit facility to $1.5 billion and extended the maturity date to May 26, 2020. As of February 16, 2016, Boardwalk Pipeline had outstanding borrowings of $470 million resulting in over $1.0 billion of available borrowing capacity and is in compliance with all covenant requirements under the credit facility.
As of December 31, 2015, there were 339,897,547 shares of Loews common stock outstanding. Depending on market and other conditions, we may purchase our shares and shares of our subsidiaries outstanding common stock in the open market or otherwise. In 2015, we purchased 33.3 million shares of Loews common stock and 1.1 million shares of Diamond Offshore.
In April of 2015, Fitch Ratings, Inc. downgraded our unsecured debt from A+ to A and the outlook remains stable. Our current unsecured debt ratings are A2 for Moody’s and A+ for S&P with a stable outlook for both. In December of 2015, S&P affirmed our A+ corporate and issuer credit ratings in connection with S&P’s newly published criteria on investment holding companies. We have an effective Registration Statement on Form S-3 registering the future sale of an unlimited amount of our debt and equity securities. From time to time, we consider issuance of Parent Company indebtedness under this registration statement.
(c) Future policy benefits 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, 2015. Additional information on future policy benefits 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 $18 million to the Company’s pension and postretirement plans in 2016.
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. Future commitments for the full term under the services agreement and leases are estimated to aggregate approximately $650 million.
Net realized investment results decreased $66 million in 2015 as compared with 2014, driven by higher OTTI losses recognized in earnings and lower net realized investment gains on sales of securities. Net realized investment gains increased $22 million in 2014 as compared with 2013, driven by higher net realized investment gains on sales of securities. Further information on CNA’s realized gains and losses, including CNA’s OTTI losses and derivative gains (losses), as well as CNA’s impairment decision process, is set forth in Notes 1 and 3 of the Notes to Consolidated Financial Statements included under Item 8.
The following table presents available-for-sale fixed maturity securities in a gross unrealized loss position by ratings distribution:
The investment portfolio is periodically analyzed for changes in duration and related price change risk. Additionally, CNA periodically reviews the sensitivity of the portfolio to the level of foreign exchange rates and other factors that contribute to market price changes. A summary of these risks and specific analysis on changes is in Quantitative and Qualitative Disclosures about Market Risk included under
Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2015. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013). Based on this assessment, our management believes that, as of December 31, 2015, our internal control over financial reporting was effective.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have audited the accompanying consolidated balance sheets of Loews Corporation and subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income (loss), equity, and cash flows for each of the three years in the period ended December 31, 2015. Our audits also included the financial statement schedules listed in the Index at Item 15. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedules based on our audits.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2015, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 19, 2016 expressed an unqualified opinion on the Company’s internal control over financial reporting.
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 20 for additional information on segments.
The cost of fixed maturity securities classified as available-for-sale is adjusted for amortization of premiums and accretion of discounts, which are included in Net investment income on the Consolidated Statements of Income. The amortization of premium and accretion of discount for fixed maturity securities takes into consideration call and maturity dates that produce the lowest yield. This represents a change from prior reporting periods as previously the amortization of premiums was to maturity. This change in estimate, effected by a change in accounting principle, will result in a better reflection of the yield on fixed maturity securities with call provisions. This change, which was adopted in the fourth quarter of 2015, decreased Net investment income and the amortized cost of fixed maturity securities by $39 million in the Consolidated Statements of Income for the year ended December 31, 2015 and the Consolidated Balance Sheet as of December 31, 2015. This adjustment decreased basic and diluted net income per share by $0.06 for the year ended December 31, 2015.
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 former Bluegrass Project, as discussed in Note 2, that are accounted for under the equity method. The Company’s investment in these entities was $234 million and $158 million for the years ended December 31, 2015 and 2014 and reported in Other assets on the Company’s Consolidated Balance Sheets. Equity income (loss) for these investments was $43 million, $(62) million and $12 million for the years ended December 31, 2015, 2014 and 2013 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 $348 million, consisting of the amount of the investment and debt guarantees.
Revenue recognition - Premiums on property and casualty insurance contracts are recognized in proportion to the underlying risk insured which are principally earned ratably over the duration of the policies. Premiums on long term care contracts are earned ratably over the policy year in which they are due. The reserve for unearned premiums represents the portion of premiums written relating to the unexpired terms of coverage.
Claim and claim adjustment expense reserves are presented net of anticipated amounts due from insureds related to losses under deductible policies of $1.2 billion and $1.4 billion as of December 31, 2015 and 2014. A significant portion of these amounts are supported by collateral. CNA also has an allowance for uncollectible deductible
amounts, which is presented as a component of the allowance for doubtful accounts included in Receivables on the Consolidated Balance Sheets.
Structured settlements have been negotiated for certain property and casualty insurance claims. Structured settlements are agreements to provide fixed periodic payments to claimants. CNA’s obligations for structured settlements not funded by annuities are included in claim and claim adjustment expense reserves and carried at present values determined using interest rates ranging from 5.5% to 8.0% at December 31, 2015 and 2014. At December 31, 2015 and 2014, the discounted reserves for unfunded structured settlements were $560 million and $582 million, net of discount of $880 million and $924 million.
CNA has established an allowance for doubtful accounts on reinsurance receivables which relates to both amounts already billed on ceded paid losses as well as ceded reserves that will be billed when losses are paid in the future. The allowance for doubtful accounts on reinsurance receivables is estimated on the basis of periodic evaluations of balances due from reinsurers, reinsurer solvency, management’s experience and current economic conditions. Reinsurer financial strength ratings are updated and reviewed on an annual basis or sooner if CNA becomes aware of significant changes related to a reinsurer. Because billed receivables generally approximate 4% or less of total
CNA accounts for its investments in life settlement contracts using the fair value method. Under the fair value method, each life settlement contract is carried at its fair value at the end of each reporting period. The change in fair value, life insurance proceeds received and periodic maintenance costs, such as premiums, necessary to keep the underlying policy in force, are recorded in Other revenues on the Consolidated Statements of Income.
The fair value of CNA’s investments in life settlement contracts were $74 million and $82 million at December 31, 2015 and 2014, and are included in Other assets on the Consolidated Balance Sheets. The cash receipts and payments related to life settlement contracts are included in Cash flows from operating activities on the Consolidated Statements of Cash Flows.
Goodwill - Goodwill represents the excess of purchase price over fair value of net assets of acquired entities. Goodwill is tested for impairment annually or when certain triggering events require additional tests. Subsequent reversal of a goodwill impairment charge is not permitted. See Note 7 for additional information on goodwill.
Stock based compensation - The Company records compensation expense upon issuance of share-based payment awards for all awards it grants, modifies or cancels primarily on a straight-line basis over the requisite service period, generally three to four years. The share-based payment awards are valued using the Black-Scholes option pricing model. The application of this valuation model involves assumptions that are judgmental and highly sensitive in the valuation of these awards. These assumptions include the term that the awards are expected to be outstanding, an estimate of the volatility of the underlying stock price, applicable risk-free interest rates and the dividend yield of the Company’s stock.
For each of the years ended December 31, 2015, 2014 and 2013, approximately 0.3 million, 0.6 million and 0.9 million potential shares attributable to exercises under the Loews Corporation Stock Option Plan were included in the calculation of diluted net income per share. For those same periods, approximately 4.8 million, 2.3 million and 1.5 million Stock Appreciation Rights (“SARs”) were not included in the calculation of diluted net income per share due to the exercise price being greater than the average stock price.
Supplementary cash flow information - Cash payments made for interest on long term debt, net of capitalized interest, amounted to $513 million, $501 million and $415 million for the years ended December 31, 2015, 2014 and 2013. Cash payments for federal, foreign, state and local income taxes amounted to $110 million, $189 million and $183 million for the years ended December 31, 2015, 2014 and 2013. Investing activities exclude $3 million and $43 million of accrued capital expenditures for the years ended December 31, 2015 and 2013 and include $14 million of previously accrued capital expenditures for the year ended December 31, 2014.
In May of 2015, the FASB issued ASU 2015-09, “Financial Services - Insurance (Topic 944): Disclosures about Short-Duration Contracts.” The updated accounting guidance requires enhanced disclosures to provide additional information about insurance liabilities for short-duration contracts. The updated guidance is effective for annual reporting periods beginning after December 15, 2015 and for interim periods beginning after December 15, 2016. The Company is currently evaluating the effect the updated guidance will have on its financial statement disclosures.
On August 1, 2014, CNA completed the sale of CAC, its former life insurance subsidiary, which is reported as discontinued operations in the Consolidated Statements of Income for years ended December 31, 2014 and 2013. See Note 19 for further discussion of discontinued operations.
On September 30, 2014, the Company sold HighMount Exploration & Production LLC (“HighMount”), its former natural gas and oil exploration and production subsidiary. As of December 31, 2014, the Company had no remaining natural gas and oil properties. The results of this sold business are reported as discontinued operations in the Consolidated Statements of Income for years ended December 31, 2014 and 2013. See Note 19 for further discussion of discontinued operations.
In 2015, Loews Hotels paid a total of approximately $330 million to acquire two hotels and in 2014, acquired three hotels for a total cost of approximately $230 million. These acquisitions were funded with a combination of cash and property-level debt.
(a) Includes gross realized gains of $133, $178 and $198 and gross realized losses of $222, $136 and $179 on available-for-sale securities for the years ended December 31, 2015, 2014 and 2013.
Based on current facts and circumstances, the Company believes the unrealized losses presented in the table above are not indicative of the ultimate collectibility of the current amortized cost of the securities, but rather are attributable to changes in interest rates, credit spreads and other factors, including volatility in the energy and metals and mining sectors due to declines in the price of oil and other commodities. As of December 31, 2015, the Company held fixed maturity securities and equity securities with an estimated fair value of $2.5 billion and a cost or amortized cost of $2.7 billion in the energy and metals and mining sectors. The portion of these securities in a gross unrealized loss position had an estimated fair value of $1.4 billion and a cost or amortized cost of $1.6 billion. The Company has no current intent to sell securities with unrealized losses, nor is it more likely than not that it will be required to sell prior to recovery of amortized cost; accordingly, the Company has determined that there are no additional OTTI losses to be recorded at December 31, 2015.
The following table presents the activity related to the pretax credit loss component reflected in Retained earnings on fixed maturity securities still held at December 31, 2015, 2014 and 2013 for which a portion of an OTTI loss was recognized in Other comprehensive income.
The carrying value of limited partnerships as of December 31, 2015 and 2014 was approximately $3.3 billion and $3.7 billion which includes undistributed earnings of $952 million and $1.3 billion. Limited partnerships comprising 70.8% of the total carrying value are reported on a current basis through December 31, 2015 with no reporting lag, 12.8% are reported on a one month lag and the remainder are reported on more than a one month lag. The number of limited partnerships held and the strategies employed provide diversification to the limited partnership portfolio and the overall invested asset portfolio.
Limited partnerships comprising 76.6% and 78.6% of the carrying value at December 31, 2015 and 2014 employ hedge fund strategies that generate returns through investing in marketable securities in the public fixed income and equity markets. Limited partnerships comprising 23.4% and 18.6% of the carrying value at December 31, 2015 and 2014 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 56.4% were equity related, 28.9% pursued a multi-strategy approach, 11.4% were focused on distressed investments and 3.3% were fixed income related at December 31, 2015.
The ten largest limited partnership positions held totaled $1.5 billion and $1.8 billion as of December 31, 2015 and 2014. Based on the most recent information available regarding the Company’s percentage ownership of the individual limited partnerships, the carrying value reflected on the Consolidated Balance Sheets represents approximately 2.8% and 3.9% of the aggregate partnership equity at December 31, 2015 and 2014, and the related income reflected on the Consolidated Statements of Income represents approximately 2.8%, 4.3% and 3.7% of the changes in total partnership equity for the years ended December 31, 2015, 2014 and 2013.
The Company enters into interest rate swaps, futures and forward commitments to purchase securities to manage interest rate risk. Credit derivatives such as credit default swaps are entered into to modify the credit risk inherent in certain investments. Forward contracts, futures, swaps and options are used primarily to manage foreign currency and commodity price risk.
The following tables present the aggregate contractual or notional amount and estimated fair value related to derivative financial instruments.
As of December 31, 2015, the Company had committed approximately $398 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 $2.8 billion and $3.0 billion were deposited by CNA’s insurance subsidiaries under requirements of regulatory authorities and others as of December 31, 2015 and 2014.
Securities may be transferred in or out of levels within the fair value hierarchy based on the availability of observable market information and quoted prices used to determine the fair value of the security. The availability of observable market information and quoted prices varies based on market conditions and trading volume. There were $63 million of transfers from Level 2 to Level 1 and $52 million of transfers from Level 1 to Level 2 during the year ended December 31, 2015. There were $24 million of transfers from Level 2 to Level 1 and $1 million of transfers from Level 1 to Level 2 during the year ended December 31, 2014. The Company’s policy is to recognize transfers between levels at the beginning of quarterly reporting periods.
Level 1 securities include highly liquid and exchange traded bonds and redeemable preferred stock, valued using quoted market prices. Level 2 securities include most other fixed maturity securities as the significant inputs are observable in the marketplace. All classes of Level 2 fixed maturity securities are valued using a methodology based on information generated by market transactions involving identical or comparable assets, a discounted cash flow methodology or a combination of both when necessary. Common inputs for all classes of fixed maturity securities include prices from recently executed transactions of similar securities, marketplace quotes, benchmark yields, spreads off benchmark yields, interest rates and U.S. Treasury or swap curves. Specifically for asset-backed securities, key inputs include prepayment and default projections based on past performance of the underlying collateral and current market data. Fixed maturity securities are primarily assigned to Level 3 in cases where broker/dealer quotes are significant inputs to the valuation and there is a lack of transparency as to whether these quotes are based on information that is observable in the marketplace. Level 3 securities also include private placement debt securities whose fair value is determined using internal models with inputs that are not market observable.
Capitalized interest related to the construction and upgrade of qualifying assets amounted to approximately $36 million, $80 million and $92 million for the years ended December 31, 2015, 2014 and 2013.
In 2015, Diamond Offshore took delivery of one ultra-deepwater drillship. The net book value of this newly constructed rig was $655 million at December 31, 2015, of which $225 million was reported in Construction in process at December 31, 2014. At December 31, 2015, Construction in Process included $270 million related to one rig still under construction.
In 2014, Diamond Offshore sold a jack-up rig for $17 million, resulting in a gain of $9 million ($3 million after tax and noncontrolling interests). This gain was recorded in Other revenues on the Consolidated Statements of Income.
During 2015, in response to a continued deterioration of the market fundamentals in the oil and gas industry, including the dramatic decline in oil prices, significant cutbacks in customer capital spending plans and contract cancellations by customers, as well as pending regulatory requirements in the U.S. Gulf of Mexico, Diamond Offshore evaluated 25 of its drilling rigs for impairment. Based on this evaluation, Diamond Offshore determined that 17 of these rigs, consisting of two ultra-deepwater, one deepwater and nine mid-water floaters and five jack-up rigs, were impaired.
of these impaired rigs is reported in Property, plant and equipment on the Consolidated Balance Sheets at December 31, 2015.
Diamond Offshore’s assumptions are necessarily subjective and are an inherent part of the asset impairment evaluation. If market fundamentals in the oil and gas industry deteriorate further or if Diamond Offshore is unable to secure new or extend existing contracts for its current, actively-marketed drilling fleet or reactivate any of its cold stacked rigs or if Diamond Offshore experiences unfavorable changes to actual dayrates and rig utilization, additional impairment losses may be required to be recognized in future periods.
As a result of the continued deterioration of the market fundamentals in the oil and gas industry, the Company assessed the carrying value of goodwill related to its investment in Diamond Offshore. An impairment charge of $20 million was recorded in Other operating expenses in the third quarter of 2015 to write-off all goodwill attributable to Diamond Offshore.
of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably estimable than long-tail claims, such as workers’ compensation, general liability and professional liability claims. Adjustments to prior year reserve estimates, if necessary, are reflected in the results of operations in the period that the need for such adjustments is determined. There can be no assurance that CNA’s ultimate cost for insurance losses will not exceed current estimates.
Favorable net prior year development of $50 million, $14 million and $9 million was recorded in Life & Group Non-Core for the years ended December 31, 2015, 2014 and 2013. The favorable net prior year development for the year ended December 31, 2015 was driven by favorable claim severity.
Favorable development in other professional liability and management liability related to better than expected large loss emergence in financial institutions primarily in accident years 2011 through 2014. Additional favorable development related to lower than expected severity for professional services in accident years 2011 and prior. Unfavorable development was recorded related to increased frequency of large claims on public company management liability in accident years 2012 through 2014.
Favorable development for surety coverages was primarily due to lower than expected frequency of large losses in accident years 2013 and prior.
Unfavorable development for workers’ compensation was primarily due to higher than expected severity related to Defense Base Act (“DBA”) contractors in accident years 2008 through 2014.
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 DBA contractors in accident years 2010 through 2013 and the recognition of losses related to favorable premium development in accident year 2013.
The following table and discussion presents further detail of the development recorded for the International segment:
Reinsurance commutations in the first quarter of 2014 reduced ceded losses from prior years. Overall the commutations increased net operating income because of the release of the related allowance for uncollectible reinsurance.
The commutation of a third-party capital provider’s 15% participation in the 2012 year of account resulted in recognition of the 15% share of year of account premiums, losses and expenses.
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”). At the transaction effective date, 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, 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, CNA recognized a provision for uncollectible third-party reinsurance which increased the expected recovery from NICO.
As of December 31, 2015 and 2014, the cumulative amounts ceded under the LPT were $2.6 billion and $2.5 billion. The unrecognized deferred retroactive reinsurance benefit was $241 million and $176 million as of December 31, 2015 and 2014.
In connection with the planned relocation of CNA’s global headquarters, on February 12, 2016, CNA agreed to sell the current principal executive offices of CNA. Concurrently, CNA agreed to lease back the current office space until the relocation of the global headquarters under a separate lease agreement, which is expected to occur in 2018. These anticipated lease agreements include expected future minimum lease payments of $9 million in 2016, $10 million in 2017, $4 million in 2018, $0 in 2019, $5 million in 2020 and $138 million thereafter through the remainder of the seventeen year lease term on the new office space.
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 these jurisdictions include years 2009 to 2015. The 2013 federal income tax return is currently under examination.
At December 31, 2015, 2014 and 2013, $49 million, $51 million and $76 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, 2015, 2014 and 2013. The Company recorded income tax expense of $2 million and $38 million for the years ended December 31, 2015 and 2013 and income tax benefit of $22 million for the year ended December 31, 2014 related to penalties.
Due to the 2015 expiration of the statute of limitations in Mexico for the 2009 tax year for one of Diamond Offshore’s subsidiaries operating in Mexico, Diamond Offshore reversed an $11 million accrual for an uncertain tax position of which $4 million is interest and $1 million is penalty.
Although realization of deferred tax assets is not assured, management believes it is more likely than not that the recognized deferred tax assets will be realized through recoupment of ordinary and capital taxes paid in prior carryback years and through future earnings, reversal of existing temporary differences and available tax planning strategies.
Diamond Offshore has a $1.5 billion senior unsecured revolving credit facility. In October 2015, Diamond Offshore entered into an extension agreement of the revolving credit facility which, among other things, provides for a one-year extension of the maturity date for most of the lenders. The extended revolving credit facility matures in October 2020, except for $40 million of commitments that mature in March 2019 and $60 million of commitments that mature in October 2019. In addition, Diamond Offshore also has the option to increase the revolving commitments under the revolving credit facility by up to an additional $500 million from time to time, upon receipt of additional commitments from new or existing lenders, and to request one additional one-year extension of the maturity date. Up to $250 million of the facility may be used for the issuance of performance or other standby letters of credit and up to $100 million may be used for swingline loans. At December 31, 2015 and 2014, there were no amounts outstanding under the credit agreement.
As of December 31, 2015, Diamond Offshore had $287 million outstanding of commercial paper supported by its existing $1.5 billion revolving credit facility. As of December 31, 2015, the commercial paper notes had a weighted average interest rate of 0.9% and a weighted average remaining term of 5.8 days.
Boardwalk Pipeline intends to refinance all of the outstanding $250 million aggregate principal amount of 5.9% notes due 2016 on a long term basis and has sufficient available capacity under their revolving credit facility to extend the amount that would otherwise come due in less than one year. The Boardwalk Pipeline Senior Notes due in 2016 are included in Long term debt on the Consolidated Balance Sheets.
In March of 2015, Boardwalk Pipeline completed a public offering of an additional $250 million aggregate principal amount of its 5.0% senior notes due December 15, 2024. Boardwalk Pipeline originally issued $350 million aggregate principal amount of its 5.0% senior notes due December 15, 2024 in November of 2014. During 2015, Boardwalk Pipeline used the net proceeds from this offering to retire all of the outstanding $250 million aggregate principal amount of 4.6% notes that matured on June 1, 2015 and repaid at maturity the entire $275 million aggregate principal amount of its 5.1% senior notes.
In May of 2015, Boardwalk Pipeline entered into an amended revolving credit agreement having aggregate lending commitments of $1.5 billion and a maturity date of May 26, 2020. Outstanding borrowings under Boardwalk’s revolving credit facility as of December 31, 2015 and 2014 were $375 million and $120 million with a weighted-average interest rate on the borrowings of 1.7% and 1.5%. At December 31, 2015, Boardwalk Pipeline was in compliance with all covenants under the credit facility and had available borrowing capacity of $1.1 billion.
During 2015, Boardwalk Pipeline repaid the $200 million of outstanding borrowings and terminated all related commitments of their variable-rate term loan.
In September of 2015, Loews Hotels entered into an $87 million mortgage loan agreement which bears interest at London Interbank Offered Rate (“LIBOR”) plus an applicable margin. The mortgage loan agreement is due October 1, 2018 and includes two optional one-year extensions, subject to applicable conditions.
There are no restrictions on the Company’s retained earnings or net income with regard to payment of dividends. However, as a holding company, Loews relies upon invested cash balances and distributions from its subsidiaries to generate the funds necessary to declare and pay any dividends to holders of its common stock. The ability of the Company’s subsidiaries to pay dividends is subject to, among other things, the availability of sufficient earnings and funds in such subsidiaries, compliance with covenants in their respective loan agreements and 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 13 for a discussion of the regulatory restrictions on CNA’s availability to pay dividends.
The Company purchased 1.1 million shares of Diamond Offshore common stock at an aggregate cost of $29 million during 2015. The Company’s percentage ownership interest in Diamond Offshore increased as a result of these transactions, from 52% to 53%. The Company’s purchase price of the shares was lower than the carrying value of its investment in Diamond Offshore, resulting in an increase to Additional paid-in capital (“APIC”) of $5 million.
CNA has a prescribed practice as it relates to the accounting under Statement of Statutory Accounting Principles No. 62R (“SSAP No. 62R”), Property and Casualty Reinsurance, paragraphs 67 and 68 in conjunction with the 2010 loss portfolio transfer with NICO as further discussed in Note 8. The prescribed practice allows CNA to aggregate all third party AE&P reinsurance balances administered by NICO in Schedule F and to utilize the loss portfolio transfer as collateral for the underlying third-party reinsurance balances for purposes of calculating the statutory reinsurance penalty. This prescribed practice increased statutory capital and surplus at December 31, 2015 by $90 million.
The statutory capital and surplus presented above for CCC was approximately 266% and 270% of company action level RBC at December 31, 2015 and 2014. 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 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, 2015, the Company had committed $105 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.
The table below presents the estimated future minimum benefit payments at December 31, 2015.
In 2016, it is expected that contributions of approximately $14 million will be made to pension plans and $4 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 57% were equity related, 37% pursued a multi-strategy approach and 6% were focused on distressed investments at December 31, 2015.
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, 2015 and 2014:
There were no Level 3 assets at December 31, 2015 and 2014.
In 2015, the Company awarded SARs totaling 924,000 shares. In accordance with the Loews Plan, the Company has the ability to settle SARs in shares or cash and has the intention to settle in shares. The SARs balance at December 31, 2015 was 7,350,858 shares. There were 5,357,709 shares and 6,099,228 shares available for grant as of December 31, 2015 and 2014.
The weighted average remaining contractual terms of awards outstanding and exercisable as of December 31, 2015 were 5.2 years and 4.1 years. The aggregate intrinsic values of awards outstanding and exercisable at December 31, 2015 were $9 million and $9 million. The total intrinsic value of awards exercised was $5 million, $8 million and $11 million for the years ended 2015, 2014 and 2013. The total fair value of shares vested was $6 million, $7 million and $7 million for the years ended 2015, 2014 and 2013.
Included in the direct and ceded earned premiums for the years ended December 31, 2015, 2014 and 2013 are $3.3 billion, $2.6 billion and $2.2 billion related to property business that is 100% reinsured under a significant third party captive program. The third party captives that participate in this program are affiliated with the non-insurance company policyholders, therefore this program provides a means for the policyholders to self-insure this property risk. CNA receives and retains a ceding commission.
The Company and its subsidiaries are parties to litigation arising in the ordinary course of business. The outcome of this litigation will not, in the opinion of management, materially affect the Company’s results of operations or equity.
undisclosed liabilities. Certain provisions of the indemnification agreements survive indefinitely, while others survive until the applicable statutes of limitation expire, or until the agreed upon contract terms expire.
Diamond Offshore is financially obligated under a contract with Hyundai Heavy Industries, Co. Ltd. (“Hyundai”) for the construction of a dynamically positioned, harsh environment semisubmersible drilling rig. The total cost of the rig including shipyard costs, capital spares, commissioning, project management and shipyard supervision is estimated to be $764 million. The remaining contractual payment of $440 million is due upon delivery of the rig, which is expected to occur in mid-2016.
The Consolidated Statements of Income include discontinued operations of HighMount as follows:
In 2014 and 2013, HighMount recorded ceiling test impairment charges of $29 million and $291 million ($19 million and $186 million after tax) related to the carrying value of its natural gas and oil properties. The 2014 write-down was primarily attributable to insufficient reserve additions from exploration activities due to variability in well performance where HighMount was testing different horizontal target zones and hydraulic fracture designs. The 2013 write-downs were primarily attributable to negative reserve revisions due to variability in well performance where HighMount was testing different horizontal target zones and hydraulic fracture designs and due to reduced
average NGL prices used in the ceiling test calculations. Had the effects of HighMount’s cash flow hedges not been considered in calculating the ceiling limitation, the impairments would have been $29 million and $301 million ($18 million and $192 million after tax) for the years ended December 31, 2014 and 2013.
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 of London marketplace. Other Non-Core primarily includes the results of CNA’s long term care business that is in run-off and also includes certain 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.