transportation and storage of natural gas and natural gas liquids and gathering and processing of natural gas (Boardwalk Pipeline Partners, LP (“Boardwalk Pipeline”), a 53% owned subsidiary);
goodwill impairment charges of $398 million in 2013 primarily related to HighMount reflecting the continued low market prices for natural gas and natural gas liquids and recent history of negative reserve revisions; and
a $111 million charge in 2013 related to CNA’s retroactive reinsurance agreement to cede its legacy asbestos and environmental pollution liabilities to National Indemnity, a subsidiary of Berkshire Hathaway, Inc. (“Loss Portfolio Transfer” or “LPT”). Under retroactive reinsurance accounting, amounts ceded through the LPT in excess of the consideration paid result in a deferred gain that is recognized in income over future periods. During the fourth quarter of 2013, the cumulative amounts ceded under the LPT exceeded the consideration paid, resulting in the recognition of an accounting loss.
CNA’s earnings increased primarily from improved non-catastrophe current accident year underwriting results, higher investment income and lower catastrophe losses. These increases were partially offset by a lower level of favorable net prior year development in 2013 as compared to 2012. The prior year catastrophe losses included $171 million (after tax and noncontrolling interests) related to Storm Sandy.
Additionally, an exposure exists with respect to the collectibility of amounts due from customers on other receivables. An allowance for doubtful accounts is recorded on the basis of periodic evaluations of balances due currently or in the future, management’s experience and current economic conditions.
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 fiscal and monetary policies. Changes in these assumptions can have a material impact on pension obligations and pension expense.
HighMount follows the full cost method of accounting for natural gas and oil exploration and production activities. Under the full cost method, all direct costs of property acquisition, exploration and development activities are capitalized and subsequently depleted using the units-of-production method. The depletable base of costs includes estimated future costs to be incurred in developing proved natural gas and oil reserves, as well as capitalized asset retirement costs, net of projected salvage values. Capitalized costs in the depletable base are subject to a ceiling test. The test limits capitalized amounts to a ceiling, the present value of estimated future net revenues to be derived from the production of proved natural gas and oil reserves, using calculated average prices adjusted for any cash flow hedges in place. If net capitalized costs exceed the ceiling test at the end of any quarterly period, then a write-down of the assets must be recognized in that period. A write-down may not be reversed in future periods, even though higher natural gas and oil prices may subsequently increase the ceiling. For the years ended December 31, 2013 and 2012, HighMount recognized impairment charges of $291 million and $680 million ($186 million and $433 million after tax) related to the carrying value of natural gas and oil properties, as discussed further in Note 7 of the Notes to Consolidated Financial Statements included under Item 8. In addition, gains or losses on the sale or other disposition of natural gas and oil properties are not recognized unless the gain or loss would significantly alter the relationship between capitalized costs and proved reserves.
On February 10, 2014, CNA entered into a definitive agreement to sell the majority of its run-off annuity and pension deposit business. Further information on the sale is included in Note 23 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. Examples of emerging or potential claims and coverage issues include:
uncertainty in future medical costs in workers’ compensation. In particular, medical cost inflation could be greater than expected due to new treatments, drugs and devices; increased health care utilization; and/or the future costs of health care facilities. In addition, the relationship between workers’ compensation and government and private health care providers could change, potentially shifting costs to workers’ compensation;
The Loss Portfolio Transfer is a retroactive reinsurance contract. During 2013 the cumulative amounts ceded under the Loss Portfolio Transfer exceeded the consideration paid, resulting in a $189 million deferred retroactive reinsurance gain. This deferred benefit will be recognized in earnings in future periods in proportion to actual recoveries under the Loss Portfolio Transfer. Over the life of the contract, there is no economic impact as long as any additional losses are within the limit under the contract.
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 and warranty. CNA Specialty and CNA Commercial contain both long-tail and short-tail exposures. Hardy contains primarily short-tail exposures. Other contains long-tail exposures.
Currently, CNA’s recorded reserves are modestly higher than the actuarial point estimate. For CNA Commercial, CNA Specialty and Hardy, 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.
The key assumptions fundamental to the reserving process are often different for various products and accident or policy years. Some of these assumptions are explicit assumptions that are required of a particular method, but most of the assumptions are implicit and cannot be precisely quantified. An example of an explicit assumption is the pattern employed in the paid development method. However, the assumed pattern is itself based on several implicit assumptions such as the impact of inflation on medical costs and the rate at which claim professionals close claims.
Within CNA Specialty, CNA believes a material deviation to its net reserves is reasonably possible for professional liability and management liability products and Surety products. This includes professional liability coverages provided to various professional firms, including architects, real estate agents, small and mid-sized accounting firms, law firms and other professional firms. This also includes D&O, employment practices, fiduciary, fidelity and surety coverages, as well as insurance products serving the health care delivery system. The most significant factor affecting reserve estimates for these products is claim severity. Claim severity is driven by the cost of medical care, the cost of wage replacement, legal fees, judicial decisions, legislative changes and other factors. Underwriting and claim handling decisions such as the classes of business written and individual claim settlement decisions can also impact claim severity. If the estimated claim severity increases by 9%, CNA estimates that the net reserves would increase by approximately $550 million. If the estimated claim severity decreases by 3%, CNA estimates that net reserves would decrease by approximately $200 million. CNA’s net reserves for these products were approximately $5.9 billion at December 31, 2013.
Within CNA Commercial, the two types of business for which CNA believes a significant deviation to its net reserves is reasonably possible are workers’ compensation and general liability.
For CNA Commercial 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 CNA Commercial general liability were approximately $3.7 billion at December 31, 2013.
In light of the many uncertainties associated with establishing the estimates and making the assumptions necessary to establish reserve levels, CNA reviews its reserve estimates on a regular basis and makes adjustments in the period that the need for such adjustments is determined. These reviews have resulted in CNA’s identification of information and trends that have caused CNA to change its reserves in prior periods and could lead to the
identification of a need for additional material increases or decreases in claim and claim adjustment expense reserves, which could materially affect our results of operations and equity and CNA’s business and insurer financial strength and corporate debt ratings positively or negatively. See the Ratings section of this MD&A for further information regarding CNA’s financial strength and corporate debt ratings.
The actuarial assumptions represent management’s best estimates at the date the contract was issued plus a margin for adverse deviation. Actuarial assumptions include estimates of morbidity, mortality, policy persistency, discount rates and expenses over the life of the contracts. Under GAAP, 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.
CNA’s payout annuity reserves consist primarily of single premium group and structured settlement annuities. The annuity payments are generally fixed and are either for a specified period or contingent on the survival of the payee. These reserves are discounted except for reserves for loss adjustment expenses on structured settlements not funded by annuities in its property and casualty insurance companies. In 2012 and 2011, CNA recognized a premium deficiency on its payout annuity reserves. Therefore, the actuarial assumptions established at time of issue have been unlocked and updated to management’s then current best estimate. The actuarial assumptions that management believes are subject to the most variability are discount rate and mortality.
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. 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 actuarial assumptions that management believes are subject to the most variability are discount rate, morbidity, and persistency, which can be affected by policy lapses and death. There is limited historical data and industry data available to CNA for these reserves, as only a small portion of the long term care policies which have been written to date are in claims paying status and trends in morbidity and mortality change over time. As a result, CNA’s long term care reserves may be subject to material increase if these trends develop adversely to its expectations.
The following table summarizes the Life & Group Non-Core policyholder reserves:
(a) To the extent that unrealized gains on fixed income securities supporting long term care products and payout 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 do not include $342 million and $369 million related to Deferred acquisition costs at December 31, 2013 and 2012.
Net written premiums increased $385 million in 2013 as compared with 2012, including an increase of $279 million related to Hardy. Excluding Hardy, the increase in net written premiums was primarily driven by increased rate, partially offset by previous underwriting actions taken in certain business classes in CNA Commercial. Net earned premiums increased $391 million in 2013 as compared with 2012, including $241 million related to Hardy. Excluding Hardy, the increase in net earned premiums was consistent with increases in net written premiums.
Net operating income increased $383 million in 2013 as compared to 2012, primarily due to improved underwriting results, higher net investment income and a settlement benefit of $28 million (after tax and noncontrolling interests) in 2013 for CNA Commercial. These favorable impacts were partially offset by unfavorable net prior year development in 2013 for CNA 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.
Favorable net prior year development decreased by $189 million, from $428 million in 2011 to $239 million in 2012. Further information on net prior year development is included in Note 9 of the Notes to Consolidated Financial Statements included under Item 8.
Life & Group Non-Core primarily includes the results of the life and group lines of business that are in run-off. Other primarily 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.
The following table summarizes the results of CNA’s Life & Group Non-Core and Other operations for the years ended December 31, 2013, 2012 and 2011.
Net loss decreased $101 million in 2012 as compared with 2011. The results include expenses of $22 million (after tax and noncontrolling interests) in 2012 and $104 million (after tax and noncontrolling interests) in 2011 related to CNA’s payout annuity business, due to unlocking actuarial reserve assumptions. The initial reserving assumptions for these contracts were determined at issuance, including a margin for adverse deviation, and were locked in throughout the life of the contract unless a premium deficiency developed. The increase to the related reserves in 2012 related to anticipated adverse changes in discount rates, which reflected the low interest rate environment and CNA’s view of expected future investment yields. The increase in 2011 related to anticipated adverse changes in mortality and discount rates. Additionally, long term care claim reserves were increased $18 million (after tax and noncontrolling interests) in 2012 and $30 million (after tax and noncontrolling interests) in 2011.
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 revenues are dayrates for rigs and rig utilization rates, 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. Revenue from dayrate drilling contracts are generally recognized 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 be compensated.
Diamond Offshore’s pretax income is also a function of varying levels of operating expenses. Operating expenses generally are not affected by changes in dayrates, and short term reductions in utilization do not necessarily result in lower operating expenses. For instance, if a rig is to be idle for a short period of time, few decreases in operating expenses may actually occur since the rig is typically maintained in a prepared or “warm stacked” state with a full crew. In addition, when a rig is idle, Diamond Offshore is responsible for certain operating expenses such as rig fuel and supply boat costs, which are typically costs of the operator when a rig is under contract. However, if the rig is to be idle for an extended period of time, Diamond Offshore may reduce the size of a rig’s crew and take steps to “cold stack” the rig, which lowers expenses and partially offsets the impact on pretax income.
Operating expenses represent all direct and indirect costs associated with the operation and maintenance of Diamond Offshore’s drilling equipment. The principal components of Diamond Offshore’s operating costs are, among other things, direct and indirect costs of labor and benefits, repairs and maintenance, freight, regulatory inspections, boat and helicopter rentals and insurance. Labor and repair and maintenance costs represent the most significant components of Diamond Offshore’s operating expenses. In general, labor costs increase primarily due to higher salary levels, rig staffing requirements and costs associated with labor regulations in the geographic regions in which Diamond Offshore’s rigs operate. In addition, the costs associated with training new and seasoned employees can be significant. Diamond Offshore expects its labor and training costs to increase in 2014 as a result of increased hiring and training activities as it continues the process of crewing its remaining drillships and semisubmersible rigs under construction. Costs to repair and maintain equipment fluctuate depending upon the type
During 2014, six of Diamond Offshore’s rigs will require 5-year surveys and another three rigs will complete surveys that commenced in 2013. These nine rigs are expected to be out of service for approximately 380 days in the aggregate. Diamond Offshore also expects to spend an additional approximately 670 days during 2014 for intermediate surveys, the mobilization of rigs, contract acceptance testing and extended maintenance projects, including contract preparation work for the Ocean Endeavor (approximately 162 days) and North Sea enhancements for the Ocean Patriot (approximately 165 days). The service-life-extension project for the Ocean Confidence is expected to commence late in the first quarter of 2014, and the rig will be out of service for the balance of the year (approximately 290 days). 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.
Diamond Offshore is self-insured for physical damage to rigs and equipment caused by named windstorms in the U.S. Gulf of Mexico. If a named windstorm in the U.S. Gulf of Mexico 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, 2014, Diamond Offshore carries physical damage insurance for certain losses other than those caused by named windstorms in the U.S. Gulf of Mexico 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.
The ultra-deepwater market has weakened, with an increasing number of rigs competing for fewer available jobs, resulting in a downward trend in recent contract dayrate fixtures and shorter term contracts executed. The most active ultra-deepwater floater markets remain primarily within the offshore basins of West Africa, Brazil and the Gulf of Mexico. However, there has been limited tendering activity thus far in 2014 and the outlook is uncertain for the remainder of 2014. If this trend continues, ultra-deepwater floaters could experience lower utilization, or idle time, and realize lower margins. Many industry analysts predict that there will be an oversupply of floaters in the ultra-deepwater market by the end of 2014.
(b) As of February 5, 2014, for deepwater floaters includes (i) $308 million attributable to contracted operations offshore Brazil for the years 2014 to 2016 and (ii) $36 million for the years 2014 and 2015 attributable to future work for the Ocean Apex, which is under construction.
The following table reflects the amount of Diamond Offshore’s contract drilling backlog by year as of February 5, 2014:
(a) As of February 5, 2014, for ultra-deepwater floaters includes (i) $499 million and $324 million for the years 2014 and 2015, attributable to contracted operations offshore Brazil, (ii) $174 million, $361 million and $362 million for the years 2014 to 2016, and $909 million in the aggregate for the years 2017 to 2019, attributable to future work for two newbuild drillships, one of which is under construction and (iii) $107 million for the year 2016 and $534 million in the aggregate for the years 2017 to 2019 attributable to future work for the ultra-deepwater semisubmersible rig under construction.
(b) As of February 5, 2014, for deepwater floaters includes (i) $112 million, $134 million and $62 million for the years 2014 to 2016, attributable to contracted operations offshore Brazil and (ii) $29 million and $7 million for the years 2014 and 2015 attributable to future work for the Ocean Apex, which is under construction.
(c) As of February 5, 2014, for mid-water floaters includes $342 million and $79 million for the years 2014 and 2015, attributable to contracted operations offshore Brazil.
The following table reflects the percentage of rig days committed by year as of February 5, 2014. 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 rigs under construction.
(b) Revenue earning days for the years ended December 31, 2012 and 2011 included approximately 87 days and 720 days, earned by Diamond Offshore’s jack-up rigs during the respective periods 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).
(e) Average daily revenue is defined as contract drilling revenue (excluding revenue for mobilization, demobilization and contract preparation) per revenue earning day.
The following table summarizes the results of operations for Diamond Offshore for the years ended December 31, 2013, 2012 and 2011 as presented in Note 22 of the Notes to Consolidated Financial Statements included under Item 8:
Revenue generated by mid-water floaters decreased $77 million in 2013 as compared with 2012, as a result of decreased utilization of $119 million and a reduction in amortized mobilization and contract preparation fees of $8 million, partially offset by higher average daily revenue of $50 million. Revenue earning days decreased primarily due to an increase in planned downtime for shipyard inspections and projects, cold-stacking of a rig, and 136 fewer days for the Ocean Quest and Ocean Lexington for which the associated revenue of $61 million was not recognized due to the financial condition of two of Diamond Offshore’s customers and since collection of the amounts due was not reasonably assured, 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.
Net income decreased $80 million in 2013 as compared with 2012 reflecting the decline in revenue, increase in contract drilling expense and recognition of bad debt expense of $23 million, partially offset by lower interest expense. The decrease in interest expense is primarily due to an increase in interest capitalized on eligible construction projects in 2013, partially offset by incremental interest expense for the senior unsecured notes issued in 2013 and interest expense associated with uncertain tax positions in the Mexico tax jurisdiction. Net income for 2012 also included a $32 million gain (after tax and noncontrolling interests) on the sale of six jack-up rigs and an impairment loss of $19 million (after tax and noncontrolling interests) recognized on three mid-water floaters.
Revenue generated by ultra-deepwater floaters increased $61 million in 2012 as compared with 2011, primarily due to increased average daily revenue of $30 million and increased utilization of $30 million due to higher revenue earning days. The increase in average daily revenue was primarily due to higher dayrates earned by the Ocean Monarch operating internationally during 2012 compared with the rig operating in the GOM in 2011. The increase in revenue earning days was primarily due to downtime associated with the Ocean Monarch in 2011, partially offset by a decrease in revenue earning days in 2012 for other ultra-deepwater rigs as a result of scheduled surveys and shipyard projects as well as unscheduled downtime for repairs in 2012.
Revenue generated by deepwater floaters decreased $135 million in 2012 as compared with 2011, primarily due to a $76 million decrease in average daily revenue, a $47 million decrease in utilization as a result of fewer revenue earning days and a $12 million decrease in amortized mobilization fees. The decline in average daily revenue during 2012 was primarily due to the completion of the Ocean Valiant’s contract in Angola in December of 2011 which was at a significantly higher dayrate than the rig earned during 2012. The decrease in utilization during 2012 was primarily due to higher incremental downtime for shipyard projects and inspections as compared with 2011.
Revenue generated by mid-water floaters decreased $207 million in 2012 as compared with 2011, primarily due to a $166 million decrease in utilization, a $28 million decrease in average daily revenue and a $13 million decrease in amortized mobilization fees. Revenue earning days decreased by 615, primarily attributable to planned downtime for mobilization and shipyard projects, unplanned downtime for repairs, the warm stacking of rigs between contracts and additional days a rig was cold-stacked.
Net income decreased in 2012 as compared with 2011 reflecting a decline in revenue and a $19 million impairment loss (after tax and noncontrolling interests) on three mid-water floaters which were expected to be disposed of in 2013. Net income for 2012 included a $32 million gain (after tax and noncontrolling interests) on the sale of six jack-up rigs. In addition, interest expense decreased $27 million in 2012 as compared with 2011 primarily due to incremental interest costs capitalized during 2012 related to the continuing rig construction projects.
differentials, generally the difference in the price of natural gas at receipt and delivery points across Boardwalk Pipeline’s natural gas pipeline system, influence how much customers are willing to pay to transport gas between those points. Basis differentials can be affected by, among other things, the availability and supply of natural gas, the proximity of supply areas to end use markets, competition from other pipelines, including pipelines under development, available transportation and storage capacity, storage inventories, regulatory developments, weather and general market demand in markets served by Boardwalk Pipeline’s pipeline systems. New sources of natural gas continue to be identified and developed in the U.S., including the Marcellus and the Utica shale plays, which are closer to the traditional high value markets that Boardwalk Pipeline serves than the supply basins connected to Boardwalk Pipeline’s facilities. As a result, pipeline infrastructure has been and continues to be developed to move natural gas and NGLs from these supply basins to market areas, resulting in changes in pricing dynamics between supply basins, pooling points and market areas. Additionally, these new supplies of natural gas have reduced production or slowed production growth from supply areas connected to Boardwalk Pipeline’s pipelines and have caused some of the gas production that is supplied to Boardwalk Pipeline’s system to be diverted to other market areas. As a result of the new sources of supply and related pipeline infrastructure discussed above, basis differentials on Boardwalk Pipeline’s pipeline systems have narrowed significantly in recent years, reducing the transportation rates and other contract terms Boardwalk Pipeline can negotiate with its customers for available transportation capacity and for contracts due for renewal for its interruptible and firm transportation services.
A substantial portion of Boardwalk Pipeline’s transportation capacity is contracted for under firm transportation agreements. Each year a portion of Boardwalk Pipeline’s firm transportation agreements expire and needs to be renewed or replaced. Due to the factors noted above, in recent periods Boardwalk Pipeline has renewed many expiring contracts at lower rates and for shorter terms than in the past, which has materially adversely impacted its firm and interruptible transportation revenues. In light of the market conditions discussed above, natural gas transportation contracts that Boardwalk Pipeline has renewed or entered into in 2013 and in recent years have been at lower rates, and any remaining available capacity generally has been marketed and sold at lower rates under short term firm or interruptible contracts, or in some cases not sold at all. As a result, capacity reservation charges under firm transportation agreements for the year ended December 31, 2013 were lower by $45 million than they were for 2012. Boardwalk Pipeline expects this trend to continue and therefore may not be able to sell its available capacity, extend expiring contracts with existing customers or obtain replacement contracts at attractive rates or for the same term as the expiring contracts, all of which would continue to adversely impact its transportation revenues, earnings and distributable cash flows and could impact Boardwalk Pipeline on a long term basis.
More recently, Boardwalk Pipeline has seen the value of its storage and PAL services adversely impacted by the factors discussed above, which have contributed to a narrowing of natural gas price differentials between time periods, such as winter to summer (time period price spreads), and the price volatility of natural gas to decline significantly, reducing the rates Boardwalk Pipeline can charge for its storage and PAL services. Based on the current forward pricing curve, which is backwardated, time period price spreads for 2013 have significantly deteriorated from the 2012 levels and Boardwalk Pipeline expects such conditions to persist. In recent months, Boardwalk Pipeline has seen the deterioration of storage spreads accelerate and that trend is expected to continue into 2014. These market conditions, together with regulatory changes in the financial services industry, have also caused a number of gas marketers, which have traditionally been large consumers of Boardwalk Pipeline’s storage and PAL services, to exit the market, further negatively impacting the market for those services. A reduced need for storage as supply increases, narrowing time period price spreads and fewer market participants has caused, and could continue to cause demand for Boardwalk Pipeline’s storage and PAL services to decline on a long term basis.
Pipeline will not issue and sell additional limited partnership units to fund its growth or for other partnership purposes.
Total revenues increased $48 million for 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) (“Petal”) 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.
HighMount’s revenues and profitability depend substantially on natural gas and oil prices and HighMount’s ability to increase its natural gas and oil production. Natural gas and NGL prices remain at low levels due to an increase in the supply of natural gas and NGL resulting from new sources of supply recoverable from shale formations, primarily the result of technological advancements in horizontal drilling and hydraulic fracturing. As a result, it has become uneconomical for HighMount to drill new natural gas wells which has led it to change its capital investments strategy from natural gas production to exploration and development of potential oil producing properties. HighMount has drilled a number of exploratory wells on its properties in the Mississippian Lime and Woodford Shale plays in Oklahoma and in the Wolfcamp zone of its Sonora acreage. Exploration of potential oil producing properties, including drilling and completion of horizontal wells, carries more risk and is significantly more expensive than drilling traditional vertical natural gas-producing wells. HighMount is not currently drilling new wells on its Oklahoma properties and has one drilling rig working in the Wolfcamp area. To date, these exploratory wells have not yielded sufficient quantities of oil to support commercial development of these properties. Further study and refinement of drilling techniques will be required in order to determine whether there is an economic development opportunity. HighMount has incurred substantial ceiling test and other impairment charges as a result of the market conditions and drilling efforts discussed above and could incur significant additional impairment charges in the future if these conditions continue or HighMount’s efforts to develop sufficient new proved reserves are not successful.
HighMount’s operating expenses consist primarily of production expenses, production and ad valorem taxes, as well as depreciation, depletion and amortization (“DD&A”) expenses. Production expenses represent costs incurred to operate and maintain wells, related equipment and facilities and transportation costs and contain a significant fixed cost component. Production expenses per Mcfe increased primarily as a result of lower natural gas and NGL production that has absorbed HighMount’s fixed costs. HighMount’s increased focus on oil production also contributed to the increase in production cost per Mcfe due to HighMount’s oil projects generally requiring a higher cost to produce per equivalent unit than HighMount’s gas projects. Production and ad valorem taxes increase or decrease primarily when prices of natural gas and oil increase or decrease, but they are also affected by changes in production and state incentive programs, as well as appreciated property values. HighMount calculates depletion using the units-of-production method, which depletes the capitalized costs and future development costs associated with evaluated properties based on the ratio of production volumes for the current period to total remaining reserve volumes for the evaluated properties. HighMount’s depletion expense is affected by its capital spending program and projected future development costs, as well as reserve changes resulting from drilling programs, well performance and revisions due to changing commodity prices.
The following table summarizes the results of operations for HighMount for the years ended December 31, 2013, 2012 and 2011 as presented in Note 22 of the Notes to Consolidated Financial Statements included in Item 8.
Recognition of a ceiling test impairment charge is considered a triggering event for purposes of assessing any potential impairment of goodwill. The quantitative goodwill impairment analysis is a two-step process. The first step compares HighMount’s estimated fair value to its carrying value. Due to the continued low market prices for natural gas and NGLs, the recent history of quarterly ceiling test write-downs during 2012 and 2013 and potential for future impairments, and negative reserve revisions recognized during 2013, HighMount reassessed its goodwill impairment analysis. To determine fair value, HighMount used a market approach which required significant estimates and assumptions. These estimates and assumptions primarily included, but were not limited to, earnings before interest, tax, depreciation and amortization, production and reserves, control premium, discount rates and required capital expenditures. These valuation techniques were based on analysis of comparable public companies, adjusted for HighMount’s growth profile. In the first step, HighMount determined that its carrying value exceeded its fair value requiring HighMount to perform the second step and to estimate the fair value of its assets and liabilities. The carrying value of goodwill is limited to the amount that HighMount’s estimated fair value exceeds the fair value of assets and liabilities. As a result, HighMount recorded a goodwill impairment charge of $584 million ($382 million after tax) for the year ended December 31, 2013, consisting of all of its remaining goodwill.
HighMount’s operating revenues decreased $37 million for 2013 as compared with 2012 primarily due to reduced natural gas and NGL sales volumes and reduced NGL sales prices. HighMount sold 46.0 Bcfe in 2013 compared to 53.7 Bcfe in 2012. The decrease in sales volume was primarily due to the discontinued drilling of conventional vertical natural gas wells in recent years, as well as reduced maintenance of existing producing wells.
HighMount’s operating revenues decreased $93 million in 2012 as compared with 2011 due to decreased natural gas and NGL prices and sales volumes. Average prices realized per Mcfe were $5.42 in 2012 compared to $6.30 in 2011. HighMount sold 53.7 Bcfe in 2012 compared to 60.6 Bcfe in 2011. The decrease in sales volume was primarily due to the continued reduction in capital spending on natural gas drilling since 2008.
Operating expenses were $239 million and $245 million in 2012 and 2011. Production expenses and production and ad valorem taxes were $98 million in 2012 as compared with $109 million in 2011. DD&A expenses were $101 million in 2012 as compared with $94 million in 2011. The increase in DD&A expenses was primarily due to negative reserve revisions in 2011 and projected future development activity focused on developing oil reserves.
Earnings before interest, tax, depreciation and amortization (“EBITDA”) is an indicator of operating performance used by Loews Hotels to measure its ability to service debt, fund capital expenditures and expand its business. EBITDA is a non-GAAP financial measure that is not meant to replace net income as defined by GAAP. The following table reconciles EBITDA to Net income attributable to Loews Corporation for the years ended December 31, 2013, 2012 and 2011.
Results of operations for 2013 as compared to 2012 include the impact of the 2013 closure of the Loews Regency Hotel for renovation and the addition of the Loews Madison Hotel and the Loews Boston Hotel in 2013 to the portfolio of owned hotels for approximately six months. In July of 2013, partial equity interests in the Loews Madison Hotel and the Loews Boston Hotel were sold. Results for 2012 include the Loews Hollywood Hotel for approximately five months prior to a partial equity interest sale in November of 2012. Upon the sale of the equity interests, Loews Hotels’ share of earnings for these hotels is included in Equity income from joint ventures.
Revenues and operating expenses for 2013 and 2012 include $57 million and $27 million of cost reimbursements from joint venture and managed properties, relating mainly to payroll incurred on behalf of the owners of hotel properties managed by Loews Hotels.
Revenues excluding reimbursables decreased by $47 million in 2013 as compared to 2012, primarily due to the 2013 closure of the Loews Regency Hotel.
Revenue per available room (“RevPAR”) is an industry measure of the combined effect of occupancy rates and average room rates on room revenues. Other hotel operating revenues, not included in RevPAR, primarily include guest charges for food and beverages. RevPAR, occupancy rates and average room rates as discussed below are for owned and joint venture hotels. RevPAR decreased $5.41 to $168.67 for 2013 as compared to 2012 reflecting a decrease in occupancy and average room rates. Occupancy rates decreased to 75.2% in 2013 from 76.3% in 2012. Average room rates decreased by $3.60, or 1.6%, in 2013 as compared to 2012. Excluding the Loews Regency Hotel which was closed for renovation throughout 2013, RevPAR increased $3.76 for 2013 as compared to 2012, reflecting an increase in average room rates.
Equity earnings from joint venture properties decreased in 2013 as compared to 2012, primarily due to the impact of renovations and the development of joint venture properties.
Revenues excluding reimbursables increased by $33 million in 2012 as compared to 2011, primarily due to the addition of the Loews Hollywood Hotel in 2012 and higher RevPAR.
Owned and joint venture hotels RevPAR increased $8.93 to $174.08 in 2012 as compared to 2011 reflecting improving occupancy and average room rates; occupancy rates increased to 76.3% in 2012 from 73.6% in 2011; and average room rates increased by $3.65, or 1.6%, in 2012 as compared to 2011.
The following table summarizes the results of operations for Corporate and Other for the years ended December 31, 2013, 2012 and 2011 as presented in Note 22 of the Notes to Consolidated Financial Statements included under Item 8:
Net investment income increased by $60 million for 2012 as compared to 2011, primarily due to improved performance of equity and fixed income investments in the trading portfolio, partially offset by lower performance of limited partnership investments for 2012.
For 2013, net cash provided by operating activities was $1.2 billion as compared with $1.3 billion for 2012. Tax payments were $129 million in 2013 as compared to tax recoveries of $29 million in 2012. Additionally, increased premium receipts were partially offset by increased claim payments.
withdrawn at any time by the issuing organization. Each agency’s rating should be evaluated independently of any other agency’s rating. One or more of these agencies could take action in the future to change the ratings of CNA’s insurance subsidiaries.
Hardy benefits from the collective financial strength of the Lloyd’s market, which is rated A+ by S&P and A by A.M. Best. The outlook by both rating agencies is positive.
Cash and investments totaled $2.1 billion at December 31, 2013, compared to $1.5 billion at December 31, 2012. In 2013, Diamond Offshore paid cash dividends totaling $490 million, consisting of aggregate regular cash dividends of $69 million and aggregate special cash dividends of $421 million. On February 5, 2014, Diamond Offshore declared a regular quarterly dividend of $0.125 per share and a special dividend of $0.75 per share.
Cash provided by operating activities in 2013 was $1.1 billion, compared to $1.3 billion in 2012, a decrease of $245 million compared to the 2012 period, primarily due to lower earnings.
Diamond Offshore is currently obligated under various agreements in connection with the construction of three ultra-deepwater drillships, an ultra-deepwater floater, a deepwater floater, and a North Sea enhancement project. The Ocean Onyx and the Ocean BlackHawk were delivered in December of 2013 and January of 2014 and the final installments on these construction contracts aggregating $403 million were paid in January of 2014. The following is a summary of Diamond Offshore’s remaining construction projects as of February 5, 2014:
(b) Total project costs include contractual payments for shipyard construction, commissioning, capital spares and project management costs and does not include capitalized interest.
For 2014, Diamond Offshore has budgeted approximately $2.1 billion for capital expenditures of which approximately $1.5 billion and $82 million are expected to be spent on current rig construction projects and the Ocean Patriot North Sea enhancement project and approximately $184 million is expected to be spent on a service life extension project for the Ocean Confidence. The remainder will be spent on Diamond Offshore’s ongoing rig equipment enhancement/replacement program. Diamond Offshore expects to finance its 2014 capital expenditures through the use of existing cash balances and cash flows from operations.
As a result of Diamond Offshore’s intention to indefinitely reinvest the earnings of its wholly owned subsidiary, Diamond Offshore International Limited (“DOIL”), to finance its foreign activities, Diamond Offshore does not expect such earnings to be available for distribution to its stockholders or to finance its domestic activities. Diamond Offshore believes that the operating cash flows generated by and cash reserves of DOIL, and the operating cash flows available to and cash reserves of Diamond Offshore will be sufficient to meet both its working capital requirements and its capital commitments. However, in light of the significant cash requirements of Diamond Offshore’s capital expansion program in 2014 and 2015, Diamond Offshore may make use of its credit facility to finance its capital expenditures, working capital requirements and to maintain a certain level of cash reserves. Diamond Offshore will continue to make periodic assessments based on its capital spending programs and industry conditions and will adjust capital spending programs if required. Diamond Offshore, may, from time to time, issue debt or equity securities, or a combination thereof, to finance capital expenditures, the acquisition of assets and
At December 31, 2013 and 2012, cash and investments amounted to $29 million and $4 million. Funds from operations for the year ended December 31, 2013 amounted to $534 million, compared to $576 million in 2012. In 2013 and 2012, Boardwalk Pipeline’s capital expenditures were $295 million and $227 million. During 2012, Boardwalk Pipeline purchased from us the remaining 80% interest in Petal for $285 million and acquired Louisiana Midstream for $620 million. These acquisitions were funded using cash from operations, borrowings under Boardwalk Pipeline’s revolving credit facility and debt and equity offerings. For the years ended December 31, 2013 and 2012, Boardwalk Pipeline paid cash distributions of $534 million and $479 million to its partners.
HighMount’s credit agreement contains financial covenants typical for these types of agreements, including a maximum debt to capitalization ratio and a minimum ratio of the net present value of its projected future cash flows from its proved natural gas and oil reserves to total debt. The calculation of net present value, performed at year-end, is based on commodity prices determined by the lenders and HighMount’s proved reserves at the time of measurement. A decline in commodity prices can reduce HighMount’s borrowing capacity requiring repayment of a portion of its term loans. Due to the current limited capacity of HighMount’s credit agreement, we made $210 million of capital contributions to HighMount in 2013 to fund repayment of $110 million under HighMount’s revolving loan and $100 million under its term loans. In addition, during 2013, we made $139 million of capital contributions to HighMount for capital expenditures focused on the exploration and development of oil producing properties. The credit agreement also contains customary restrictions or limitations on HighMount’s ability to engage in certain transactions, including transactions with affiliates. HighMount currently has $480 million of term loans outstanding and is in compliance with all of its covenants under the credit agreement.
Loews Hotels added two properties to its portfolio in 2013, the Loews Madison Hotel and the Loews Boston Hotel. These acquisitions were initially funded with existing cash balances, debt and capital contributions by us. Subsequently, Loews Hotels sold half of its equity interests in both properties.
As of December 31, 2013, there were 387,210,096 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. During the year ended December 31, 2013, we purchased 4.9 million shares of Loews common stock.
(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, 2013. Future policy benefit reserves of $673 million and policyholders’ fund reserves of $34 million related to business which has been 100% ceded to unaffiliated parties in connection with the sale of CNA’s individual life business in 2004 are not included. 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 $64 million to the Company’s pension and postretirement plans in 2014.
Net investment income increased $228 million for 2012 as compared with 2011. The increase was primarily driven by a significant increase in limited partnership investment income, increased trading portfolio income and an increase in fixed maturity securities income. The increase in fixed maturity securities income was driven by a higher invested asset base and a favorable net impact of changes in estimates of prepayments for asset-backed securities. These favorable impacts were partially offset by the effect of investing at lower market interest rates.
Net realized investment gains decreased $19 million for 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. Net realized investment gains increased $45 million for 2012 as compared with 2011. 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.
The following table provides the maturity profile for these available-for-sale fixed maturity securities. Securities not due to mature on a single date are allocated based on weighted average life:
A further consideration in the management of the investment portfolio is the characteristics of the corresponding liabilities and the ability to align the duration of the portfolio to those liabilities and to meet future liquidity needs, minimize interest rate risk and maintain a level of income sufficient to support the underlying insurance liabilities. For portfolios where future liability cash flows are determinable and typically long term in nature, CNA segregates investments for asset/liability management purposes. The segregated investments support the liabilities in Life & Group Non-Core including annuities, structured settlements and long term care products.
We have audited the internal control over financial reporting of Loews Corporation and subsidiaries (the “Company”) as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying management’s report on internal control over financial reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2013 of the Company and our report dated February 24, 2014 expressed an unqualified opinion on those consolidated financial statements and financial statement schedules.
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, 2013, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2014 expressed an unqualified opinion on the Company’s internal control over financial reporting.
To the extent that unrealized gains on fixed income securities supporting long term care products and payout 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 is recorded, net of tax and noncontrolling interests, as a reduction of net unrealized gains through Other comprehensive income (“Shadow Adjustments”). Shadow Adjustments decreased $880 million (after tax and noncontrolling interests) and increased $710 million (after tax and noncontrolling interests) for the years ended December 31, 2013 and 2012. At December 31, 2013 and 2012, net unrealized gains on investments included in Accumulated other comprehensive income (“AOCI”) were correspondingly reduced by $478 million and $1.4 billion (after tax and noncontrolling interests).
equity method and changes in net asset values are recorded within Net investment income on the Consolidated Statements of Income.
period of time sufficient to allow for an anticipated recovery in value and (iv) general market conditions and industry or sector specific outlook.
Joint venture investments - The Company has 20% to 50% interests in operating joint ventures related to the Bluegrass Project as discussed in Note 2 and hotel properties that are accounted for under the equity method. The Company’s investment in these entities was $242 million and $67 million for the years ended December 31, 2013 and 2012 and reported in Other assets on the Company’s Consolidated Balance Sheets. Equity income for these investments was $12 million, $24 million and $24 million for the years ended December 31, 2013, 2012 and 2011 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 $336 million, consisting of the amount of the investment and debt guarantees.
The following tables present summarized financial information for these joint ventures:
Claim and claim adjustment expense reserves are presented net of anticipated amounts due from insureds related to losses under deductible policies of $1.3 billion as of December 31, 2013 and 2012. 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.
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, 2013 and 2012, the liability balances were $143 million. As of December 31, 2013 and 2012, included in Other assets on the Consolidated Balance Sheets were $1 million and $2 million of related assets for premium tax offsets. This asset is limited to the amount that is able to be offset against premium tax on future premium collections from business written or committed to be written.
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, 2013 and 2012, and $130 million and $125 million recorded as deposit liabilities at December 31, 2013 and 2012. 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 number of separate account pension deposit contracts guarantee principal and an annual minimum rate of interest. If aggregate contract value in the separate account exceeds the fair value of the related assets, an additional Policyholders’ funds liability is established. Certain of these contracts are subject to a fair value adjustment if terminated by the policyholder.
HighMount follows the full cost method of accounting for natural gas and oil exploration and production activities. Under the full cost method, all direct costs of property acquisition, exploration and development activities are capitalized. These capitalized costs are subject to a quarterly ceiling test. Under the ceiling test, amounts capitalized are limited to the present value of estimated future net revenues to be derived from the anticipated production of proved natural gas and oil reserves, assuming an average price during the twelve month period adjusted for cash flow hedges in place, and limiting the classification of proved undeveloped reserves to locations scheduled to be drilled within five years. If net capitalized costs exceed the ceiling test at the end of any quarterly period, then a permanent write-down of the assets must be recognized in that period. A write-down may not be reversed in future periods, even though higher natural gas and oil prices may subsequently increase the ceiling. Approximately 4.9% (unaudited) of HighMount’s total proved reserves as of December 31, 2013 are hedged by qualifying cash flow hedges, for which hedge adjusted prices were used to calculate estimated future net revenue. Future cash flows associated with settling asset retirement obligations that have been accrued in the Consolidated Balance Sheets are excluded from HighMount’s calculations of discounted cash flows under the full cost ceiling test.
The Company recognized compensation expense that decreased net income by $11 million for the year ended December 31, 2013. For the years ended December 31, 2012 and 2011, the Company recognized compensation expense that decreased net income by $13 million and $12 million. Several of the Company’s subsidiaries also maintain their own stock option plans. The amounts reported above include the Company’s share of expense related to its subsidiaries’ plans.
Supplementary cash flow information - Cash payments made for interest on long term debt, net of capitalized interest, amounted to $415 million, $450 million and $526 million for the years ended December 31, 2013, 2012 and 2011. Cash payments for federal, foreign, state and local income taxes amounted to $183 million, $120 million and $322 million for the years ended December 31, 2013, 2012 and 2011. Investing activities exclude $43 million, $35 million and $14 million of accrued capital expenditures for the years ended December 31, 2013, 2012 and 2011.
In the fourth quarter of 2011, HighMount acquired working interests in oil and gas properties located in Oklahoma. The purchase price was approximately $106 million in cash and was included primarily in the cost of unproved properties within Property, plant and equipment in the Consolidated Balance Sheets.
(a) Includes net unrealized gains (losses) related to changes in fair value on trading securities still held of $(2), $6 and $(58) for the years ended December 31, 2013, 2012 and 2011.
As of December 31, 2013, the Company held no non-income producing fixed maturity securities. As of December 31, 2012, the Company held nine non-income producing fixed maturity securities aggregating $1 million of fair value. As of December 31, 2013 and 2012, 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.
Based on current facts and circumstances, the Company believes the unrealized losses presented in the table above are primarily attributable to broader economic conditions, changes in interest rates and credit spreads, market illiquidity and other market factors, but are not indicative of the ultimate collectibility of the current amortized cost of the securities. The investments with longer duration, primarily included within the states, municipalities and political subdivision asset category, were more significantly impacted by changes in market interest rates. The Company has no current intent to sell these securities, 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, 2013.
Of the limited partnerships held, 79.2% and 84.1% at December 31, 2013 and 2012, employ hedge fund strategies that generate returns through investing in securities that are marketable while engaging in various management techniques primarily in public fixed income and equity markets. These hedge fund strategies include both long and short positions in fixed income, equity and derivative instruments. The 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 53.7% were equity related, 28.7% pursued a multi-strategy approach, 12.8% were focused on distressed investments and 4.8% were fixed income related at December 31, 2013.
Cash and securities with carrying values of approximately $353 million and $4 million were deposited with financial institutions as collateral for letters of credit as of December 31, 2013 and 2012. In addition, cash and securities were deposited in trusts with financial institutions to secure reinsurance and other obligations with various third parties. The carrying values of these deposits were approximately $294 million and $277 million as of December 31, 2013 and 2012.
Prices may fall within Level 1, 2 or 3 depending upon the methodologies and inputs used to estimate fair value for each specific security. In general, the Company seeks to price securities using third party pricing services. Securities not priced by pricing services are submitted to independent brokers for valuation and, if those are not available, internally developed pricing models are used to value assets using methodologies and inputs the Company believes
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, 2013 and 2012:
Securities shown in the Level 3 tables may be transferred in or out of Level 3 based on the availability of observable market information used to determine the fair value of the security. The availability of observable market information varies based on market conditions and trading volume and may cause securities to move in and out of Level 3 from reporting period to reporting period. There were no transfers between Level 1 and Level 2 during the year ended December 31, 2013. There were $106 million of transfers from Level 2 to Level 1 and $72 million of transfers from Level 1 to Level 2 during the year ended December 31, 2012. The Company’s policy is to recognize transfers between levels at the beginning of quarterly reporting periods.
For derivative financial instruments without hedge designation, changes in the fair value of derivatives not held in a trading portfolio are reported in Investment gains (losses) and changes in the fair value of derivatives held for trading purposes are reported in Net investment income on the Consolidated Statements of Income. Losses of $10 million, $5 million and $34 million were recorded in Investment gains (losses) for the years ended December 31, 2013, 2012 and 2011. Losses of $26 million, $19 million and $14 million were included in Net investment income for the years ended December 31, 2013, 2012 and 2011.
Capitalized interest related to the construction and upgrade of qualifying assets amounted to approximately $99 million, $55 million and $31 million for the years ended December 31, 2013, 2012 and 2011.
In 2012, Diamond Offshore decided to actively market for sale three mid-water rigs and one jack-up rig. Diamond Offshore recorded an impairment charge of $62 million related to the three mid-water rigs. The fair value for each rig was measured using an expected present value technique that utilized significant unobservable inputs, representing a Level 3 fair value measurement, which included assumptions for estimated proceeds that may be received on disposition of the rig and estimated costs to sell. At December 31, 2013 and 2012, the carrying value of these rigs amounted to $8 million and $12 million.
In 2013 and 2012, HighMount recorded ceiling test impairment charges of $291 million and $680 million ($186 million and $433 million after tax) related to the carrying value of its natural gas and oil properties. The impairments were recorded within Other operating expenses and as credits to Accumulated DD&A. The 2013 write-downs were primarily attributable to negative reserve revisions due to variability in well performance where HighMount is testing different horizontal target zones and hydraulic fracture designs and due to reduced average NGL prices used in the ceiling test calculations. The write-downs in 2012 were the result of significant declines in natural gas and NGL prices. Had the effects of HighMount’s cash flow hedges not been considered in calculating the ceiling limitation, the impairments would have been $301 million and $737 million ($192 million and $469 million after tax) for the years ended December 31, 2013 and 2012.
HighMount excludes from amortization the cost of unproved properties, the cost of exploratory wells in progress and major development projects in progress. Natural gas and oil property and equipment costs not being amortized as of December 31, 2013, are as follows, by the year in which such costs were incurred:
Based upon the completion of its annual goodwill impairment testing in 2013, Boardwalk Pipeline determined in the first step of the two-step quantitative goodwill impairment analysis that the carrying value of its reporting unit which included goodwill associated with the Petal acquisition as discussed in Note 2, exceeded its fair value. 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. The fair value measurement of the reporting unit was derived based on judgments and assumptions which Boardwalk Pipeline believes market participants would use in assessing the fair value of the reporting unit. These judgments and assumptions which utilized significant unobservable inputs, representing a Level 3 fair value measurement, included the valuation premise, use of a discounted cash flow model to estimate fair value and inputs to the valuation model. The inputs included, but were not limited to, forecasted operating results and the long term natural gas outlook for growth in demand. Due to the results of the first step, Boardwalk Pipeline performed the second step to compare the fair value of the reporting unit to the fair value of the reporting unit’s assets and liabilities. As a result, 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 the goodwill for the reporting unit.
Recognition of a ceiling test impairment charge is considered a triggering event for purposes of assessing any potential impairment of goodwill at HighMount under a two-step process. The first step compares HighMount’s estimated fair value to its carrying value. Due to the continued low market prices for natural gas and NGLs, the recent history of quarterly ceiling test write-downs during 2012 and 2013 and potential for future impairments, and negative reserve revisions recognized during 2013, HighMount reassessed its goodwill impairment analysis. To determine fair value, HighMount used a market approach which required significant estimates and assumptions and utilized significant unobservable inputs, representing a Level 3 fair value measurement. These estimates and assumptions primarily included, but were not limited to, earnings before interest, tax, depreciation and amortization, production and reserves, control premium, discount rates and required capital expenditures. These valuation techniques were based on analysis of comparable public companies, adjusted for HighMount’s growth profile. In the first step, HighMount determined that its carrying value exceeded its fair value requiring HighMount to perform the second step and to estimate the fair value of its assets and liabilities. The carrying value of goodwill is limited to the amount that HighMount’s estimated fair value exceeds the fair value of assets and liabilities. As a result, HighMount recorded a goodwill impairment charge of $584 million ($382 million after tax) for the year ended December 31, 2013, consisting of all of its remaining goodwill.
Changes in estimates of claim and allocated claim adjustment expense reserves and premium accruals, net of reinsurance, for prior years are defined as net prior year development. These changes can be favorable or unfavorable. The following tables and discussion include the net prior year development recorded for CNA Specialty, CNA Commercial and Other segments for the years ended December 31, 2013, 2012 and 2011.
For the year ended December 31, 2013, favorable premium development for Other is primarily due to a commutation recorded at Hardy.
For the year ended December 31, 2011, favorable premium development was recorded for CNA Specialty primarily due to changes in estimates of exposures in medical professional liability tail coverages. Unfavorable premium development for CNA Commercial was recorded due to a reduction of ultimate premium estimates relating to retrospectively rated policies, partially offset by premium adjustments on auditable policies due to increased exposures.
The following table and discussion provide further detail of the net prior year claim and allocated claim adjustment expense reserve development (“development”) recorded for the CNA Specialty segment:
Favorable development for medical professional liability was primarily due to favorable case incurred emergence in nurses, physicians, excess institutions and primary institutions in accident years 2008 and prior.
Favorable development for other professional liability and management liability was driven by better than expected loss emergence in the life agents, accountants, and architects & engineers business in accident years 2008 and prior. In addition, favorable development in CNA’s European book of business was primarily due to favorable outcomes on several large losses in financial directors and officers and errors and omissions coverages in accident years 2003 and prior.
Favorable development in warranty was driven by favorable policy year experience on an aggregate stop loss policy covering CNA’s non-insurance warranty subsidiary.
The following table and discussion provide further detail of the development recorded for the CNA Commercial segment:
Favorable development in the general liability coverages was primarily due to favorable claim emergence in accident years 2007 and prior related to both primary and umbrella liability coverages.
Overall, favorable development for property and other coverages was due to decreased frequency of large losses in commercial multi-peril coverages primarily in accident year 2010, favorable loss emergence related to catastrophe claims in accident year 2008 and favorable loss emergence related to non-catastrophe claims in accident years 2010 and prior. This development amount also included unfavorable development related to unallocated claim adjustment expenses.
The following table displays the impact of the Loss Portfolio Transfer on the Consolidated Statements of Income.
In the fourth quarter of 2013, the cumulative amounts ceded under the Loss Portfolio Transfer of $2.5 billion exceeded the $2.2 billion consideration paid, resulting in a $189 million deferred retroactive reinsurance gain in Insurance claims and policyholders’ benefits on the Consolidated Statements of Income. This deferred benefit will be recognized in earnings in future periods in proportion to actual recoveries under the Loss Portfolio Transfer. Over the life of the contract, there is no economic impact as long as any additional losses are within the limit under the contract.
return. The Company believes this approach should reduce tax-related uncertainties, if any. Although the outcome of tax audits is always uncertain, the Company believes that any adjustments resulting from audits will not have a material impact on its results of operations, financial position and cash flows. The Company and/or its subsidiaries also file income tax returns in various state, local and foreign jurisdictions. These returns, with few exceptions, are no longer subject to examination by the various taxing authorities before 2009.
(a) Includes $39 million of deferred tax assets reflected in Other assets in our Consolidated Balance Sheet at December 31, 2013.
In 2013, CNA became a member of the Federal Home Loan Bank of Chicago (“FHLBC”). FHLBC membership provides participants with access to additional sources of liquidity through various programs and services. As a requirement of membership in the FHLBC, CNA acquired $16 million of FHLBC stock giving it access to approximately $330 million of additional liquidity. As of December 31, 2013, CNA has no outstanding borrowings from the FHLBC.
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, and two one-year extensions are available prior to first and second anniversary of the closing. As of December 31, 2013, there were no borrowings under the credit facility and CNA was in compliance with all covenants.
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 14 for a discussion of the regulatory restrictions on CNA’s availability to pay dividends.
In May of 2013, Boardwalk Pipeline sold 12.7 million common units in a public offering and received net proceeds of $377 million, including an $8 million contribution from the Company to maintain its 2% general partner interest. The Company’s percentage ownership interest in Boardwalk Pipeline declined as a result of this transaction, from 55% to 53%. The issuance price of the common units exceeded the Company’s carrying value, resulting in an increase to Additional paid-in capital (“APIC”) of $51 million and an increase to AOCI of $2 million.
Combined statutory capital and surplus and net income (loss), determined in accordance with accounting practices prescribed or permitted by insurance and/or other regulatory authorities for the Combined Continental Casualty Companies and the life company, were as follows:
The statutory capital and surplus presented above for CCC was approximately 265% and 240% of company action level RBC at December 31, 2013 and 2012. 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.
Users of this information should be aware that the process of estimating quantities of proved natural gas, NGLs and crude oil reserves is very complex, requiring significant subjective decisions in the evaluation of all available geological, engineering and economic data for each reservoir. The data for a given reservoir may also change substantially over time as a result of numerous factors including, but not limited to, additional development activity, evolving production history and continual reassessment of the viability of production under varying economic conditions. As a result, revisions to existing reserve estimates may occur from time to time. Although every reasonable effort is made to ensure reserve estimates reported represent the most accurate assessments possible, the subjective decisions and variances in available data for various reservoirs make these estimates generally less precise than other estimates included in the financial statement disclosures.
Estimated net quantities of proved natural gas and oil (including condensate and NGLs) reserves at December 31, 2013, 2012 and 2011 and changes in the reserves during 2013, 2012 and 2011 are shown in the schedule below:
(a) Development costs incurred for proved undeveloped reserves were $17, $14 and $25 in 2013, 2012 and 2011.
The following provides a reconciliation of benefit obligations and plan assets:
The accumulated benefit obligation for all defined benefit pension plans was $3.3 billion and $3.6 billion at December 31, 2013 and 2012.
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 intent of this strategy is to minimize plan expenses by outperforming 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, 2013, the Company had committed $108 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.
There were no Level 3 assets at December 31, 2013 and 2012.
Savings Plans - The Company and its subsidiaries have several contributory savings plans which allow employees to make regular contributions based upon a percentage of their salaries. Matching contributions are made up to specified percentages of employees’ contributions. The contributions by the Company and its subsidiaries to these plans amounted to $123 million, $117 million and $100 million for the years ended December 31, 2013, 2012 and 2011.
The following table summarizes information about the Company’s stock options and SARs outstanding in connection with the Loews Plan at December 31, 2013:
In 2013, the Company awarded SARs totaling 903,975 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, 2013 was 5,906,074 shares. There were 6,838,923 shares and 7,129,900 shares available for grant as of December 31, 2013 and 2012.
The weighted average remaining contractual terms of awards outstanding and exercisable as of December 31, 2013, were 5.5 years and 4.4 years. The aggregate intrinsic values of awards outstanding and exercisable at December 31, 2013 were $64 million and $50 million. The total intrinsic value of awards exercised was $11 million, $18 million and $6 million for the years ended 2013, 2012 and 2011. The total fair value of shares vested was $7 million, $11 million and $11 million for the years ended 2013, 2012 and 2011.
The Company recorded stock-based compensation expense of $7 million, $8 million and $10 million related to the Loews Plan for the years ended December 31, 2013, 2012 and 2011. The related income tax benefits recognized were $2 million, $3 million and $4 million. At December 31, 2013, the compensation cost related to nonvested awards not yet recognized was $9 million, and the weighted average period over which it is expected to be recognized is 2.3 years.
CNA’s largest recoverables from a single reinsurer at December 31, 2013, including prepaid reinsurance premiums, were approximately $2.9 billion from subsidiaries of Berkshire Hathaway Group, $850 million from subsidiaries of Swiss Re Group and $350 million from subsidiaries of the Hartford Insurance Group. The recoverable from the Berkshire Hathaway Group includes amounts related to third party reinsurance for which NICO has assumed the credit risk under the terms of the Loss Portfolio Transfer as discussed in Note 9.
(b) Net income (loss) for the fourth quarter of 2012 includes a ceiling test impairment charge of $97 million at HighMount related to the carrying value of its natural gas and oil properties and catastrophe impacts incurred, net of reinsurance and including reinstatement premiums of $171 million recorded at CNA related to Storm Sandy.
In addition, CNA has agreed to provide indemnification to third party purchasers for certain losses associated with sold business entities or assets that are not limited by a contractual monetary amount. As of December 31, 2013, CNA had outstanding unlimited indemnifications in connection with the sales of certain of its business entities or assets that included tax liabilities arising prior to a purchaser’s ownership of an entity or asset, defects in title at the time of sale, employee claims arising prior to closing and in some cases losses arising from certain litigation and undisclosed liabilities. These indemnification agreements survive until the applicable statutes of limitation expire, or until the agreed upon contract terms expire.
Diamond Offshore is financially obligated under three turnkey construction contracts with Hyundai Heavy Industries, Co. Ltd. (“Hyundai”) for the construction of three dynamically positioned, ultra-deepwater drillships with expected delivery dates in the second and third quarters of 2014 and the first quarter of 2015. Diamond Offshore expects the aggregate cost of the construction of its drillships to be approximately $1.9 billion. The remaining contractual payments aggregating $1.2 billion due to Hyundai will be paid when the remaining drillships are delivered.
Diamond Offshore entered into a construction contract with Hyundai for the construction of a dynamically positioned, ultra-deepwater harsh environment semisubmersible drilling rig, expected to be delivered in the first quarter of 2016. The total cost of the rig including capital spares, commissioning and shipyard supervision is estimated to be approximately $755 million. The remaining contractual payment of $440 million is due upon delivery of the rig.
CNA’s results are reported in four business segments: CNA Specialty, CNA Commercial, Life & Group Non-Core and Other. CNA Specialty provides a broad array of professional, financial and specialty property and casualty products and services, primarily through insurance brokers and managing general underwriters. CNA Commercial includes property and casualty coverages sold to small businesses and middle market entities and organizations primarily through an independent agency distribution system. CNA Commercial also includes commercial insurance and risk management products sold to large corporations primarily through insurance brokers. Life & Group Non-Core primarily includes the results of the life and group lines of business that are in run-off. Other includes the operations of Hardy since its acquisition date of July 2, 2012, corporate expenses, including interest on corporate debt, and the results of certain property and casualty business primarily in run-off, including CNA Re and A&EP. Hardy is a specialized Lloyd’s of London underwriter primarily of short-tail exposures in marine and aviation, non-marine property, specialty lines and property treaty reinsurance.
Diamond Offshore owns and operates offshore drilling rigs that are chartered on a contract basis for fixed terms by companies engaged in exploration and production of hydrocarbons. Offshore rigs are mobile units that can be relocated based on market demand. Diamond Offshore’s fleet consists of 45 drilling rigs, including four newbuild rigs which are under construction and one rig being constructed utilizing the hull of one of Diamond Offshore’s existing mid-water floaters. On December 31, 2013, Diamond Offshore’s drilling rigs were located offshore 12 countries in addition to the United States.
HighMount is engaged in the exploration, production and marketing of natural gas and oil (including condensate and NGLs), primarily located in the Permian Basin in West Texas as well as in the Mississippian Lime in Oklahoma.
Loews Hotels operates a chain of 18 hotels, 17 of which are in the United States and one is in Canada.
The Corporate and other segment consists primarily of corporate investment income, corporate interest expense and other unallocated expenses.
The following schedules present the Company’s consolidating balance sheet information at December 31, 2013 and 2012, and consolidating statements of income information for the years ended December 31, 2013, 2012 and 2011. These schedules present the individual subsidiaries of the Company and their contribution to the consolidated financial statements. Amounts presented will not necessarily be the same as those in the individual financial statements of the Company’s subsidiaries due to adjustments for purchase accounting, income taxes and noncontrolling interests. In addition, many of the Company’s subsidiaries use a classified balance sheet which also leads to differences in amounts reported for certain line items.
The business being sold is currently reported within Life & Group Non-Core. As of December 31, 2013, gross insurance reserves for this business were approximately $3.4 billion. Results for this business were net income (after noncontrolling interests) of approximately $28 million and $7 million for the years ended December 31, 2013 and 2012 and a net loss of approximately $111 million for the year ended December 31, 2011.
The sale is subject to regulatory approvals and other customary closing conditions and is expected to close in the first half of 2014. An impairment loss of approximately $200 million (after tax and noncontrolling interests) will be recorded in the first quarter of 2014. This business will be reported as discontinued operations in the first quarter of 2014.