10-Q 1 cna2018q3.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number 1-5823
 
CNA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
 
36-6169860
(I.R.S. Employer
Identification No.)
151 N. Franklin
Chicago, Illinois
(Address of principal executive offices)
 
60606
(Zip Code)
(312) 822-5000
(Registrant's telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [x] No [ ]
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes [x] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated
filer [x]
 
Accelerated filer [ ]
 
Non-accelerated
filer [ ]
 
Smaller reporting company [ ]
 
Emerging growth company [ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [x]
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class
 
Outstanding at November 1, 2018
Common Stock, Par value $2.50
 
271,410,714




Item Number
 
Page
Number
 
PART I. Financial Information
 
1.
 
 
 
 
 
 
 
2.
3.
4.
 
PART II. Other Information
 
1.
6.

2


PART I. Financial Information
Item 1. Condensed Consolidated Financial Statements
CNA Financial Corporation
Condensed Consolidated Statements of Operations (Unaudited)
Periods ended September 30
Three Months
 
Nine Months
(In millions, except per share data)
2018
 
2017
 
2018
 
2017
Revenues
 
 
 
 
 
 
 
Net earned premiums
$
1,853

 
$
1,806

 
$
5,453

 
$
5,185

Net investment income
487

 
509

 
1,483

 
1,529

Net realized investment gains (losses):
 
 
 
 
 
 
 

Other-than-temporary impairment losses
(3
)
 
(5
)
 
(9
)
 
(9
)
Other net realized investment gains (losses)
17

 
(19
)
 
34

 
71

Net realized investment gains (losses)
14

 
(24
)
 
25

 
62

Non-insurance warranty revenue (Note J)
258

 
99

 
744

 
290

Other revenues
10

 
8

 
26

 
28

Total revenues
2,622

 
2,398

 
7,731

 
7,094

Claims, Benefits and Expenses
 
 
 
 
 
 
 
Insurance claims and policyholders’ benefits
1,312

 
1,480

 
3,978

 
4,053

Amortization of deferred acquisition costs
337

 
309

 
992

 
926

Non-insurance warranty expense (Note J)
235

 
74

 
676

 
216

Other operating expenses
302

 
307

 
903

 
875

Interest
34

 
41

 
104

 
124

Total claims, benefits and expenses
2,220

 
2,211

 
6,653

 
6,194

Income before income tax
402

 
187

 
1,078

 
900

Income tax expense
(66
)
 
(43
)
 
(181
)
 
(224
)
Net income
$
336

 
$
144

 
$
897

 
$
676

 
 
 
 
 
 
 
 
Basic earnings per share
$
1.24

 
$
0.53

 
$
3.30

 
$
2.49

 
 
 
 
 
 
 
 
Diluted earnings per share
$
1.23

 
$
0.53

 
$
3.29

 
$
2.48

 
 
 
 
 
 
 
 
Dividends declared per share
$
0.35

 
$
0.30

 
$
2.95

 
$
2.80

 
 
 
 
 
 
 
 
Weighted Average Outstanding Common Stock and Common Stock Equivalents
 
 
 
 
 
 
 
Basic
271.6

 
271.2

 
271.5

 
271.1

Diluted
272.5

 
272.1

 
272.4

 
272.0

The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).

3


CNA Financial Corporation
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2018
 
2017
 
2018
 
2017
Comprehensive Income
 
 
 
 
 
 
 
Net income
$
336

 
$
144

 
$
897

 
$
676

Other Comprehensive (Loss) Income, Net of Tax
 
 
 
 
 
 
 
Changes in:
 
 
 
 
 
 
 
Net unrealized gains on investments with other-than-temporary impairments
(1
)
 
1

 
(11
)
 
(3
)
Net unrealized gains on other investments
(158
)
 
23

 
(746
)
 
167

Net unrealized gains on investments
(159
)
 
24

 
(757
)
 
164

Foreign currency translation adjustment

 
41

 
(40
)
 
94

Pension and postretirement benefits
7

 
10

 
24

 
22

Other comprehensive (loss) income, net of tax
(152
)
 
75

 
(773
)
 
280

Total comprehensive income
$
184


$
219

 
$
124

 
$
956

The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).

4


CNA Financial Corporation
Condensed Consolidated Balance Sheets
(In millions, except share data)
September 30, 2018 (Unaudited)
 
December 31,
2017
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities at fair value (amortized cost of $38,052 and $38,215)
$
39,628

 
$
41,487

Equity securities at fair value (cost of $784 and $659)
795

 
695

Limited partnership investments
2,297

 
2,369

Other invested assets
51

 
44

Mortgage loans
868

 
839

Short term investments
1,290

 
1,436

Total investments
44,929

 
46,870

Cash
310

 
355

Reinsurance receivables (less allowance for uncollectible receivables of $29 and $29)
4,224

 
4,261

Insurance receivables (less allowance for uncollectible receivables of $46 and $44)
2,354

 
2,292

Accrued investment income
406

 
411

Deferred acquisition costs
654

 
634

Deferred income taxes
314

 
137

Property and equipment at cost (less accumulated depreciation of $208 and $274)
332

 
326

Goodwill
147

 
148

Other assets (Note A)
3,589

 
1,133

Total assets
$
57,259

 
$
56,567

Liabilities
 

 
 

Insurance reserves:
 
 
 

Claim and claim adjustment expenses
$
21,604

 
$
22,004

Unearned premiums
4,289

 
4,029

Future policy benefits
10,605

 
11,179

Short term debt

 
150

Long term debt
2,680

 
2,708

Other liabilities (includes $52 and $143 due to Loews Corporation) (Note A)
6,571

 
4,253

Total liabilities
45,749

 
44,323

Commitments and contingencies (Notes C and F)


 


Stockholders' Equity
 

 
 

Common stock ($2.50 par value; 500,000,000 shares authorized; 273,040,243 shares issued; 271,410,714 and 271,205,390 shares outstanding)
683

 
683

Additional paid-in capital
2,186

 
2,175

Retained earnings
9,456

 
9,414

Accumulated other comprehensive (loss) income
(757
)
 
32

Treasury stock (1,629,529 and 1,834,853 shares), at cost
(58
)
 
(60
)
Total stockholders’ equity
11,510

 
12,244

Total liabilities and stockholders' equity
$
57,259

 
$
56,567

The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).

5


CNA Financial Corporation
Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine months ended September 30
 
 
 
(In millions)
2018
 
2017
Cash Flows from Operating Activities
 
 
 
Net income
$
897

 
$
676

Adjustments to reconcile net income to net cash flows provided by operating activities:
 
 
 
Deferred income tax expense
37

 
125

Trading portfolio activity
2

 
8

Net realized investment gains
(25
)
 
(62
)
Equity method investees
136

 
89

Net amortization of investments
(48
)
 
(30
)
Depreciation and amortization
59

 
66

Changes in:
 
 
 
Receivables, net
(47
)
 
18

Accrued investment income
5

 
(31
)
Deferred acquisition costs
(24
)
 
(34
)
Insurance reserves
108

 
248

Other assets
(193
)
 
(121
)
Other liabilities
(107
)
 
(106
)
Other, net
68

 
48

Total adjustments
(29
)
 
218

Net cash flows provided by operating activities
868

 
894

Cash Flows from Investing Activities
 

 
 

Dispositions:
 
 
 
Fixed maturity securities - sales
6,622

 
4,167

Fixed maturity securities - maturities, calls and redemptions
1,838

 
2,635

Equity securities
69

 
22

Limited partnerships
304

 
160

Mortgage loans
83

 
22

Purchases:
 
 
 
Fixed maturity securities
(8,244
)
 
(6,877
)
Equity securities
(177
)
 
(18
)
Limited partnerships
(380
)
 
(85
)
Mortgage loans
(112
)
 
(153
)
Change in other investments
(10
)
 
(2
)
Change in short term investments
158

 
(29
)
Purchases of property and equipment
(87
)
 
(80
)
Other, net
16

 
20

Net cash flows provided (used) by investing activities
80

 
(218
)
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).

6


Nine months ended September 30
 
 
 
(In millions)
2018
 
2017
Cash Flows from Financing Activities
 
 
 
Dividends paid to common stockholders
$
(801
)
 
$
(761
)
Proceeds from the issuance of debt

 
496

Repayment of debt
(180
)
 
(391
)
Other, net
(8
)
 
(17
)
Net cash flows used by financing activities
(989
)

(673
)
Effect of foreign exchange rate changes on cash
(4
)
 
9

Net change in cash
(45
)
 
12

Cash, beginning of year
355

 
271

Cash, end of period
$
310

 
$
283

The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).


7


CNA Financial Corporation
Condensed Consolidated Statements of Stockholders' Equity (Unaudited)
Nine months ended September 30
 
 
 
(In millions)
2018
 
2017
Common Stock
 
 
 
Balance, beginning of period
$
683

 
$
683

Balance, end of period
683

 
683

Additional Paid-in Capital
 
 
 
Balance, beginning of period
2,175

 
2,173

Stock-based compensation
11

 
(6
)
Balance, end of period
2,186

 
2,167

Retained Earnings
 
 
 
Balance, beginning of period, as previously reported
9,414

 
9,359

Cumulative effect adjustments from changes in accounting guidance, net of tax
(50
)
 

Balance, beginning of period, as adjusted
9,364

 
9,359

Dividends to common stockholders
(805
)
 
(762
)
Net income
897

 
676

Balance, end of period
9,456

 
9,273

Accumulated Other Comprehensive (Loss) Income
 
 
 
Balance, beginning of period, as previously reported
32

 
(173
)
Cumulative effect adjustments from changes in accounting guidance, net of tax
(16
)
 

Balance, beginning of period, as adjusted
16

 
(173
)
Other comprehensive (loss) income
(773
)
 
280

Balance, end of period
(757
)
 
107

Treasury Stock
 
 
 
Balance, beginning of period
(60
)
 
(73
)
Stock-based compensation
2

 
12

Balance, end of period
(58
)
 
(61
)
Total stockholders' equity
$
11,510

 
$
12,169

The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).


8


CNA Financial Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note A. General
Basis of Presentation
The Condensed Consolidated Financial Statements include the accounts of CNA Financial Corporation (CNAF) and its subsidiaries. Collectively, CNAF and its subsidiaries are referred to as CNA or the Company. Loews Corporation (Loews) owned approximately 89% of the outstanding common stock of CNAF as of September 30, 2018.
The accompanying Condensed Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Intercompany amounts have been eliminated. Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, including certain financial statement notes, is not required for interim reporting purposes and has been condensed or omitted. These statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in CNAF's Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2017, including the summary of significant accounting policies in Note A. The preparation of Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the Condensed Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.
The interim financial data as of September 30, 2018 and for the three and nine months ended September 30, 2018 and 2017 is unaudited. However, in the opinion of management, the interim data includes all adjustments, including normal recurring adjustments, necessary for a fair statement of the Company's results for the interim periods. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.
Recently Adopted Accounting Standards Updates (ASU)
ASU 2014-09: In May 2014, the Financial Accounting Standards Board (FASB) issued ASU No. 2014-09, Revenue Recognition (Topic 606): Revenue from Contracts with Customers. The standard excludes from its scope the accounting for insurance contracts, financial instruments, and certain other agreements that are governed under other GAAP guidance. The updated guidance requires an entity to recognize revenue as performance obligations are met, in an amount that reflects the consideration the entity is entitled to receive for the transfer of the promised goods or services.
On January 1, 2018, the Company adopted the updated guidance using the modified retrospective method applied to all contracts which were not completed as of the date of adoption, with the cumulative effect recognized as an adjustment to the opening balance of Retained earnings. Prior period amounts have not been adjusted and continue to be reported in accordance with the previous accounting guidance.
Under the new guidance, revenue on warranty products and services was recognized more slowly compared to the historic revenue recognition pattern. In addition, for warranty products where the Company acts as the principal in the transaction, Non-insurance warranty revenue and Non-insurance warranty expense are increased to reflect the gross amount paid by consumers, including the retail seller’s markup which is considered a commission to the Company's agent. This gross-up of revenue and expense also resulted in an increase to Other assets and Other liabilities on the Company's Condensed Consolidated Balance Sheets as the revenue and expense are recognized over the actuarially determined expected claims emergence pattern.

9


The cumulative effect changes to the Condensed Consolidated Balance Sheet for the adoption of the updated guidance on January 1, 2018 were as follows:
(In millions)
Balance as of December 31, 2017
 
Adjustments Due to Adoption of Topic 606
 
Balance as of January 1, 2018
Other assets
$
1,133

 
$
1,882

 
$
3,015

Other liabilities
4,253

 
1,969

 
6,222

Deferred income taxes
137

 
21

 
158

Retained earnings
9,414

 
(66
)
 
9,348

The impact of adoption on the Condensed Consolidated Statements of Operations and Balance Sheet was as follows:
Periods ended September 30, 2018
Three Months
 
Nine Months
 
Prior to Adoption
 
Effect of Adoption
 
As Reported
 
Prior to Adoption
 
Effect of Adoption
 
As Reported
(In millions)
Statement of operations:
 
 
 
 
 
 
 
 
 
 
 
Non-insurance warranty revenue
$
109

 
$
149

 
$
258

 
$
315

 
$
429

 
$
744

Total revenues
2,473

 
149

 
2,622

 
7,302

 
429

 
7,731

 
 
 
 
 
 
 
 
 
 
 
 
Non-insurance warranty expense
82

 
153

 
235

 
240

 
436

 
676

Total claims, benefits and expenses
2,067

 
153

 
2,220

 
6,217

 
436

 
6,653

 
 
 
 
 
 
 
 
 
 
 
 
Income before income tax
406

 
(4
)
 
402

 
1,085

 
(7
)
 
1,078

Income tax expense
(67
)
 
1

 
(66
)
 
(183
)
 
2

 
(181
)
Net income
339

 
(3
)
 
336

 
902

 
(5
)
 
897

 
 
 
 
 
 
 
 
 
 
 
 
Balance sheet(1) at September 30, 2018:
 
 
 
 
 
 


 
 
 
 
Other assets
 
 
 
 
 
 
$
3,284

 
$
305

 
$
3,589

Other liabilities
 
 
 
 
 
 
6,259

 
312

 
6,571

Deferred income taxes
 
 
 
 
 
 
312

 
2

 
314

Retained earnings
 
 
 
 
 
 
9,461

 
(5
)
 
9,456

(1)
The Prior to Adoption amounts presented in this table include the cumulative effect adjustment at adoption presented in the prior table.
See Note J to the Condensed Consolidated Financial Statements for additional information regarding non-insurance revenues from contracts with customers.

10


ASU 2016-01: In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.  The updated accounting guidance requires changes to the reporting model for financial instruments. The guidance primarily changes the model for equity securities by requiring changes in the fair value of equity securities (except those accounted for under the equity method of accounting, those without readily determinable fair values and those that result in consolidation of the investee) to be recognized through the income statement. The Company adopted the updated guidance on January 1, 2018 and recognized a cumulative effect adjustment that increased beginning Retained earnings by $28 million, net of tax. Prior period amounts have not been adjusted and continue to be reported in accordance with the previous accounting guidance.
For the three and nine months ended September 30, 2018, the Company recognized $2 million in pretax gains and $23 million in pretax losses within Net realized investment gains (losses) for the change in fair value of non-redeemable preferred stock and $1 million in pretax losses and $1 million in pretax gains within Net investment income for the change in fair value of common stock as a result of this change. For the three and nine months ended September 30, 2017, there was a $1 million increase and less than a $1 million increase in the fair value of common stock and less than a $1 million increase and a $7 million increase in the fair value of non-redeemable preferred stock recognized in Other comprehensive income. The Company's non-redeemable preferred stock contain characteristics of debt securities, are priced similarly to bonds, and are held primarily for income generation through periodic dividends. While recognition of gains and losses on these securities are no longer discretionary, management does not consider the changes in fair value of non-redeemable preferred stock to be reflective of our primary operations. As such, the changes in the fair value of these securities are recorded through Net realized investments gains (losses). The Company owns certain common stock with the intention of holding the securities primarily for market appreciation and as such, the changes in the fair value of these securities are recorded through Net investment income.
ASU 2017-07: In March 2017, the FASB issued ASU No. 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The updated accounting guidance requires changes to the presentation of the components of net periodic benefit cost on the income statement by requiring service cost to be presented with other employee compensation costs and other components of net periodic pension cost to be presented outside of any subtotal of operating income. The ASU also stipulates that only the service cost component of net benefit cost is eligible for capitalization. The Company adopted the updated guidance effective January 1, 2018. The guidance was applied on a prospective basis for capitalization of service costs and on a retrospective basis for the presentation of the service cost and other components of net periodic benefit costs in the Company's Condensed Consolidated Statements of Operations and in its disclosures. The Company expanded the related footnote disclosure, Note G to the Condensed Consolidated Financial Statements, to disclose the amount of service cost and non-service cost components of net periodic benefit cost and the line items in the Condensed Consolidated Statements of Operations in which such amounts are reported. The change limiting the costs eligible for capitalization is not material to the Company’s results of operations or financial position.
ASU 2018-02: In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. GAAP requires the remeasurement of deferred tax assets and liabilities due to a change in the tax rate to be included in Net income, even if the related income tax effects were originally recognized in Accumulated other comprehensive income (AOCI). The ASU allows a reclassification from AOCI to Retained earnings for stranded tax effects resulting from the new U.S. Federal corporate income tax rate enacted on December 22, 2017. The Company early adopted the updated guidance effective January 1, 2018 and elected to reclassify the stranded income tax effects relating to the reduction in the Federal corporate income tax rate from AOCI to Retained earnings at the beginning of the period of adoption. The net impact of the accounting change resulted in a $12 million increase in AOCI and a corresponding decrease in Retained earnings. The $12 million increase in AOCI is comprised of a $142 million increase in net unrealized gains (losses) on investments partially offset by a $130 million decrease in unrecognized pension and postretirement benefits.

11


The Company releases tax effects from AOCI utilizing the security-by-security approach for Net unrealized gains (losses) on investments with Other-than-temporary impairment (OTTI) losses and Net unrealized gains (losses) on other investments. For Pension and postretirement benefits, tax effects from AOCI are released at enacted tax rates based on the pre-tax adjustments to pension liabilities or assets recognized within OCI.
ASU 2018-13: In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820) Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The updated accounting guidance requires changes to the disclosures for fair value measurement by adding, removing and modifying disclosures. This guidance is effective for fiscal years beginning after December 15, 2019, including interim periods therein and early adoption is permitted. As of September 30, 2018, the Company adopted the updated guidance and added disclosures on changes in unrealized gains (losses) on Level 3 assets recognized in Other comprehensive income as well as the weighted average rate used to develop significant inputs utilized in the fair value measurements of Level 3 assets. The Company also eliminated disclosures on the amount of transfers between Level 1 and Level 2 assets and the policy for timing of transfers between Levels.
Accounting Standards Pending Adoption
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842): Accounting for Leases. The updated accounting guidance requires lessees to recognize on the balance sheet assets and liabilities for the rights and obligations created by the majority of leases, including those historically accounted for as operating leases. The guidance is effective for interim and annual periods beginning after December 15, 2018 and prescribes a modified retrospective transition method but allows entities to utilize a practical expedient and apply the guidance prospectively beginning with the adoption date. The Company has decided to utilize the practical expedient. The Company is currently evaluating the effect the updated guidance will have on the Company's financial statements. It is expected that assets and liabilities will increase based on the present value of remaining lease payments for leases in place at the adoption date; however, this is not expected to be material to the Company's results of operations or financial position.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The updated accounting guidance requires changes to the recognition of credit losses on financial instruments not accounted for at fair value through net income. The guidance is effective for interim and annual periods beginning after December 15, 2019. The Company is currently evaluating the effect the guidance will have on the Company's financial statements, but expects the primary changes to be the use of the expected credit loss model for its mortgage loan portfolio and reinsurance receivables and the use of the allowance method rather than the write-down method for credit losses within the available-for-sale fixed maturities portfolio. The expected credit loss model will require a financial asset to be presented at the net amount expected to be collected. The allowance method for available-for-sale debt securities will allow the Company to record reversals of credit losses if the estimate of credit losses declines.
In August 2018, the FASB issued ASU 2018-12, Financial Services-Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts.  The updated accounting guidance requires changes to the measurement and disclosure of long-duration contracts.  The standard requires entities to annually update cash flow assumptions, including morbidity and persistency, and update discount rate assumptions quarterly using an upper-medium grade fixed-income instrument yield.  The effect of changes in cash flow assumptions will be recorded in Net income and the effect of changes in discount rate assumptions will be recorded in Other comprehensive income.
This guidance is effective for interim and annual periods beginning after December 15, 2020, and requires restatement of the prior periods presented. Early adoption is permitted. The Company is currently evaluating the method and timing of adoption and the effect the updated guidance will have on its financial statements. The annual updating of cash flow assumptions is expected to increase income statement volatility. The quarterly change in discount rate is expected to increase volatility in the Company’s stockholders' equity, but that will be somewhat mitigated because Shadow Adjustments are eliminated under the new guidance.

12


In August 2018, the FASB issued ASU No. 2018-14, Compensation -Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20) Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans. The updated accounting guidance modifies the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans by removing, modifying and adding disclosures. The guidance is effective for annual periods ending after December 15, 2020, and early adoption is permitted. The Company anticipates early adopting this standard in the fourth quarter of 2018.
Income Tax Reform Update
On December 22, 2017, H.R.1, “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018,” was signed into law (Tax Reform Legislation).
Shortly after enactment, the Securities and Exchange Commission Staff issued Staff Accounting Bulletin No. 118 (SAB 118) to provide guidance on accounting for the Tax Reform Legislation impacts when the measurements of the income tax effects are complete, incomplete, or incomplete but for which a provisional amount can be estimated. SAB 118 permits the recognition of provisional amounts, and adjustments to provisional amounts, in subsequent reporting periods within the one year measurement period.
The Company has reflected the following incomplete but reasonably estimated provisional items in Deferred income taxes on the Condensed Consolidated Balance Sheet at September 30, 2018. Adjustments to the Company's provisional amounts for the three and nine months ended September 30, 2018 did not impact income tax expense.
The Company has recalculated its insurance reserves and the transition adjustment from existing law.
The Company has recalculated amounts under special accounting method provisions for recognizing income for Federal income tax purposes no later than for financial accounting purposes and the transition adjustment from existing law.
The Company has not recorded current or deferred taxes with respect to the international provisions since it does not expect to have inclusions in U.S. taxable income for certain earnings of foreign subsidiaries in future years.

13


Note B. Earnings (Loss) Per Share
Earnings (loss) per share is based on the weighted average number of outstanding common shares. Basic earnings (loss) per share excludes the impact of dilutive securities and is computed by dividing Net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
For the three and nine months ended September 30, 2018, approximately 900 thousand and 925 thousand potential shares attributable to exercises or conversions into common stock under stock-based employee compensation plans were included in the calculation of diluted earnings per share. For those same periods, approximately 1 thousand and 3 thousand potential shares attributable to exercises or conversions into common stock under stock-based employee compensation plans were not included in the calculation of diluted earnings per share, because the effect would have been antidilutive.
For the three and nine months ended September 30, 2017, approximately 907 thousand and 916 thousand potential shares attributable to exercises or conversions into common stock under stock-based employee compensation plans were included in the calculation of diluted earnings per share. For those same periods, less than 1 thousand and approximately 4 thousand potential shares attributable to exercises or conversions into common stock under stock-based employee compensation plans were not included in the calculation of diluted earnings per share, because the effect would have been antidilutive.

14


Note C. Investments
The significant components of Net investment income are presented in the following table.
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2018
 
2017
 
2018
 
2017
Fixed maturity securities
$
449

 
$
455

 
$
1,339

 
$
1,367

Equity securities
10

 
1

 
32

 
4

Limited partnership investments
23

 
51

 
93

 
157

Mortgage loans
11

 
9

 
36

 
24

Short term investments
6

 
4

 
18

 
10

Trading portfolio
1

 
3

 
6

 
9

Other
1

 
1

 
4

 
2

Gross investment income
501

 
524

 
1,528

 
1,573

Investment expense
(14
)
 
(15
)
 
(45
)
 
(44
)
Net investment income
$
487

 
$
509

 
$
1,483

 
$
1,529

During the three and nine months ended September 30, 2018, Net investment income was reduced by a $2 million loss due to the change in fair value of common stock still held as of September 30, 2018.
Net realized investment gains (losses) are presented in the following table.
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2018
 
2017
 
2018
 
2017
Net realized investment gains (losses):
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Gross realized gains
$
42

 
$
34

 
$
148

 
$
139

Gross realized losses
(32
)
 
(18
)
 
(116
)
 
(47
)
Net realized investment gains (losses) on fixed maturity securities
10

 
16

 
32

 
92

Equity securities
2

 

 
(23
)
 

Derivatives
1

 
(1
)
 
10

 
(3
)
Short term investments and other
1

 
(39
)
 
6

 
(27
)
Net realized investment gains (losses)
$
14

 
$
(24
)
 
$
25

 
$
62

During the three and nine months ended September 30, 2018, $2 million of Net realized investment gains and $23 million of Net realized investment losses were recognized due to the change in fair value of non-redeemable preferred stock still held as of September 30, 2018. Net realized investment gains (losses) for the three and nine months ended September 30, 2017 included a $42 million loss related to the redemption of the Company's $350 million senior notes due November 2019.
The components of OTTI losses recognized in earnings by asset type are presented in the following table.
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2018
 
2017
 
2018
 
2017
Fixed maturity securities available-for-sale:

 
 
 
 
 
 
Corporate and other bonds
$
1

 
$
4

 
$
6

 
$
8

Asset-backed
2

 
1

 
3

 
1

OTTI losses recognized in earnings
$
3

 
$
5

 
$
9

 
$
9


15


The following tables present a summary of fixed maturity and equity securities.
September 30, 2018 (1)
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
Unrealized
OTTI
Losses (Gains)
(In millions)
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
18,348

 
$
887

 
$
215

 
$
19,020

 
$

States, municipalities and political subdivisions
10,171

 
994

 
20

 
11,145

 

Asset-backed:
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
5,024

 
62

 
115

 
4,971

 
(24
)
Commercial mortgage-backed
2,165

 
23

 
36

 
2,152

 

Other asset-backed
1,732

 
6

 
9

 
1,729

 

Total asset-backed
8,921

 
91

 
160

 
8,852

 
(24
)
U.S. Treasury and obligations of government-sponsored enterprises
145

 
2

 
2

 
145

 

Foreign government
457

 
4

 
6

 
455

 

Redeemable preferred stock
9

 
1

 

 
10

 

Total fixed maturity securities available-for-sale
38,051

 
1,979

 
403

 
39,627

 
$
(24
)
Total fixed maturity securities trading
1

 
 
 
 
 
1

 
 
Total fixed maturity securities
$
38,052

 
$
1,979

 
$
403

 
$
39,628

 
 

December 31, 2017
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
Unrealized
OTTI
Losses (Gains)
(In millions)
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
17,210

 
$
1,625

 
$
28

 
$
18,807

 
$

States, municipalities and political subdivisions
12,478

 
1,551

 
2

 
14,027

 
(11
)
Asset-backed:
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
5,043

 
109

 
32

 
5,120

 
(27
)
Commercial mortgage-backed
1,840

 
46

 
14

 
1,872

 

Other asset-backed
1,083

 
16

 
5

 
1,094

 

Total asset-backed
7,966

 
171

 
51

 
8,086

 
(27
)
U.S. Treasury and obligations of government-sponsored enterprises
111

 
2

 
4

 
109

 

Foreign government
437

 
9

 
2

 
444

 

Redeemable preferred stock
10

 
1

 

 
11

 

Total fixed maturity securities available-for-sale
38,212

 
3,359

 
87

 
41,484

 
$
(38
)
Total fixed maturity securities trading
3

 
 
 
 
 
3

 
 
Equity securities available-for-sale:
 
 
 
 
 
 
 
 
 
Common stock
21

 
7

 
1

 
27

 
 
Preferred stock
638

 
31

 
1

 
668

 
 
Total equity securities available-for-sale
659

 
38

 
2

 
695

 
 
Total fixed maturity and equity securities
$
38,874

 
$
3,397

 
$
89

 
$
42,182

 
 
(1)
As of January 1, 2018, the Company adopted ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The change in fair value of equity securities is now recognized through the income statement. See Note A to the Condensed Consolidated Financial Statements for additional information.


16


The net unrealized gains on investments included in the tables above are recorded as a component of AOCI. When presented in AOCI, these amounts are net of tax and any required Shadow Adjustments. To the extent that unrealized gains on fixed income securities supporting certain products within the Life & Group segment would result in a premium deficiency if realized, a related increase in Insurance reserves is recorded, net of tax, as a reduction of net unrealized gains through Other comprehensive income (loss) (Shadow Adjustments). As of September 30, 2018 and December 31, 2017, the net unrealized gains on investments included in AOCI were correspondingly reduced by Shadow Adjustments of $1,115 million and $1,411 million.

17


The following tables present the estimated fair value and gross unrealized losses of fixed maturity and equity securities in a gross unrealized loss position by the length of time in which the securities have continuously been in that position.
 
Less than 12 Months
 
12 Months or Longer
 
Total
September 30, 2018 (1)
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
(In millions)
 
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
7,546

 
$
197

 
$
342

 
$
18

 
$
7,888

 
$
215

States, municipalities and political subdivisions
807

 
19

 
2

 
1

 
809

 
20

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
3,409

 
89

 
501

 
26

 
3,910

 
115

Commercial mortgage-backed
968

 
15

 
322

 
21

 
1,290

 
36

Other asset-backed
953

 
9

 
45

 

 
998

 
9

Total asset-backed
5,330

 
113

 
868

 
47

 
6,198

 
160

U.S. Treasury and obligations of government-sponsored enterprises
35

 

 
42

 
2

 
77

 
2

Foreign government
188

 
4

 
64

 
2

 
252

 
6

Total
$
13,906

 
$
333

 
$
1,318

 
$
70

 
$
15,224

 
$
403


 
Less than 12 Months
 
12 Months or Longer
 
Total
December 31, 2017
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
(In millions)
 
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
1,354

 
$
21

 
$
168

 
$
7

 
$
1,522

 
$
28

States, municipalities and political subdivisions
72

 
1

 
85

 
1

 
157

 
2

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
1,228

 
5

 
947

 
27

 
2,175

 
32

Commercial mortgage-backed
403

 
4

 
212

 
10

 
615

 
14

Other asset-backed
248

 
3

 
18

 
2

 
266

 
5

Total asset-backed
1,879

 
12

 
1,177

 
39

 
3,056

 
51

U.S. Treasury and obligations of government-sponsored enterprises
49

 
2

 
21

 
2

 
70

 
4

   Foreign government
166

 
2

 
4

 

 
170

 
2

Total fixed maturity securities available-for-sale
3,520

 
38

 
1,455

 
49

 
4,975

 
87

Equity securities available-for-sale:

 

 

 

 

 

Common stock
7

 
1

 

 

 
7

 
1

Preferred stock
93

 
1

 

 

 
93

 
1

Total equity securities available-for-sale
100

 
2

 

 

 
100

 
2

Total
$
3,620

 
$
40

 
$
1,455

 
$
49

 
$
5,075

 
$
89

(1)
As of January 1, 2018, the Company adopted ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The change in fair value of equity securities is now recognized through the income statement. See Note A to the Condensed Consolidated Financial Statements for additional information.

18


Based on current facts and circumstances, the Company believes the unrealized losses presented in the September 30, 2018 securities in a gross unrealized loss position table above are not indicative of the ultimate collectibility of the current amortized cost of the securities, but rather are attributable to changes in interest rates, credit spreads and other factors. The Company has no current intent to sell securities with unrealized losses, nor is it more likely than not that it will be required to sell prior to recovery of amortized cost; accordingly, the Company has determined that there are no additional OTTI losses to be recorded as of September 30, 2018.
The following table presents the activity related to the pretax credit loss component reflected in Retained earnings on fixed maturity securities still held as of September 30, 2018 and 2017 and for which a portion of an OTTI loss was recognized in Other comprehensive income (loss).
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2018
 
2017
 
2018
 
2017
Beginning balance of credit losses on fixed maturity securities
$
21

 
$
30

 
$
27

 
$
36

Reductions for securities sold during the period
(2
)
 
(2
)
 
(8
)
 
(8
)
Ending balance of credit losses on fixed maturity securities
$
19

 
$
28

 
$
19

 
$
28

Contractual Maturity
The following table presents available-for-sale fixed maturity securities by contractual maturity.
 
September 30, 2018
 
December 31, 2017
(In millions)
Cost or
Amortized
Cost
 
Estimated
Fair
Value
 
Cost or
Amortized
Cost
 
Estimated
Fair
Value
Due in one year or less
$
1,457

 
$
1,473

 
$
1,135

 
$
1,157

Due after one year through five years
8,017

 
8,197

 
8,165

 
8,501

Due after five years through ten years
16,453

 
16,475

 
16,060

 
16,718

Due after ten years
12,124

 
13,482

 
12,852

 
15,108

Total
$
38,051

 
$
39,627

 
$
38,212

 
$
41,484

Actual maturities may differ from contractual maturities because certain securities may be called or prepaid. Securities not due at a single date are allocated based on weighted average life.
Derivative Financial Instruments
The Company holds an embedded derivative on a funds withheld liability with a notional value of $174 million and $167 million as of September 30, 2018 and December 31, 2017 and a fair value of $6 million and $(3) million as of September 30, 2018 and December 31, 2017. The embedded derivative on the funds withheld liability is accounted for separately and reported with the funds withheld liability in Other liabilities on the Condensed Consolidated Balance Sheets.
Investment Commitments
As of September 30, 2018, the Company had committed approximately $605 million to future capital calls from various third-party limited partnership investments in exchange for an ownership interest in the related partnerships.
As of September 30, 2018, the Company had mortgage loan commitments of $16 million representing signed loan applications received and accepted.
The Company invests in various privately placed debt securities, including bank loans, as part of its overall investment strategy and has committed to additional future purchases, sales and funding. Purchases and sales of privately placed debt securities are recorded once funded. As of September 30, 2018, the Company had commitments to purchase or fund additional amounts of $282 million and sell $87 million under the terms of such securities.

19


Note D. Fair Value
Fair value is the price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The following fair value hierarchy is used in selecting inputs, with the highest priority given to Level 1, as these are the most transparent or reliable.
Level 1 - Quoted prices for identical instruments in active markets.
Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets.
Level 3 - Valuations derived from valuation techniques in which one or more significant inputs are not observable.
Prices may fall within Level 1, 2 or 3 depending upon the methodology 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 a methodology and inputs the Company believes market participants would use to value the assets. Prices obtained from third-party pricing services or brokers are not adjusted by the Company.
The Company performs control procedures over information obtained from pricing services and brokers to ensure prices received represent a reasonable estimate of fair value and to confirm representations regarding whether inputs are observable or unobservable. Procedures may include i) the review of pricing service methodologies or broker pricing qualifications, ii) back-testing, where past fair value estimates are compared to actual transactions executed in the market on similar dates, iii) exception reporting, where period-over-period changes in price are reviewed and challenged with the pricing service or broker based on exception criteria, iv) deep dives, where the Company performs an independent analysis of the inputs and assumptions used to price individual securities and v) pricing validation, where prices received are compared to prices independently estimated by the Company.

20


Assets and Liabilities Measured at Fair Value
Assets and liabilities measured at fair value on a recurring basis are presented in the following tables. Corporate bonds and other includes obligations of the U.S. Treasury, government-sponsored enterprises, foreign governments and redeemable preferred stock.
September 30, 2018
 
 
 
 
 
 
Total
Assets/Liabilities
at Fair Value
(In millions)
Level 1
 
Level 2
 
Level 3
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate bonds and other
$
183

 
$
19,260

 
$
188

 
$
19,631

States, municipalities and political subdivisions

 
11,145

 

 
11,145

Asset-backed

 
8,554

 
298

 
8,852

Total fixed maturity securities
183

 
38,959

 
486

 
39,628

Equity securities:
 
 
 
 
 
 
 
Common stock
101

 

 
4

 
105

Non-redeemable preferred stock
51

 
625

 
14

 
690

Total equity securities
152

 
625

 
18

 
795

Short term and other
252

 
931

 

 
1,183

Total assets
$
587

 
$
40,515

 
$
504

 
$
41,606

Liabilities
 
 
 
 
 

 
 

Other liabilities
$

 
$
(6
)
 
$

 
$
(6
)
Total liabilities
$

 
$
(6
)
 
$

 
$
(6
)
December 31, 2017
 
 
 
 
 
 
Total
Assets/Liabilities
at Fair Value
(In millions)
Level 1
 
Level 2
 
Level 3
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate bonds and other
$
128

 
$
19,148

 
$
98

 
$
19,374

States, municipalities and political subdivisions

 
14,026

 
1

 
14,027

Asset-backed

 
7,751

 
335

 
8,086

Total fixed maturity securities
128

 
40,925

 
434

 
41,487

Equity securities:
 
 
 
 
 
 
 
Common stock
23

 

 
4

 
27

Non-redeemable preferred stock
68

 
584

 
16

 
668

Total equity securities
91

 
584

 
20

 
695

Short term and other
396

 
958

 

 
1,354

Total assets
$
615

 
$
42,467

 
$
454

 
$
43,536

Liabilities
 
 
 
 
 

 
 

Other liabilities
$

 
$
3

 
$

 
$
3

Total liabilities
$

 
$
3

 
$

 
$
3


21


The tables below present a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3).
Level 3
(In millions)
Corporate bonds and other
 
States, municipalities and political subdivisions
 
Asset-backed
 
Equity securities
 
Derivative financial instruments
 
Total
Balance as of July 1, 2018
$
94

 
$
1

 
$
273

 
$
17

 
$

 
$
385

Total realized and unrealized investment gains (losses):
 
 
 
 
 
 
 
 
 
 


Reported in Net realized investment gains (losses)

 

 
(2
)
 
1

 

 
(1
)
Reported in Net investment income

 

 

 

 

 

Reported in Other comprehensive income

 

 

 

 

 

Total realized and unrealized investment gains (losses)

 

 
(2
)
 
1

 

 
(1
)
Purchases
67

 

 
55

 

 

 
122

Sales

 

 

 

 

 

Settlements
(3
)
 
(1
)
 
(25
)
 

 

 
(29
)
Transfers into Level 3
30

 

 
29

 

 

 
59

Transfers out of Level 3

 

 
(32
)
 

 

 
(32
)
Balance as of September 30, 2018
$
188

 
$

 
$
298

 
$
18

 
$

 
$
504

Unrealized gains (losses) on Level 3 assets and liabilities held as of September 30, 2018 recognized in Net income (loss)
$

 
$

 
$
(2
)
 
$
1

 
$

 
$
(1
)
Unrealized gains (losses) on Level 3 assets and liabilities held as of September 30, 2018 recognized in Other Comprehensive Income

 

 
1

 

 

 
1


Level 3
(In millions)
Corporate bonds and other
 
States, municipalities and political subdivisions
 
Asset-backed
 
Equity securities
 
Derivative financial instruments
 
Life settlement contracts
 
Total
Balance as of July 1, 2017
$
100

 
$
1

 
$
218

 
$
19

 
$

 
$
1

 
$
339

Total realized and unrealized investment gains (losses):
 
 
 
 
 
 
 
 
 
 
 
 
 
Reported in Net realized investment gains (losses)
1

 

 

 

 

 

 
1

Reported in Other revenues

 

 

 

 

 

 

Reported in Other comprehensive income
1

 

 
1

 

 

 

 
2

Total realized and unrealized investment gains (losses)
2

 

 
1

 

 

 

 
3

Purchases
13

 

 
39

 

 

 

 
52

Sales

 

 

 

 

 
(1
)
 
(1
)
Settlements
(11
)
 

 
(13
)
 

 

 

 
(24
)
Transfers into Level 3
15

 

 
101

 

 

 

 
116

Transfers out of Level 3

 

 

 

 

 

 

Balance as of September 30, 2017
$
119

 
$
1

 
$
346

 
$
19

 
$

 
$

 
$
485

Unrealized gains (losses) on Level 3 assets and liabilities held as of September 30, 2017 recognized in Net income (loss)
$

 
$

 
$

 
$

 
$

 
$

 
$



22


Level 3
(In millions)
Corporate bonds and other
 
States, municipalities and political subdivisions
 
Asset-backed
 
Equity securities
 
Derivative financial instruments
 
Total
Balance as of January 1, 2018
$
98

 
$
1

 
$
335

 
$
20

 
$

 
$
454

Total realized and unrealized investment gains (losses):
 
 
 
 
 
 
 
 
 
 
 
Reported in Net realized investment gains (losses)
(1
)
 

 
5

 
(2
)
 

 
2

Reported in Net investment income

 

 

 

 

 

Reported in Other comprehensive income
(1
)
 

 
(6
)