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Bryan Hsu

CNA AT A GLANCE

P/E ► -46.1   EV/EBITDA ► -118   ROA ► -0.1% AVG ROE ► -2.2% AVG Debt to Equity ► 4.16 AVG Current Ratio ► 0   Interest Coverage Ratio ► 13.2 AVG

 

 

 

 

 

 

CNA Financial Holding Company (NYSE: CNA) is the seventh largest commercial insurance writer and the thirteenth largest property & casualty insurance company in the United States.^[1] CNA divides its operations into two main segments. Its core business of property and casualty insurance is divided into Specialty and Standard lines, while its non-core segment is split into Life & Group non-core and Corporation & Other non-core.^[2] Their insurance underwriting business has been unprofitable for the last fifteen years, but CNA has been able to turn a profit due to steady performance of its investment portfolio. However, lately, due in part to the 2008 Financial Crisis and CNA's shift to riskier asset-backed securities from bonds and other fixed income securities, CNA has lost the steady investment income it previously had.

Second quarter revenues of 2009 were down from a year ago falling $869 million from $4.6 billion to $3.9 billion. ^[3] CNA posted a negative net income of $90 million in 2Q of 2009 compared to a $368 million gain in 2Q of 2008. ^[3] The fall in second quarter revenues from a year ago is a result of the loss in investment income for CNA's investment portfolio. CNA lost $750 million in asset-backed securities alone up from a $160 million loss a year ago due to the fact that it doubled the size of asset-backed securities in its portfolio since the 1Q of 2008.^[4]

Though CNA is the 7th largest insurance writer, it has not been able to achieve a combined ratio below 100% in the last 15 years.^[5] In other words, management has not been able to correctly estimate claims payments and has under allocated funds for claims payouts, resulting in losses being recorded on the books due to the mismatch. Despite CNA's inability to underwrite insurance successfully it has been able to post gains due to investment income. But in 2008, CNA doubled the amount of riskier asset-backed securities in its portfolio resulting in investment income losses during 1&2Q of 2009 of $297 million and $829 million respectively. ^[4][6]

Company Overview

With 9000 employees and thirty two branches, CNA Financial Holding Corp. is the thirteenth largest property and casualty insurance provider in the United States. They provide property and casualty insurance to small and medium businesses, as well as, commercial insurance and risk management services to large corporations through their Standard Lines. CNA provides its core property and casualty products through its two subsidiaries: Continental Casualty Company and Continental Insurance Company.^[7]

2008 CNA Direct Written Premiums by Region^[8]

Business and Financial Metrics

In 2008, CNA's net operating revenue fell by $1.15 billion an 11% decrease from 2007 results.^[9] The loss was due to increased investment losses and decreased operating income. For 2008, investment losses totaled $638 million up from a $270 million loss in 2007.^[10] Net earned premiums have been falling since 2000; premiums are the largest source of income for CNA making up 92% of total revenue for CNA in 2008.^[11][12][13] Premiums earned were down $333 million in 2008 or 4% compared to 2007. ^[12]

The other major source of revenue for CNA is investment income. CNA, like other major insurance companies, reinvests its earned premiums to create a claims loss provision, in essence a safety net, from which CNA pays out present claims and even future claims. Traditionally, this investment portfolio has yielded a 5% return due to 82% of the portfolio being bonds. ^[14] However, in 2008, CNA had $1.3 billion in realized investment losses, due to 22% of CNA's investments being in collateralized mortgage obligations which were hurt by the subprime lending and housing crash. ^[15]

Net income fell drastically in 2008, CNA posted a loss of $299 million as opposed to the $851 million gain posted in 2007.^[9] CNA's inability to predict insurance claims and expenses is quite evident not only through its combined ratio, but even more so whenever its investment income fails to mask CNA's inability as is evident in 2008, 2003, and 2001 when CNA posted losses. ^[9][13][11]

A note on the financial metrics selected. The importance of Net Earned Premiums for an insurance company lies in the fact that these are the premiums which the company can claim as revenue from premiums since they have not been paid out for policyholder claims. While premiums written are good indicators of business, they are only potential revenue. Net investment income gauges the health of an insurance company's claims loss provision or its "safety net" which is supposed to mitigate the other risks in their insurance business.

The combined ratio is an integral insurance industry metric. In layman's terms, it's the ratio of how much money is paid out in claims to the money coming in (premiums earned). For example, CNA's most recent 2008 ratio of 109% means that for every $1 that CNA took in from earned premiums it paid out $1.09 in claims. Naturally, the lower the combined ratio, the better. The combined ratio clearly shows any observer how well an insurance company is able to predict claims and set aside reserves for potential claims, because if a company underestimates, as CNA has done for the past 15 years, the company will be paying out more than it planned which results in losses.

Business Segments

2008 Net Income by Segment ^[20]

2008 Total Revenue by Segment^[21]

Commercial Property and Casualty

• Standard Lines(39% of Revenue^[21],-10% of Income^[20])

Standard Lines encompasses the property and casualty insurance offered to small, medium and large businesses. Property services include standard and excess property coverage as well as marine coverage. Casualty services range from worker's compensation, to general and product liability. ^[22]

Compared to 2007, everything was down in 2008. Total net earned premiums and premiums written, fell by 9% or $303 million and $213 million or 6.5%, respectively.^[22] Investment income tumbled 42% or $372 million; however, net realized investment losses cut sharply into the already low investment income with losses totaling $317 million. ^[22] Due to the falls in premiums earned as well as the steep losses in investment income, standard lines reported a loss of $96 million in 2008 from a gain of $505 million the year before.^[22]

The fall in written premiums is blamed on the fall of production in 2008 related to the 2008 financial crisis, which resulted in less demand for CNA's risk management and property and casualty services. ^[23][22] In 2008 catastrophe impacts were also up from $48 million in 2007 to $227 million in 2008.^[22] Lower earned/written premiums, coupled with the net realized investment losses and higher catastrophe claims, caused the losses in the net income for standard lines.

• Specialty Lines(48% of Revenue^[21],33% of Income^[20])

There are four business groups that fall under specialty lines: US specialty lines, surety, warranty, and CNA Global. US specialty lines cater to non "traditional" property and casualty needs, for example, professional liability, employment practices, and fidelity coverage.^[24] CNA Surety provides fidelity and surety bonds for CNA's surety services, while automobile warranty services make up CNA's warranty offerings.^[24] CNA Global encompasses property and casualty insurance offered outside of the US. ^[24]

Special Lines was the only business segment that posted positive gains in 2008, with $299 million in net income. ^[25] However, in keeping with the downward trend of the Standard Lines segment, Specialty Line 2008 numbers were lower than 2007's as well. Net income was lower by $269 million or 47.5% from 2007. ^[25] Net written premiums were down $71 million from 2007, slightly over a 2% decrease. ^[25]

Lower net income figures were direct results of lower demand--retention rates for renewable plans hovered at 84%. ^[25] On the upside, it is noteworthy to point out that Specialty lines is the only segment that has had a combined ratio that has been below 100% since 2004. ^[25][26]

Non-Core Operations

• Life & Group Non-core(9% of Revenue^[21],-39% of Income^[20])

The Life & Group Non-core segment represents those life and group lines of business that have been sold or place into run off. ^[24] They continue to service their payout annuity business and pension deposit business. ^[24] Since CNA no longer is writing new premiums, the only premium revenue comes from earned premiums which fell by $6 million in 2008. Losses in this segment increased by $149 million to $344 million in 2008. ^[27] Increased losses were attributed to poor performance in the investment portfolio (net realized loss of $236 million) and adverse performance of CNA's pension deposit business. ^[27]

• Corporate & Other Non-core(4% of Revenue^[21],-18% of Income^[20])

Corporate & other non core consists of property and casualty insurance placed into run off such as CNA RE, and certain corporate expenses. ^[28] Revenues decreased by 90% in 2008 as compared to 2007, falling $268 million. Total net loss fell from $19 million to $165 million. ^[28]

Key Trends and Forces

Unprofitable Insurance Writing Hurts Future Viability

Since 1992, CNA Financial has not had achieved a combined ratio below 100%, in fact, CNA has never had a year in which its ratio fell below 106% using GAAP standards. Over the past sixteen years, CNA has averaged a 126.28% combined ratio.^{[29][30][31][32][33]} CNA's inability to predict claims payouts over such a long period of operation severely hurts their future ability to write profitable insurance. Its core operations of property and casualty insurance have not been profitable in the least bit, averaging 126.86% for Standard Lines and 114.68% for Specialty Lines over the eleven years from 2008-1997.^{[34][35][36][37]} Poor claims predictions coupled with net earned/written premiums that have fallen every year since 1997, do not evidence signs of a profitable nor viable insurance business. As mentioned earlier, CNA has relied heavily on investment income to make up for its losses in underwriting insurance, but with the credit crunch and housing crisis in 2008, that investment income is no longer able to make up for losses due to poor claims predictions.

Investment Portfolio Takes On Increased Risk with Bonds

CNA's claims loss provision portfolio consists of 82.4% bonds as of the end of 2008. ^[38] Bonds are affected inversely to the movement of interest rates. In other words, as interest rates increase, the value of the bond decreases. Although in the short term, interest rate fluctuations are minimal, long term bond holdings are more susceptible to interest rate moments. With over 58% of its bond's not mature for another 5 years, CNA's long term bond holdings will be subject to interest rate ups and downs. ^[39] With such a highly un-diversified investment portfolio, CNA places its investment income at risk to swings in the interest rate. Although with current interest rates at all time lows (0%-.25%) bonds are stable investments, such large holdings of one type of security presents risks.^[40]

Among the different types of bonds according to their rating, CNA holds 35% non-governmental AAA bonds, followed by 28% in AA or A rated, and 17% in BBB rated bonds. ^[39] CNA only holds 11% of government issued bonds which are traditionally low risk, steady income bonds, and instead CNA has opted for higher risk, higher income bonds in a bid to make up for its poor underwriting.^[39] However, with the current financial crisis CNA's bond portfolio is at risk of losing its principal as many large companies such as GE, GM and CIT go bankrupt or teeter on the verge of bankruptcy. Other companies such as The Travelers Companies (TRV) take on a "much more conservative investment strategy" with 94% of the total investment portfolio in bonds and nearly 64% in steady income, low risk government and municipal bonds. ^[41] CNA has taken on more risk for its claims loss provision and jeopardizes future claims payouts as well as steady future investment income.

Amount of Exposure to Asbestos Liability Is Unpredictable

CNA has $1.2 billion left in reserves set aside specially for asbestos related claims, as of the end of 2008, after ceding $910 million of the reserves during 2008 to reinsurance claims. ^[42] Asbestos related claims have risen since 2006, with net claims in 2008 totally $147 million. ^[42] A large problem with asbestos claims however is the fact that many of the policy holders have claimed that their policies do not have so called aggregated limits on coverage; in essence, they claim that CNA is liable for all asbestos claims without a cap for a total amount. ^[42] However, CNA has taken an aggressive stance in limiting its losses by actively seeking to settle claims quickly, one such example is the Wellington Agreement in which The Continental Insurance Company, a subsidiary of CNA, and 47 other asbestos producers and their insurers reached a settlement on all asbestos related claims pertaining to those 47 producers. ^[43] However, litigation involving CNA and its subsidiaries are numerous and wide spread. New suits have been filed against CNA in New York, Montana, Texas, and New Jersey. ^[44] The total extent of losses attributable to asbestos claims is not readily available, because of the complications involving the number of new claims, the nature of these claims (i.e. work related, or if there is manifestation of asbestosis), as well as the litigation enviroment (i.e. how juries have historically decided cases) in each of the states that these new claims are filed. ^[45]

Competition

• The Travelers Companies (TRV) is a holding company that offers commercial and personal property and casualty insurance to the same group of consumers CNA caters to. They operate through their subsidiaries in three business segments: business insurance, financial, professional & international insurance, and personal insurance. ^[46] Net earned premiums rose by $109 million to $21.58 billion in 2008 compared to 2007.^[47] Total revenue was $22.4 billion in 2008, and Traveler's posted a positive net income of $2.92 billion. ^[48]
• American Financial Group (AFG) is also a holding company that offers property and casualty insurance, but focuses on specialized commercial business insurance needs such as marina, marine cargo, and crime coverage for the government. ^[49] In 2008, net earned premiums for AFG increased by $164 million to $2.87 billion.^[50] Total revenue fell however, by $86 million to $4.29 billion in 2008 compared to the previous year; net income fell by 48.8% to $196 million from $383 million. ^[51]
• Arch Capital Group (ACGL) provides through its subsidiaries property and casualty, executive assurance, and healthcare insurance and reinsurance products and services. To underscore the fact that it operates in these two areas, it reports earnings in two segments: insurance and reinsurance. ^[52] Arch's net earned premiums fell a little over 3% in 2008 to $2.85 billion compared to 2007; net income tumbled by two thirds to $291 million. ^[53] Net Revenue fell by $485 million to $2.97 billion in 2008. ^[53]

Market Share

Of the top 25 insurance companies, CNA ranks fourteenth in market share, with a 1.72% market share.

2008 Top 25 Companies by Countrywide Premium^[57]

References

1. ↑ CNA 10-K 2008 Pg. 3
2. ↑ Reuters CNA
3. ↑ ^{3.0 3.1} CNA 10-Q 2009 2Q Pg. 3
4. ↑ ^{4.0 4.1} CNA 2009 10-Q 2Q Pg. 14
5. ↑ Morningstar CNA
6. ↑ CNA 2009 10-Q 1Q Pg. 13
7. ↑ Google Finance CNA
8. ↑ CNA 2008 10-K Pg. 5
9. ↑ ^{9.0 9.1 9.2 9.3 9.4} CNA 2008 10-K Pg. 22
10. ↑ CNA 2008 10-K Pg. 23
11. ↑ ^{11.0 11.1} CNA 2003 10-K Pg. 18
12. ↑ ^{12.0 12.1} CNA 2008 10-K Pg. 66
13. ↑ ^{13.0 13.1} CNA 2005 10-K Pg. 71
14. ↑ CNA 2008 10-K Pg. 82, 88, 150
15. ↑ CNA 2008 10-K Pg. 66, 87
16. ↑ ^{16.0 16.1 16.2} CNA 2009 10-Q 2Q Pg. 3
17. ↑ CNA 2008 10-Q 3Q Pg. 3
18. ↑ ^{18.0 18.1 18.2} CNA 2008 10-K Pg. 5
19. ↑ ^{19.0 19.1} CNA 2005 10-K Pg. 5
20. ↑ ^{20.0 20.1 20.2 20.3 20.4} CNA 2008 10-K Pg. 34-41
21. ↑ ^{21.0 21.1 21.2 21.3 21.4} CNA 2008 10-K Pg. 134
22. ↑ ^{22.0 22.1 22.2 22.3 22.4 22.5} CNA 2008 10-K Pg. 34
23. ↑ CIA World Factbook USA Economy 2008
24. ↑ ^{24.0 24.1 24.2 24.3 24.4} CNA 2008 10-K Pg. 37
25. ↑ ^{25.0 25.1 25.2 25.3 25.4} CNA 2008 10-K Pg. 38
26. ↑ CNA 2005 10-K Pg. 38
27. ↑ ^{27.0 27.1} CNA 2008 10-K pg. 40
28. ↑ ^{28.0 28.1} CNA 2008 10-K Pg. 41
29. ↑ CNA 2008 10-K Pg. 5
30. ↑ CNA 2005 10-K Pg. 5
31. ↑ CNA 2002 10-K Pg. 7
32. ↑ CNA 1999 10-K Pg. 6
33. ↑ CNA 1996 10-K Pg. 7
34. ↑ CNA 2008 10-K Pg. 38,34
35. ↑ CNA 2005 10-K Pg.34,38
36. ↑ CNA 200210-K Pg. 38,44
37. ↑ CNA 1999 10-K Pg.16,18
38. ↑ CNA 2008 10-K Pg. 67
39. ↑ ^{39.0 39.1 39.2} CNA 2008 10-K Pg. 53
40. ↑ Wikipedia Federal Funds Rate
41. ↑ TRV 2008 10-K Pg. 100-101]
42. ↑ ^{42.0 42.1 42.2} CNA 2008 10-K Pg. 104
43. ↑ CNA 2008 10-K Pg. 43
44. ↑ CNA 2008 10-K Pg. 106
45. ↑ CNA 2008 10-K Pg. 107
46. ↑ Reuters TRV
47. ↑ CNA 2008 10-K Pg. 70
48. ↑ TRV 2008 10-K Pg. 68
49. ↑ Reuters AFG
50. ↑ AFG 2008 10-K Pg. 3
51. ↑ AFG 2008 10-K Pg. 23
52. ↑ Yahoo! Finance ACGL
53. ↑ ^{53.0 53.1} ACGL 2008 10-K Pg. 68
54. ↑ TRV 2008 10-K Pg. 70
55. ↑ AFG 2008 10-K Pg. F-3
56. ↑ ACGL 2008 10-K Pg. 68-70
57. ↑ National Association of Insurance Commissioners 2008 Report