CNA FINANCIAL CORP - FORM 10-Q - July 30, 2018

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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 June 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)

333 S. Wabash, Chicago, Illinois 60604
(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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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 [ ] (Do not check if a smaller reporting company)
 
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 July 26, 2018
Common Stock, Par value $2.50
 
271,395,494



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 June 30
Three Months
 
Six Months
(In millions, except per share data)
2018
 
2017
 
2018
 
2017
Revenues
 
 
 
 
 
 
 
Net earned premiums
$
1,815

 
$
1,734

 
$
3,600

 
$
3,379

Net investment income
506

 
475

 
996

 
1,020

Net realized investment (losses) gains:
 
 
 
 
 
 
 

Other-than-temporary impairment losses
—

 
(2
)
 
(6
)
 
(4
)
Other net realized investment (losses) gains
(1
)
 
52

 
17

 
90

Net realized investment (losses) gains
(1
)
 
50

 
11

 
86

Non-insurance warranty revenue (Note J)
248

 
98

 
486

 
191

Other revenues
6

 
9

 
16

 
20

Total revenues
2,574

 
2,366

 
5,109

 
4,696

Claims, Benefits and Expenses
 
 
 
 
 
 
 
Insurance claims and policyholders’ benefits
1,327

 
1,280

 
2,666

 
2,573

Amortization of deferred acquisition costs
359

 
312

 
655

 
617

Non-insurance warranty expense (Note J)
225

 
72

 
441

 
142

Other operating expenses
298

 
292

 
601

 
568

Interest
35

 
40

 
70

 
83

Total claims, benefits and expenses
2,244

 
1,996

 
4,433

 
3,983

Income before income tax
330

 
370

 
676

 
713

Income tax expense
(60
)
 
(98
)
 
(115
)
 
(181
)
Net income
$
270

 
$
272

 
$
561

 
$
532

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.99

 
$
1.01

 
$
2.07

 
$
1.96

 
 
 
 
 
 
 
 
Diluted earnings per share
$
0.99

 
$
1.00

 
$
2.06

 
$
1.96

 
 
 
 
 
 
 
 
Dividends declared per share
$
0.30

 
$
0.25

 
$
2.60

 
$
2.50

 
 
 
 
 
 
 
 
Weighted Average Outstanding Common Stock and Common Stock Equivalents
 
 
 
 
 
 
 
Basic
271.5

 
271.1

 
271.5

 
271.0

Diluted
272.4

 
271.9

 
272.4

 
271.9

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

3

CNA Financial Corporation
Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Comprehensive Income (Loss)
 
 
 
 
 
 
 
Net income
$
270

 
$
272

 
$
561

 
$
532

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

 
(10
)
 
(4
)
Net unrealized gains on other investments
(159
)
 
77

 
(588
)
 
144

Net unrealized gains on investments
(160
)
 
77

 
(598
)
 
140

Foreign currency translation adjustment
(52
)
 
42

 
(40
)
 
53

Pension and postretirement benefits
7

 
5

 
17

 
12

Other comprehensive (loss) income, net of tax
(205
)
 
124

 
(621
)
 
205

Total comprehensive income (loss)
$
65


$
396

 
$
(60
)
 
$
737

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)
June 30, 2018 (Unaudited)
 
December 31,
2017
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities at fair value (amortized cost of $37,928 and $38,215)
$
39,795

 
$
41,487

Equity securities at fair value (cost of $762 and $659)
773

 
695

Limited partnership investments
2,363

 
2,369

Other invested assets
48

 
44

Mortgage loans
865

 
839

Short term investments
1,308

 
1,436

Total investments
45,152

 
46,870

Cash
288

 
355

Reinsurance receivables (less allowance for uncollectible receivables of $29 and $29)
4,535

 
4,261

Insurance receivables (less allowance for uncollectible receivables of $44 and $44)
2,598

 
2,292

Accrued investment income
396

 
411

Deferred acquisition costs
673

 
634

Deferred income taxes
296

 
137

Property and equipment at cost (less accumulated depreciation of $234 and $274)
347

 
326

Goodwill
147

 
148

Other assets (Note A)
3,426

 
1,133

Total assets
$
57,858

 
$
56,567

Liabilities
 

 
 

Insurance reserves:
 
 
 

Claim and claim adjustment expenses
$
21,990

 
$
22,004

Unearned premiums
4,410

 
4,029

Future policy benefits
10,667

 
11,179

Short term debt
30

 
150

Long term debt
2,679

 
2,708

Other liabilities (includes $100 and $143 due to Loews Corporation) (Note A)
6,667

 
4,253

Total liabilities
46,443

 
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; 271,391,107 and 271,205,390 shares outstanding)
683

 
683

Additional paid-in capital
2,179

 
2,175

Retained earnings
9,216

 
9,414

Accumulated other comprehensive (loss) income
(605
)
 
32

Treasury stock (1,649,136 and 1,834,853 shares), at cost
(58
)
 
(60
)
Total stockholders’ equity
11,415

 
12,244

Total liabilities and stockholders' equity
$
57,858

 
$
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)
Six months ended June 30
 
 
 
(In millions)
2018
 
2017
Cash Flows from Operating Activities
 
 
 
Net income
$
561

 
$
532

Adjustments to reconcile net income to net cash flows provided by operating activities:
 
 
 
Deferred income tax expense
15

 
122

Trading portfolio activity
(13
)
 
(11
)
Net realized investment gains
(11
)
 
(86
)
Equity method investees
(15
)
 
42

Net amortization of investments
(30
)
 
(21
)
Depreciation and amortization
41

 
43

Changes in:
 
 
 
Receivables, net
(587
)
 
(195
)
Accrued investment income
15

 
1

Deferred acquisition costs
(43
)
 
(41
)
Insurance reserves
563

 
262

Other assets
(178
)
 
(118
)
Other liabilities
(11
)
 
(45
)
Other, net
47

 
30

Total adjustments
(207
)
 
(17
)
Net cash flows provided by operating activities
354

 
515

Cash Flows from Investing Activities
 

 
 

Dispositions:
 
 
 
Fixed maturity securities - sales
4,781

 
3,142

Fixed maturity securities - maturities, calls and redemptions
1,306

 
1,770

Equity securities
25

 
22

Limited partnerships
93

 
100

Mortgage loans
68

 
17

Purchases:
 
 
 
Fixed maturity securities
(5,608
)
 
(4,840
)
Equity securities
(127
)
 
(8
)
Limited partnerships
(72
)
 
(47
)
Mortgage loans
(94
)
 
(72
)
Change in other investments
(6
)
 
(3
)
Change in short term investments
135

 
81

Purchases of property and equipment
(76
)
 
(68
)
Other, net
14

 
17

Net cash flows provided by investing activities
439

 
111

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

6

Six months ended June 30
 
 
 
(In millions)
2018
 
2017
Cash Flows from Financing Activities
 
 
 
Dividends paid to common stockholders
$
(706
)
 
$
(676
)
Repayment of debt
(150
)
 
—

Other, net
1

 
(1
)
Net cash flows used by financing activities
(855
)

(677
)
Effect of foreign exchange rate changes on cash
(5
)
 
5

Net change in cash
(67
)
 
(46
)
Cash, beginning of year
355

 
271

Cash, end of period
$
288

 
$
225

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)
Six months ended June 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
4

 
(6
)
Balance, end of period
2,179

 
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 paid to common stockholders
(709
)
 
(680
)
Net income
561

 
532

Balance, end of period
9,216

 
9,211

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
(621
)
 
205

Balance, end of period
(605
)
 
32

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

 
8

Balance, end of period
(58
)
 
(65
)
Total stockholders' equity
$
11,415

 
$
12,028

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 June 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 June 30, 2018 and for the three and six months ended June 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 will be recognized more slowly compared to the historic revenue recognition pattern. In addition, for warranty products in which 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 June 30, 2018
Three Months
 
Six 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
$
105

 
$
143

 
$
248

 
$
206

 
$
280

 
$
486

Total revenues
2,431

 
143

 
2,574

 
4,829

 
280

 
5,109

 
 
 
 
 
 
 
 
 
 
 
 
Non-insurance warranty expense
80

 
145

 
225

 
158

 
283

 
441

Total claims, benefits and expenses
2,099

 
145

 
2,244

 
4,150

 
283

 
4,433

 
 
 
 
 
 
 
 
 
 
 
 
Income before income tax
332

 
(2
)
 
330

 
679

 
(3
)
 
676

Income tax expense
(61
)
 
1

 
(60
)
 
(116
)
 
1

 
(115
)
Net income
271

 
(1
)
 
270

 
563

 
(2
)
 
561

 
 
 
 
 
 
 
 
 
 
 
 
Balance sheet(1) at June 30, 2018:
 
 
 
 
 
 


 
 
 
 
Other assets
 
 
 
 
 
 
$
3,228

 
$
198

 
$
3,426

Other liabilities
 
 
 
 
 
 
6,466

 
201

 
6,667

Deferred income taxes
 
 
 
 
 
 
295

 
1

 
296

Retained earnings
 
 
 
 
 
 
9,218

 
(2
)
 
9,216

(1)
The Prior to Adoption amounts presented include the cumulative effect adjustment at adoption.
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 six months ended June 30, 2018, the Company recognized $10 million and $25 million in pretax losses within Net realized investment gains (losses) for the change in fair value of non-redeemable preferred stock and $2 million and $2 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 six months ended June 30, 2017, there was less than a $1 million decrease and a $1 million decrease in the fair value of common stock and a $2 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.
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.

11

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. 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.
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 June 30, 2018. The effects of the adjustments to the Company’s provisional amounts for the three and six months ended June 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.

12

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 six months ended June 30, 2018, approximately 835 thousand and 929 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 445 thousand and 2 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 six months ended June 30, 2017, approximately 847 thousand and 915 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 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.

13

Note C. Investments
The significant components of Net investment income are presented in the following table.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Fixed maturity securities
$
444

 
$
457

 
$
890

 
$
912

Equity securities
12

 
2

 
22

 
3

Limited partnership investments
40

 
16

 
70

 
106

Mortgage loans
14

 
8

 
25

 
15

Short term investments
6

 
3

 
12

 
6

Trading portfolio
3

 
4

 
5

 
6

Other
3

 
—

 
3

 
1

Gross investment income
522

 
490

 
1,027

 
1,049

Investment expense
(16
)
 
(15
)
 
(31
)
 
(29
)
Net investment income
$
506

 
$
475

 
$
996

 
$
1,020

During the three and six months ended June 30, 2018, $2 million and $1 million of Net investment income was recognized due to the change in fair value of common stock still held as of June 30, 2018.
Net realized investment gains (losses) are presented in the following table.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Net realized investment gains (losses):
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Gross realized gains
$
37

 
$
56

 
$
106

 
$
105

Gross realized losses
(33
)
 
(12
)
 
(84
)
 
(29
)
Net realized investment gains (losses) on fixed maturity securities
4

 
44

 
22

 
76

Equity securities
(10
)
 
—

 
(25
)
 
—

Derivatives
4

 
(3
)
 
9

 
(2
)
Short term investments and other
1

 
9

 
5

 
12

Net realized investment gains (losses)
$
(1
)
 
$
50

 
$
11

 
$
86

During the three and six months ended June 30, 2018, $10 million and $25 million of Net realized investment losses were recognized due to the change in fair value of non-redeemable preferred stock still held as of June 30, 2018.
The components of OTTI losses recognized in earnings by asset type are presented in the following table.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Fixed maturity securities available-for-sale:

 
 
 
 
 
 
Corporate and other bonds
$
—

 
$
2

 
$
5

 
$
4

Asset-backed
—

 
—

 
1

 
—

OTTI losses recognized in earnings
$
—

 
$
2

 
$
6

 
$
4


14

The following tables present a summary of fixed maturity and equity securities.
June 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
$
17,883

 
$
938

 
$
203

 
$
18,618

 
$
—

States, municipalities and political subdivisions
10,856

 
1,161

 
8

 
12,009

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
4,961

 
72

 
85

 
4,948

 
(25
)
Commercial mortgage-backed
2,082

 
23

 
33

 
2,072

 
—

Other asset-backed
1,557

 
9

 
9

 
1,557

 
—

Total asset-backed
8,600

 
104

 
127

 
8,577

 
(25
)
U.S. Treasury and obligations of government-sponsored enterprises
127

 
3

 
3

 
127

 
—

Foreign government
436

 
6

 
5

 
437

 
—

Redeemable preferred stock
9

 
1

 
—

 
10

 
—

Total fixed maturity securities available-for-sale
37,911

 
2,213

 
346

 
39,778

 
$
(25
)
Total fixed maturity securities trading
17

 
 
 
 
 
17

 
 
Total fixed maturity securities
$
37,928

 
$
2,213

 
$
346

 
$
39,795

 
 

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.


15

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 June 30, 2018 and December 31, 2017, the net unrealized gains on investments included in AOCI were correspondingly reduced by Shadow Adjustments of $1,186 million and $1,411 million.

16

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
June 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
$
6,963

 
$
192

 
$
193

 
$
11

 
$
7,156

 
$
203

States, municipalities and political subdivisions
723

 
8

 
3

 
—

 
726

 
8

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
3,183

 
68

 
344

 
17

 
3,527

 
85

Commercial mortgage-backed
913

 
16

 
228

 
17

 
1,141

 
33

Other asset-backed
632

 
6

 
27

 
3

 
659

 
9

Total asset-backed
4,728

 
90

 
599

 
37

 
5,327

 
127

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

 
1

 
19

 
2

 
68

 
3

Foreign government
178

 
3

 
40

 
2

 
218

 
5

Total
$
12,641

 
$
294

 
$
854

 
$
52

 
$
13,495

 
$
346


 
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.

17

Based on current facts and circumstances, the Company believes the unrealized losses presented in the June 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 June 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 June 30, 2018 and 2017 and for which a portion of an OTTI loss was recognized in Other comprehensive income (loss).
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Beginning balance of credit losses on fixed maturity securities
$
25

 
$
32

 
$
27

 
$
36

Reductions for securities sold during the period
(4
)
 
(2
)
 
(6
)
 
(6
)
Ending balance of credit losses on fixed maturity securities
$
21

 
$
30

 
$
21

 
$
30

Contractual Maturity
The following table presents available-for-sale fixed maturity securities by contractual maturity.
 
June 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
$
1,301

 
$
1,322

 
$
1,135

 
$
1,157

Due after one year through five years
8,211

 
8,421

 
8,165

 
8,501

Due after five years through ten years
16,138

 
16,240

 
16,060

 
16,718

Due after ten years
12,261

 
13,795

 
12,852

 
15,108

Total
$
37,911

 
$
39,778

 
$
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 $161 million and $167 million as of June 30, 2018 and December 31, 2017 and a fair value of $4 million and $(3) million as of June 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 June 30, 2018, the Company had committed approximately $551 million to future capital calls from various third-party limited partnership investments in exchange for an ownership interest in the related partnerships.
As of June 30, 2018, the Company had mortgage loan commitments of $15 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 June 30, 2018, the Company had commitments to purchase or fund additional amounts of $272 million and sell $111 million under the terms of such securities.

18

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.

19

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 and foreign governments and redeemable preferred stock.
June 30, 2018
 
 
 
 
 
 
Total
Assets/Liabilities
at Fair Value
(In millions)
Level 1
 
Level 2
 
Level 3
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate bonds and other
$
166

 
$
18,949

 
$
94

 
$
19,209

States, municipalities and political subdivisions
—

 
12,008

 
1

 
12,009

Asset-backed
—

 
8,304

 
273

 
8,577

Total fixed maturity securities
166

 
39,261

 
368

 
39,795

Equity securities:
 
 
 
 
 
 
 
Common stock
85

 
—

 
4

 
89

Non-redeemable preferred stock
67

 
604

 
13

 
684

Total equity securities
152

 
604

 
17

 
773

Short term and other
167

 
1,050

 
—

 
1,217

Total assets
$
485

 
$
40,915

 
$
385

 
$
41,785

Liabilities
 
 
 
 
 

 
 

Other liabilities
$
—

 
$
(4
)
 
$
—

 
$
(4
)
Total liabilities
$
—

 
$
(4
)
 
$
—

 
$
(4
)
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


20

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 April 1, 2018
$
100

 
$
1

 
$
279

 
$
18

 
$
—

 
$
398

Total realized and unrealized investment gains (losses):
 
 
 
 
 
 
 
 
 
 


Reported in Net realized investment gains (losses)
—

 
—

 
—

 
(1
)
 
—

 
(1
)
Reported in Net investment income
—

 
—

 
—

 
—

 
—

 
—

Reported in Other comprehensive income
(1
)
 
—

 
(1
)
 
—

 
—

 
(2
)
Total realized and unrealized investment gains (losses)
(1
)
 
—

 
(1
)
 
(1
)
 
—

 
(3
)
Purchases
2

 
—

 
41

 
—

 
—

 
43

Sales
(5
)
 
—

 
—

 
—

 
—

 
(5
)
Settlements
(2
)
 
—

 
(6
)
 
—

 
—

 
(8
)
Transfers into Level 3
—

 
—

 
13

 
—

 
—

 
13

Transfers out of Level 3
—

 
—

 
(53
)
 
—

 
—

 
(53
)
Balance as of June 30, 2018
$
94

 
$
1

 
$
273

 
$
17

 
$
—

 
$
385

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

 
$
—

 
$
—

 
$
(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 April 1, 2017
$
121

 
$
1

 
$
256

 
$
19

 
$
—

 
$
46

 
$
443

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

 
—

 
—

 
—

 
13

Sales
—

 
—

 
—

 
(1
)
 
—

 
(45
)
 
(46
)
Settlements
(11
)
 
—

 
(7
)
 
—

 
—

 
—

 
(18
)
Transfers into Level 3
—

 
—

 
24

 
—

 
—

 
—

 
24

Transfers out of Level 3
(10
)
 
—

 
(70
)
 
—

 
—

 
—

 
(80
)
Balance as of June 30, 2017
$
100

 
$
1

 
$
218

 
$
19

 
$
—

 
$
1

 
$
339

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

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—



21

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
)
 
—

 
7

 
(3
)
 
—

 
3

Reported in Net investment income
—

 
—

 
—

 
—

 
—

 
—

Reported in Other comprehensive income
(1
)
 
—

 
(6
)
 
—

 
—

 
(7
)
Total realized and unrealized investment gains (losses)
(2
)
 
—

 
1

 
(3
)
 
—

 
(4
)
Purchases
2

 
—

 
71

 
—

 
—

 
73

Sales
(5
)
 
—

 
(72
)
 
—

 
—

 
(77
)
Settlements
(4
)
 
—

 
(12
)
 
—

 
—

 
(16
)
Transfers into Level 3
5

 
—

 
13

 
—

 
—

 
18

Transfers out of Level 3
—

 
—

 
(63
)
 
—

 
—

 
(63
)
Balance as of June 30, 2018
$
94

 
$
1

 
$
273

 
$
17

 
$
—

 
$
385

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

 
$
—

 
$
—

 
$
(3
)
 
$
—

 
$
(3
)

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 January 1, 2017
$
130

 
$
1

 
$
199

 
$
19

 
$
—

 
$
58

 
$
407

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

 
—

 
1

 
—

 
1

 
—

 
2

Reported in Other revenues
—

 
—

 
—

 
—

 
—

 
6

 
6

Reported in Other comprehensive income
1

 
—

 
3

 
2

 
—

 
—

 
6

Total realized and unrealized investment gains (losses)
1

 
—

 
4

 
2

 
1

 
6

 
14

Purchases
5

 
—

 
51

 
1

 
—

 
—

 
57

Sales
(1
)
 
—

 
—

 
(3
)
 
(1
)
 
(58
)
 
(63
)
Settlements
(25
)
 
—

 
(13
)
 
—

 
—

 
(5
)
 
(43
)
Transfers into Level 3
—

 
—

 
52

 
—

 
—

 
—

 
52

Transfers out of Level 3
(10
)
 
—

 
(75
)
 
—

 
—

 
—

 
(85
)
Balance as of June 30, 2017
$
100

 
$
1

 
$
218

 
$
19

 
$
—

 
$
1

 
$
339

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

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—



22

Securities may be transferred in or out of levels within the fair value hierarchy based on the availability of observable market information and quoted prices used to determine the fair value of the security. The availability of observable market information and quoted prices varies based on market conditions and trading volume. During the three months ended June 30, 2018, there were no transfers between Level 1 and Level 2. During the six months ended June 30, 2018, there were $29 million of transfers from Level 2 to Level 1 and no transfers from Level 1 to Level 2. During the three and six months ended June 30, 2017 there were no transfers between Level 1 and Level 2. The Company's policy is to recognize transfers between levels at the beginning of quarterly reporting periods.

23

Valuation Methodologies and Inputs
The following section describes the valuation methodologies and relevant inputs used to measure different financial instruments at fair value, including an indication of the level in the fair value hierarchy in which the instruments are generally classified.
Fixed Maturity Securities
Level 1 securities include highly liquid and exchange traded bonds and redeemable preferred stock, valued using quoted market prices. Level 2 securities include most other fixed maturity securities as the significant inputs are observable in the marketplace. All classes of Level 2 fixed maturity securities are valued using a methodology based on information generated by market transactions involving identical or comparable assets, a discounted cash flow methodology, or a combination of both when necessary. Common inputs for all classes of fixed maturity securities include prices from recently executed transactions of similar securities, marketplace quotes, benchmark yields, spreads off benchmark yields, interest rates and U.S. Treasury or swap curves. Specifically for asset-backed securities, key inputs include prepayment and default projections based on past performance of the underlying collateral and current market data. Fixed maturity securities are primarily assigned to Level 3 in cases where broker/dealer quotes are significant inputs to the valuation and there is a lack of transparency as to whether these quotes are based on information that is observable in the marketplace. Level 3 securities also include private placement debt securities whose fair value is determined using internal models with inputs that are not market observable.
Equity Securities
Level 1 securities include publicly traded securities valued using quoted market prices. Level 2 securities are primarily valued using pricing for similar securities, recently executed transactions and other pricing models utilizing market observable inputs. Level 3 securities are primarily priced using broker/dealer quotes and internal models with inputs that are not market observable.
Short Term and Other Invested Assets
Securities that are actively traded or have quoted prices are classified as Level 1. These securities include money market funds and treasury bills. Level 2 primarily includes commercial paper, for which all inputs are market observable. Fixed maturity securities purchased within one year of maturity are classified consistent with fixed maturity securities discussed above. Short term investments as presented in the tables above differ from the amounts presented on the Condensed Consolidated Balance Sheets because certain short term investments, such as time deposits, are not measured at fair value.
As of June 30, 2018 and December 31, 2017, there were approximately $42 million and $39 million of overseas deposits within other invested assets, which can be redeemed at net asset value in 90 days or less. Overseas deposits are excluded from the fair value hierarchy because their fair value is recorded using the net asset value per share (or equivalent) practical expedient.
Life Settlement Contracts
The Company sold its life settlement contracts to a third party in 2017. The valuation of the life settlement contracts was based on the terms of sale. The contracts were classified as Level 3 as there was not an active market for life settlement contracts.
Derivative Financial Investments
Level 2 investments primarily include the embedded derivative on the funds withheld liability. The embedded derivative on funds withheld liability is valued using the change in fair value of the assets supporting the funds withheld liability, which are fixed maturity securities valued with observable inputs.

24

Significant Unobservable Inputs
The following tables present quantitative information about the significant unobservable inputs utilized by the Company in the fair value measurements of Level 3 assets. Valuations for assets and liabilities not presented in the tables below are primarily based on broker/dealer quotes for which there is a lack of transparency as to inputs used to develop the valuations. The quantitative detail of these unobservable inputs is neither provided nor reasonably available to the Company.
June 30, 2018
Estimated Fair Value
(In millions)
 
Valuation Technique(s)
 
Unobservable Input(s)
 
Range
 (Weighted Average)
Fixed maturity securities
$
130

 
Discounted cash flow
 
Credit spread
 
1% - 12% (3%)
December 31, 2017
Estimated Fair Value
(In millions)
 
Valuation Technique(s)
 
Unobservable Input(s)
 
Range
 (Weighted Average)
Fixed maturity securities
$
136

 
Discounted cash flow
 
Credit spread
 
1% - 12% (3%)
For fixed maturity securities, an increase to the credit spread assumptions would result in a lower fair value measurement.
Financial Assets and Liabilities Not Measured at Fair Value
The carrying amount and estimated fair value of the Company's financial assets and liabilities which are not measured at fair value on the Condensed Consolidated Balance Sheets are presented in the following tables.
June 30, 2018
Carrying
Amount
 
Estimated Fair Value
(In millions)
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
 
Mortgage loans
$
865

 
$
—

 
$
—

 
$
850

 
$
850

Note receivable
34


—


—

 
34

 
34

Liabilities
 
 
 
 
 
 
 
 
 
Short term debt
$
30

 
$
—

 
$
30

 
$
—

 
$
30

Long term debt
2,679

 
—

 
2,754

 
—

 
2,754

December 31, 2017
Carrying
Amount
 
Estimated Fair Value
(In millions)
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
 
Mortgage loans
$
839

 
$
—

 
$
—

 
$
844

 
$
844

Note receivable
46

 
—

 
—

 
46

 
46

Liabilities
 
 
 
 
 
 
 
 
 
Short term debt
$
150

 
$
—

 
$
150

 
$
—

 
$
150

Long term debt
2,708

 
—

 
2,896

 
—

 
2,896

The following methods and assumptions were used to estimate the fair value of these financial assets and liabilities.
The fair values of mortgage loans were based on the present value of the expected future cash flows discounted at the current interest rate for origination of similar quality loans, adjusted for specific loan risk.
The fair value of the note receivable was based on the present value of the expected future cash flows discounted at the current interest rate for origination of similar notes, adjusted for specific credit risk.
The Company's senior notes and debentures were valued based on observable market prices. The fair value for other debt was estimated using discounted cash flows based on current incremental borrowing rates for similar borrowing arrangements.
The carrying amounts reported on the Condensed Consolidated Balance Sheets for Cash, Short term investments not carried at fair value, Accrued investment income and certain Other assets and Other liabilities approximate fair value due to the short term nature of these items. These assets and liabilities are not listed in the tables above.

25

Note E. Claim and Claim Adjustment Expense Reserves
The Company's property and casualty insurance claim and claim adjustment expense reserves represent the estimated amounts necessary to resolve all outstanding claims, including incurred but not reported (IBNR) claims as of the reporting date. The Company's reserve projections are based primarily on detailed analysis of the facts in each case, the Company's experience with similar cases and various historical development patterns. Consideration is given to such historical patterns as claim reserving trends and settlement practices, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions, including inflation, and public attitudes. All of these factors can affect the estimation of claim and claim adjustment expense reserves.
Establishing claim and claim adjustment expense reserves, including claim and claim adjustment expense reserves for catastrophic events that have occurred, is an estimation process. Many factors can ultimately affect the final settlement of a claim and, therefore, the necessary reserve. Changes in the law, results of litigation, medical costs, the cost of repair materials and labor rates can affect ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably estimable than long-tail claims, such as workers' compensation, general liability and professional liability claims. Adjustments to prior year reserve estimates, if necessary, are reflected in the results of operations in the period that the need for such adjustments is determined. There can be no assurance that the Company's ultimate cost for insurance losses will not exceed current estimates.
Catastrophes are an inherent risk of the property and casualty insurance business and have contributed to material period-to-period fluctuations in the Company's results of operations and/or equity. The Company reported catastrophe losses, net of reinsurance, of $26 million and $60 million for the three and six months ended June 30, 2018. The company reported catastrophe losses, net of reinsurance, of $39 million and $73 million for the three and six months ended June 30, 2017. Net catastrophe losses in 2018 and 2017 related primarily to U.S. weather-related events.

26

Liability for Unpaid Claim and Claim Adjustment Expenses Rollforward
The following table presents a reconciliation between beginning and ending claim and claim adjustment expense reserves, including claim and claim adjustment expense reserves of the Life & Group segment.
For the six months ended June 30
 
 
 
(In millions)
2018
 
2017
Reserves, beginning of year:
 
 
 
Gross
$
22,004

 
$
22,343

Ceded
3,934

 
4,094

Net reserves, beginning of year
18,070

 
18,249

Net incurred claim and claim adjustment expenses:
 
 
 
Provision for insured events of current year
2,552

 
2,443

Decrease in provision for insured events of prior years
(112
)
 
(159
)
Amortization of discount
92

 
93

Total net incurred (1)
2,532

 
2,377

Net payments attributable to:
 
 
 
Current year events
(312
)
 
(266
)
Prior year events
(2,387
)
 
(2,331
)
Total net payments
(2,699
)
 
(2,597
)
Foreign currency translation adjustment and other
(70
)
 
70

Net reserves, end of period
17,833

 
18,099

Ceded reserves, end of period
4,157

 
4,080

Gross reserves, end of period
$
21,990

 
$
22,179

(1)
Total net incurred above does not agree to Insurance claims and policyholders' benefits as reflected on the Condensed Consolidated Statements of Operations due to amounts related to retroactive reinsurance deferred gain accounting, uncollectible reinsurance and loss deductible receivables, and benefit expenses related to future policy benefits which are not reflected in the table above.
Net Prior Year Development
Changes in estimates of claim and claim adjustment expense reserves, net of reinsurance, for prior years are defined as net prior year loss reserve development (development). These changes can be favorable or unfavorable. The following table presents development recorded for the Specialty, Commercial, International and Corporate & Other segments.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Pretax (favorable) unfavorable development:
 
 
 
 
 
 
 
Specialty
$
(44
)
 
$
(23
)
 
$
(74
)
 
$
(35
)
Commercial
(13
)
 
(34
)
 
(22
)
 
(77
)
International
(2
)
 
2

 
(2
)
 
—

Corporate & Other
—

 
—

 
—

 
—

Total pretax (favorable) unfavorable development
$
(59
)
 
$
(55
)
 
$
(98
)
 
$
(112
)


27

Specialty
The following table presents further detail of the development recorded for the Specialty segment.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Pretax (favorable) unfavorable development:
 
 
 
 
 
 
 
Medical Professional Liability
$
3

 
$
2

 
$
23

 
$
22

Other Professional Liability and Management Liability
(34
)
 
(37
)
 
(68
)
 
(69
)
Surety
(15
)
 
—

 
(30
)
 
—

Warranty
(6
)
 
6

 
(6
)
 
6

Other
8

 
6

 
7

 
6

Total pretax (favorable) unfavorable development
$
(44
)
 
$
(23
)
 
$
(74
)
 
$
(35
)
Three Months
2018
Favorable development in other professional liability and management liability was primarily in professional liability errors and omissions (E&O) reflecting lower than expected claim frequency in accident years 2014 through 2016 and favorable severity for accident years 2012 and prior.
Favorable development in surety was driven by continued lower than expected loss emergence on accident years 2015 and prior. 
2017
Favorable development in other professional liability and management liability was primarily due to lower than expected claim frequency in accident years 2013 through 2015 and lower than expected severity in accident years 2014 through 2016 for professional liability.
Six Months
2018
Unfavorable development for medical professional liability was primarily due to higher than expected severity in accident years 2014 and 2017 in our hospitals business.
Favorable development in other professional liability and management liability was primarily due to lower than expected claim frequency for accident years 2013 through 2017 related to financial institutions. Additional favorable development was in professional liability errors and omissions (E&O) reflecting lower than expected claim frequency in accident years 2014 through 2016 and favorable severity for accident years 2012 and prior.
Favorable development for surety was due to continued lower than expected loss emergence for accident years 2015 and prior.
2017
Unfavorable development in medical professional liability was primarily due to continued higher than expected frequency in aging services.
Favorable development in other professional liability and management liability was primarily due to favorable settlements on closed claims and a lower than expected frequency of large losses for accident years 2011 through 2016 for professional and management liability, lower than expected claim frequency in accident years 2013 through 2015 for professional liability and lower than expected severity in accident years 2014 through 2016 for professional liability.

28

Commercial
The following table presents further detail of the development recorded for the Commercial segment.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Pretax (favorable) unfavorable development:
 
 
 
 
 
 
 
Commercial Auto
$
—

 
$
1

 
$
(1
)
 
$
(25
)
General Liability
26

 
1

 
18

 
(17
)
Workers' Compensation
(6
)
 
(47
)
 
(12
)
 
(47
)
Property and Other
(33
)
 
11

 
(27
)
 
12

Total pretax (favorable) unfavorable development
$
(13
)
 
$
(34
)
 
$
(22
)
 
$
(77
)
Three Months
2018
Unfavorable development in general liability was driven by higher than expected claim severity in umbrella in accident years 2013 through 2015. 
Favorable development in property and other was driven by lower than expected claim severity from catastrophes in accident year 2017.
2017
Favorable development for workers’ compensation was primarily related to decreases in frequency and severity in recent accident years, partially attributable to California reforms related to decreases in medical costs.
Unfavorable development for property and other was primarily due to higher than expected severity in accident year 2016.
Six Months
2018
Unfavorable development in general liability was driven by higher than expected claim severity in umbrella in accident years 2013 through 2015. 
Favorable development in property and other was driven by lower than expected claim severity from catastrophes in accident year 2017.
2017
Favorable development for commercial auto was primarily due to lower than expected severity in accident years 2013 through 2015.
Favorable development for general liability was due to lower than expected severity in life sciences.
Favorable development for workers’ compensation was primarily related to decreases in frequency and severity in recent accident years, partially attributable to California reforms related to decreases in medical costs.
Unfavorable development for property and other was primarily due to higher than expected severity in accident year 2016.

29

International
The following table presents further detail of the development recorded for the International segment.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Pretax (favorable) unfavorable development:
 
 
 
 
 
 
 
Casualty
$
(6
)
 
$
1

 
$
(6
)
 
$
1

Property
12

 
(10
)
 
12

 
(11
)
Energy and Marine
(5
)
 
(3
)
 
(5
)
 
(3
)
Specialty
9

 
16

 
9

 
15

Healthcare and Technology
(12
)
 
(2
)
 
(12
)
 
(2
)
Total pretax (favorable) unfavorable development
$
(2
)
 
$
2

 
$
(2
)
 
$
—

Three Months
2018
Unfavorable development in property was primarily driven by higher than expected severity in Canada and higher than expected frequency in Hardy, both in accident year 2017.
Unfavorable development in specialty was driven by increased severity in accident year 2017 related to professional indemnity.
Favorable development in healthcare and technology was primarily driven by lower than expected frequency in accident years 2015 and prior related to healthcare in Europe.
2017
Favorable development for property was due to better than expected frequency in accident years 2014 through 2016.
Unfavorable development for specialty was primarily due to higher than expected severity in accident year 2015 arising from the management liability business, partially offset by favorable development in accident years 2014 and prior. Additional unfavorable development was related to adverse large claims experience in the Hardy political risks portfolio, relating largely to accident year 2016.
Six Months
2018
The drivers of development for the six month period were consistent with the three month summary above.
2017
The drivers of development for the six month period were generally consistent with the three month summary above.


30

Asbestos and Environmental Pollution (A&EP) Reserves
In 2010, Continental Casualty Company (CCC) together with several of the Company’s other insurance subsidiaries completed a transaction with National Indemnity Company (NICO), a subsidiary of Berkshire Hathaway Inc., under which substantially all of the Company’s legacy A&EP liabilities were ceded to NICO through a Loss Portfolio Transfer (LPT). At the effective date of the transaction, the Company ceded approximately $1.6 billion of net A&EP claim and allocated claim adjustment expense reserves to NICO under a retroactive reinsurance agreement with an aggregate limit of $4 billion. The $1.6 billion of claim and allocated claim adjustment expense reserves ceded to NICO was net of $1.2 billion of ceded claim and allocated claim adjustment expense reserves under existing third-party reinsurance contracts. The NICO LPT aggregate reinsurance limit also covers credit risk on the existing third-party reinsurance related to these liabilities. The Company paid NICO a reinsurance premium of $2 billion and transferred to NICO billed third-party reinsurance receivables related to A&EP claims with a net book value of $215 million, resulting in total consideration of $2.2 billion.
In years subsequent to the effective date of the LPT, the Company recognized adverse prior year development on its A&EP reserves resulting in additional amounts ceded under the LPT. As a result, the cumulative amounts ceded under the LPT have exceeded the $2.2 billion consideration paid, resulting in the NICO LPT moving into a gain position, requiring retroactive reinsurance accounting. Under retroactive reinsurance accounting, this gain is deferred and only recognized in earnings in proportion to actual paid recoveries under the LPT. Over the life of the contract, there is no economic impact as long as any additional losses incurred are within the limit of the LPT. In a period in which the Company recognizes a change in the estimate of A&EP reserves that increases or decreases the amounts ceded under the LPT, the proportion of actual paid recoveries to total ceded losses is affected and the change in the deferred gain is recognized in earnings as if the revised estimate of ceded losses was available at the effective date of the LPT. The effect of the deferred retroactive reinsurance benefit is recorded in Insurance claims and policyholders' benefits in the Condensed Consolidated Statement of Operations.
The following table presents the impact of the Loss Portfolio Transfer on the Condensed Consolidated Statements of Operations.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Additional amounts ceded under LPT:
 
 
 
 
 
 
 
Net A&EP adverse development before consideration of LPT
$
—

 
$
—

 
$
113

 
$
60

Provision for uncollectible third-party reinsurance on A&EP
—

 
—

 
(16
)
 
—

Total additional amounts ceded under LPT
—

 
—

 
97

 
60

Retroactive reinsurance benefit recognized
(15
)
 
(3
)
 
(72
)
 
(43
)
Pretax impact of deferred retroactive reinsurance
$
(15
)
 
$
(3
)
 
$
25

 
$
17

Based upon the Company's annual A&EP reserve review, net unfavorable prior year development of $113 million and $60 million was recognized before consideration of cessions to the LPT for the six months ended June 30, 2018 and 2017. Additionally, in 2018, the Company released a portion of its provision for uncollectible third party reinsurance. The 2018 unfavorable development was driven by higher than anticipated defense costs on direct asbestos environmental accounts and paid losses on assumed reinsurance exposures. The 2017 unfavorable development was driven by modestly higher anticipated payouts on claims from known sources of asbestos exposure. While the unfavorable development was ceded to NICO under the LPT, the Company’s Net income for the six month periods were negatively affected due to the application of retroactive reinsurance accounting.
As of June 30, 2018 and December 31, 2017, the cumulative amounts ceded under the LPT were $3.0 billion and $2.9 billion. The unrecognized deferred retroactive reinsurance benefit was $351 million and $326 million as of June 30, 2018 and December 31, 2017.
NICO established a collateral trust account as security for its obligations to the Company. The fair value of the collateral trust account was $3.0 billion and $3.1 billion as of June 30, 2018 and December 31, 2017. In addition, Berkshire Hathaway Inc. guaranteed the payment obligations of NICO up to the aggregate reinsurance limit as well as certain of NICO’s performance obligations under the trust agreement. NICO is responsible for claims handling and billing and collection from third-party reinsurers related to the Company’s A&EP claims.

31

Note F. Legal Proceedings, Contingencies and Guarantees
CNA 401(k) Plus Plan Litigation
In September 2016, a class action lawsuit was filed against CCC, Continental Assurance Company (CAC) (a former subsidiary of CCC), CNAF, the Investment Committee of the CNA 401(k) Plus Plan (Plan), The Northern Trust Company and John Does 1-10 (collectively Defendants) related to the Plan. The complaint alleges that Defendants breached fiduciary duties to the Plan and caused prohibited transactions in violation of the Employee Retirement Income Security Act of 1974 when the Plan's Fixed Income Fund’s annuity contract with CAC was canceled. The plaintiff alleges he and a proposed class of Plan participants who had invested in the Fixed Income Fund suffered lower returns in their Plan investments as a consequence of these alleged violations and seeks relief on behalf of the putative class. The Plan trustees have provided notice to their fiduciary coverage insurance carriers.
The plaintiff, Defendants and the Plan's fiduciary insurance carriers have agreed on terms to settle this matter and have executed settlement agreements. The plaintiff and Defendants have proposed a class settlement for court approval, and the court granted preliminary approval subject to a fairness hearing. Based on the executed settlement agreements, management has recorded its best estimate of the Company's probable loss and does not believe that the ultimate resolution of this matter will have a material impact on the Company’s results of operations or financial position.
Small Business Premium Rate Adjustment
In 2016 and 2017, the Company identified rating errors related to its multi-peril package product and workers' compensation policies within its Small Business unit and determined that it would voluntarily issue premium refunds along with interest on affected policies. After the rating errors were identified, written and earned premium have been reported net of any impact from the premium rate adjustments. The Company increased Earned premium by $1 million and reduced Earned premium by $37 million for the three and six months ended June 30, 2017. Interest expense increased for interest due to policyholders on the premium rate adjustments by $1 million and $6 million for the three and six months ended June 30, 2017.
The policyholder refunds for the multi-peril package product were issued in the third quarter of 2017. The policyholder refunds for workers’ compensation policies are in process and are expected to be completed by the end of 2018. Interest expense of $1 million was recorded for the six months ended June 30, 2018. The estimated refund liability, including interest, for the workers' compensation policies as of June 30, 2018 was $47 million.
Other Litigation
The Company is a party to other routine litigation incidental to its business, which, based on the facts and circumstances currently known, is not material to the Company's results of operations or financial position.
Guarantees
As of June 30, 2018 and December 31, 2017, the Company had recorded liabilities of approximately $5 million related to guarantee and indemnification agreements and management believes that it is not likely that any future indemnity claims will be significantly greater than the amounts recorded.
In the course of selling business entities and assets to third parties, the Company agreed to guarantee the performance of certain obligations of previously owned subsidiaries and to indemnify purchasers for losses arising out of breaches of representations and warranties with respect to the business entities or assets sold, including, in certain cases, losses arising from undisclosed liabilities or certain named litigation. Such guarantee and indemnification agreements in effect for sales of business entities, assets and third-party loans may include provisions that survive indefinitely. As of June 30, 2018, the aggregate amount related to quantifiable guarantees was $375 million and the aggregate amount related to quantifiable indemnification agreements was $252 million. In certain cases, should the Company be required to make payments under any such guarantee, it would have the right to seek reimbursement from an affiliate of a previously owned subsidiary.
In addition, the Company 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 June 30, 2018, the Company 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

32

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. Certain provisions of the indemnification agreements survive indefinitely, while others survive until the applicable statutes of limitation expire, or until the agreed-upon contract terms expire.
The Company also provided guarantees, if the primary obligor fails to perform, to holders of structured settlement annuities provided by a previously owned subsidiary. As of June 30, 2018, the potential amount of future payments the Company could be required to pay under these guarantees was approximately $1.8 billion, which will be paid over the lifetime of the annuitants. The Company does not believe any payment is likely under these guarantees, as the Company is the beneficiary of a trust that must be maintained at a level that approximates the discounted reserves for these annuities.

33

Note G. Benefit Plans
The components of net periodic pension cost (benefit) are presented in the following table.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Net periodic pension cost (benefit)
 
 
 
 
 
 
 
Service cost
$
—

 
$
—

 
$
—

 
$
—

Non-service cost:
 
 
 
 
 
 
 
Interest cost on projected benefit obligation
24

 
26

 
47

 
52

Expected return on plan assets
(40
)
 
(39
)
 
(80
)
 
(78
)
Amortization of net actuarial loss
9

 
9

 
18

 
18

Settlement loss
1

 
—

 
5

 
2

Total non-service cost
(6
)
 
(4
)
 
(10
)
 
(6
)
Total net periodic pension cost (benefit)
$
(6
)
 
$
(4
)
 
$
(10
)
 
$
(6
)
For the three and six months ended June 30, 2018, the Company recognized $2 million and $3 million of non-service cost in Insurance claims and policyholders' benefits and $4 million and $7 million of non-service cost in Other operating expenses.
For the three and six months ended June 30, 2017, the Company recognized $1 million and $2 million of non-service cost in Insurance claims and policyholders' benefits and $3 million and $4 million of non-service cost in Other operating expenses.

34

Note H. Accumulated Other Comprehensive Income (Loss) by Component
The tables below display the changes in Accumulated other comprehensive income (loss) by component.
(In millions)
Net unrealized gains (losses) on investments with OTTI losses
 
Net unrealized gains (losses) on other investments
 
Pension and postretirement benefits
 
Cumulative foreign currency translation adjustment
 
Total
Balance as of April 1, 2018
$
21

 
$
430

 
$
(765
)
 
$
(86
)
 
$
(400
)
Other comprehensive income (loss) before reclassifications
(1
)
 
(156
)
 
—

 
(52
)
 
(209
)
Amounts reclassified from accumulated other comprehensive income (loss) net of tax (expense) benefit of $-, $(1), $2, $- and $1
—

 
3

 
(7
)
 
—

 
(4
)
Other comprehensive income (loss) net of tax (expense) benefit of $1, $46, $(2), $- and $45
(1
)
 
(159
)
 
7

 
(52
)
 
(205
)
Balance as of June 30, 2018
$
20

 
$
271

 
$
(758
)
 
$
(138
)
 
$
(605
)
(In millions)
Net unrealized gains (losses) on investments with OTTI losses
 
Net unrealized gains (losses) on other investments
 
Pension and postretirement benefits
 
Cumulative foreign currency translation adjustment
 
Total
Balance as of April 1, 2017
$
26

 
$
709

 
$
(640
)
 
$
(187
)
 
$
(92
)
Other comprehensive income (loss) before reclassifications
(1
)
 
108

 
—

 
42

 
149

Amounts reclassified from accumulated other comprehensive income (loss) net of tax (expense) benefit of $1, $(15), $3, $-, and $(11)
(1
)
 
31

 
(5
)
 
—

 
25

Other comprehensive income (loss) net of tax (expense) benefit of $-, $(48), $(3), $- and $(51)
—

 
77

 
5

 
42

 
124

Balance as of June 30, 2017
$
26

 
$
786

 
$
(635
)
 
$
(145
)
 
$
32


35

(In millions)
Net unrealized gains (losses) on investments with OTTI losses
 
Net unrealized gains (losses) on other investments
 
Pension and postretirement benefits
 
Cumulative foreign currency translation adjustment
 
Total
Balance as of January 1, 2018, as previously reported
$
25

 
$
750

 
$
(645
)
 
$
(98
)
 
$
32

Cumulative effect adjustment from accounting change for adoption of ASU 2018-02(1)
5

 
137

 
(130
)
 
—

 
12

Cumulative effect adjustment from accounting change for adoption of ASU 2016-01(1) net of tax (expense) benefit of $-, $8, $-, $- and $8
—

 
(28
)
 
—

 
—

 
(28
)
Balance as of January 1, 2018, as adjusted
30

 
859

 
(775
)
 
(98
)
 
16

Other comprehensive income (loss) before reclassifications
(11
)
 
(570
)
 
—

 
(40
)
 
(621
)
Amounts reclassified from accumulated other comprehensive income (loss) net of tax (expense) benefit of $-, $(5), $5, $- and $-
(1
)
 
18

 
(17
)
 
—

 
—

Other comprehensive income (loss) net of tax (expense) benefit of $3, $155, $(5), $- and $153
(10
)
 
(588
)

17

 
(40
)
 
(621
)
Balance as of June 30, 2018
$
20

 
$
271

 
$
(758
)
 
$
(138
)
 
$
(605
)
(1)
See Note A to the Condensed Consolidated Financial Statements for additional information.
(In millions)
Net unrealized gains (losses) on investments with OTTI losses
 
Net unrealized gains (losses) on other investments
 
Pension and postretirement benefits
 
Cumulative foreign currency translation adjustment
 
Total
Balance as of January 1, 2017

$
30

 
$
642

 
$
(647
)
 
$
(198
)
 
$
(173
)
Other comprehensive income (loss) before reclassifications
(1
)
 
193

 
—

 
53

 
245

Amounts reclassified from accumulated other comprehensive income (loss) net of tax (expense) benefit of $(1), $(24), $7, $- and $(18)
3

 
49

 
(12
)
 
—

 
40

Other comprehensive income (loss) net of tax (expense) benefit of $1, $(86), $(7), $- and $(92)
(4
)
 
144

 
12

 
53

 
205

Balance as of June 30, 2017
$
26

 
$
786

 
$
(635
)
 
$
(145
)
 
$
32

Amounts reclassified from Accumulated other comprehensive income (loss) shown above are reported in Net income (loss) as follows:
Component of AOCI
 
Condensed Consolidated Statements of Operations Line Item Affected by Reclassifications
Net unrealized gains (losses) on investments with OTTI losses
 
Net realized investment gains (losses)
Net unrealized gains (losses) on other investments
 
Net realized investment gains (losses)
Pension and postretirement benefits
 
Other operating expenses and Insurance claims and policyholders' benefits

36

Note I. Business Segments
The Company's property and casualty commercial insurance operations are managed and reported in three business segments: Specialty, Commercial and International. These three segments are collectively referred to as Property & Casualty Operations. The Company's operations outside of Property & Casualty Operations are managed and reported in two segments: Life & Group and Corporate & Other.
Effective January 1, 2018, management changed the segment presentation of the life sciences business and technology and media related errors and omissions business within the Specialty and Commercial business segments. The life sciences business moved from the Specialty business segment to the Commercial business segment and the technology and media related errors and omissions business moved from the Commercial business segment to the Specialty business segment. The new management responsibility for these businesses better aligns with line of business underwriting expertise and the manner in which the products are sold. Prior period information has been conformed to the new segment presentation.
The accounting policies of the segments are the same as those described in Note A to the Consolidated Financial Statements within CNAF's Annual Report on Form 10-K for the year ended December 31, 2017. The Company manages most of its assets on a legal entity basis, while segment operations are generally conducted across legal entities. As such, only Insurance and Reinsurance receivables, Insurance reserves, Deferred acquisition costs and Goodwill are readily identifiable for individual segments. Distinct investment portfolios are not maintained for every individual segment; accordingly, allocation of assets to each segment is not performed. Therefore, a significant portion of Net investment income and Realized investment gains or losses are allocated primarily based on each segment's net carried insurance reserves, as adjusted. All significant intersegment income and expense has been eliminated. Income taxes have been allocated on the basis of the taxable income of the segments.
In the following tables, certain financial measures are presented to provide information used by management to monitor the Company's operating performance. Management utilizes these financial measures to monitor the Company's insurance operations and investment portfolio.
The performance of the Company's insurance operations is monitored by management through core income (loss), which is derived from certain income statement amounts. The Company's investment portfolio is monitored by management through analysis of various factors including unrealized gains and losses on securities, portfolio duration and exposure to market and credit risk.
Core income (loss) is calculated by excluding from net income (loss) the after-tax effects of i) net realized investment gains (losses), ii) income or loss from discontinued operations, iii) any cumulative effects of changes in accounting guidance and iv) deferred tax asset and liability remeasurement as a result of an enacted U.S. Federal tax rate change. The calculation of core income (loss) excludes net realized investment gains or losses because net realized investment gains or losses are generally driven by economic factors that are not necessarily consistent with key drivers of underwriting performance, and are therefore not considered an indication of trends in insurance operations.

37

The Company's results of operations and selected balance sheet items by segment are presented in the following tables.
Three months ended June 30, 2018

Specialty
 

Commercial
 
International
 
Life &
Group
 
Corporate
& Other
 
 
 
 
(In millions)
 
 
 
 
 
Eliminations
 
Total
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 

Net earned premiums
$
683

 
$
753

 
$
248

 
$
131

 
$
—

 
$
—

 
$
1,815

Net investment income
130

 
157

 
15

 
198

 
6

 
—

 
506

Non-insurance warranty revenue
248

 
—

 
—

 
—

 
—

 
—

 
248

Other revenues
—

 
8

 
(1
)
 
—

 
(1
)
 
—

 
6

Total operating revenues
1,061

 
918

 
262

 
329

 
5

 
—

 
2,575

Claims, benefits and expenses
 

 
 

 
 
 
 

 
 

 
 

 
 

Net incurred claims and benefits
372

 
470

 
166

 
327

 
(14
)
 
—

 
1,321

Policyholders’ dividends
1

 
5

 
—

 
—

 
—

 
—

 
6

Amortization of deferred acquisition costs
149

 
127

 
83

 
—

 
—

 
—

 
359

Non-insurance warranty expense
225

 
—

 
—

 
—

 
—

 
—

 
225

Other insurance related expenses
70

 
126

 
10

 
30

 
—

 
—

 
236

Other expenses
12

 
10

 
7

 
1

 
67

 
—

 
97

Total claims, benefits and expenses
829

 
738

 
266

 
358

 
53

 
—

 
2,244

Core income (loss) before income tax
232

 
180

 
(4
)
 
(29
)
 
(48
)
 
—

 
331

Income tax (expense) benefit on core income (loss)
(49
)
 
(37
)
 
(3
)
 
19

 
9

 
—

 
(61
)
Core income (loss) 
$
183

 
$
143

 
$
(7
)
 
$
(10
)
 
$
(39
)
 
$
—

 
270

Net realized investment gains (losses)
 
 
 
 
 
 
 
 
 
 
 
 
(1
)
Income tax (expense) benefit on net realized investment gains (losses)
 
 
 
 
 
 
 
 
 
 
 
 
1

Net realized investment gains (losses), after tax
 
 
 
 
 
 
 
 
 
 
 
 
—

Net income
 
 
 
 
 
 
 
 
 
 
 
 
$
270


38

Three months ended June 30, 2017

Specialty
 

Commercial
 
International
 
Life &
Group
 
Corporate
& Other
 
 
 
 
(In millions)
 
 
 
 
 
Eliminations
 
Total
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 

Net earned premiums
$
678

 
$
716

 
$
206

 
$
135

 
$
—

 
$
(1
)
 
$
1,734

Net investment income
117

 
146

 
13

 
195

 
4

 
—

 
475

Non-insurance warranty revenue
98

 
—

 
—

 
—

 
—

 
—

 
98

Other revenues
—

 
9

 
(1
)
 
—

 
1

 
—

 
9

Total operating revenues
893

 
871

 
218

 
330

 
5

 
(1
)
 
2,316

Claims, benefits and expenses
 

 
 

 
 
 
 

 
 

 
 

 
 

Net incurred claims and benefits
394

 
426

 
129

 
328

 
(2
)
 
—

 
1,275

Policyholders’ dividends
1

 
4

 
—

 
—

 
—

 
—

 
5

Amortization of deferred acquisition costs
147

 
120

 
45

 
—

 
—

 
—

 
312

Non-insurance warranty expense
72

 
—

 
—

 
—

 
—

 
—

 
72

Other insurance related expenses
71

 
129

 
31

 
32

 
(1
)
 
(1
)
 
261

Other expenses
11

 
10

 
(1
)
 
1

 
50

 
—

 
71

Total claims, benefits and expenses
696

 
689

 
204

 
361

 
47

 
(1
)
 
1,996

Core income (loss) before income tax
197

 
182

 
14

 
(31
)
 
(42
)
 
—

 
320

Income tax (expense) benefit on core income (loss)
(66
)
 
(62
)
 
(4
)
 
36

 
15

 
—

 
(81
)
Core income (loss) 
$
131

 
$
120

 
$
10

 
$
5

 
$
(27
)
 
$
—

 
239

Net realized investment gains (losses)
 
 
 
 
 
 
 
 
 
 
 
 
50

Income tax (expense) benefit on net realized investment gains (losses)
 
 
 
 
 
 
 
 
 
 
 
 
(17
)
Net realized investment gains (losses), after tax
 
 
 
 
 
 
 
 
 
 
 
 
33

Net income
 
 
 
 
 
 
 
 
 
 
 
 
$
272




39

Six months ended June 30, 2018

Specialty
 

Commercial
 
International
 
Life &
Group
 
Corporate
& Other
 
 
 
 
(In millions)
 
 
 
 
 
Eliminations
 
Total
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 

Net earned premiums
$
1,355

 
$
1,496

 
$
484

 
$
265

 
$
—

 
$
—

 
$
3,600

Net investment income
252

 
306

 
29

 
398

 
11

 
—

 
996

Non-insurance warranty revenue
486

 
—

 
—

 
—

 
—

 
—

 
486

Other revenues
1

 
16

 
(1
)
 
1

 
—

 
(1
)
 
16

Total operating revenues
2,094

 
1,818

 
512

 
664

 
11

 
(1
)
 
5,098

Claims, benefits and expenses
 

 
 

 
 
 
 

 
 

 
 

 
 

Net incurred claims and benefits
751

 
938

 
308

 
630

 
27

 
—

 
2,654

Policyholders’ dividends
2

 
10

 
—

 
—

 
—

 
—

 
12

Amortization of deferred acquisition costs
294

 
248

 
113

 
—

 
—

 
—

 
655

Non-insurance warranty expense
441

 
—

 
—

 
—

 
—

 
—

 
441

Other insurance related expenses
134

 
253

 
66

 
60

 
—

 
—

 
513

Other expenses
23

 
21

 
3

 
3

 
109

 
(1
)
 
158

Total claims, benefits and expenses
1,645

 
1,470

 
490

 
693

 
136

 
(1
)
 
4,433

Core income (loss) before income tax
449

 
348

 
22

 
(29
)
 
(125
)
 
—

 
665

Income tax (expense) benefit on core income (loss)
(95
)
 
(72
)
 
(6
)
 
33

 
26

 
—

 
(114
)
Core income (loss) 
$
354

 
$
276

 
$
16

 
$
4

 
$
(99
)
 
$
—

 
551

Net realized investment gains (losses)
 
 
 
 
 
 
 
 
 
 
 
 
11

Income tax (expense) benefit on net realized investment gains (losses)
 
 
 
 
 
 
 
 
 
 
 
 
(1
)
Net realized investment gains (losses), after tax
 
 
 
 
 
 
 
 
 
 
 
 
10

Net income
 
 
 
 
 
 
 
 
 
 
 
 
$
561

June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
Reinsurance receivables
$
926

 
$
695

 
$
265

 
$
433

 
$
2,245

 
$
—

 
$
4,564

Insurance receivables
996

 
1,311

 
327

 
8

 
—

 
—

 
2,642

Deferred acquisition costs
317

 
248

 
108

 
—

 
—

 
—

 
673

Goodwill
117

 
—

 
30

 
—

 
—

 
—

 
147

Insurance reserves
 
 
 
 
 
 
 
 
 
 
 
 
 

Claim and claim adjustment expenses
5,816

 
8,599

 
1,706

 
3,522

 
2,347

 
—

 
21,990

Unearned premiums
2,103

 
1,608

 
564

 
136

 
—

 
(1
)
 
4,410

Future policy benefits
—

 
—

 
—

 
10,667

 
—

 
—

 
10,667


40

Six months ended June 30, 2017

Specialty
 

Commercial
 
International
 
Life &
Group
 
Corporate
& Other
 
 
 
 
(In millions)
 
 
 
 
Eliminations
 
Total
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
 
 

Net earned premiums
$
1,332

 
$
1,377

 
$
403

 
$
268

 
$
—

 
$
(1
)
 
$
3,379

Net investment income
265

 
329

 
25

 
392

 
9

 
—

 
1,020

Non-insurance warranty revenue
191

 
—

 
—

 
—

 
—

 
—

 
191

Other revenues
1

 
18

 
(1
)
 
1

 
1

 
—

 
20

Total operating revenues
1,789

 
1,724

 
427

 
661

 
10

 
(1
)
 
4,610

Claims, benefits and expenses
 

 
 
 
 
 
 

 
 

 
 

 
 

Net incurred claims and benefits
794

 
849

 
244

 
658

 
19

 
—

 
2,564

Policyholders’ dividends
2

 
7

 
—

 
—

 
—

 
—

 
9

Amortization of deferred acquisition costs
289

 
237

 
91

 
—

 
—

 
—

 
617

Non-insurance warranty expense
142

 
—

 
—

 
—

 
—

 
—

 
142

Other insurance related expenses
138

 
257

 
58

 
64

 
(1
)
 
(1
)
 
515

Other expenses
21

 
25

 
(7
)
 
3

 
94

 
—

 
136

Total claims, benefits and expenses
1,386

 
1,375

 
386

 
725

 
112

 
(1
)
 
3,983

Core income (loss) before income tax
403

 
349

 
41

 
(64
)
 
(102
)
 
—

 
627

Income tax (expense) benefit on core income (loss)
(135
)
 
(118
)
 
(11
)
 
73

 
38

 
—

 
(153
)
Core income (loss)
$
268

 
$
231

 
$
30

 
$
9

 
$
(64
)
 
$
—

 
474

Net realized investment gains (losses)
 
 
 
 
 
 
 
 
 
 
 
 
86

Income tax (expense) benefit on net realized investment gains (losses)
 
 
 
 
 
 
 
 
 
 
 
 
(28
)
Net realized investment gains (losses), after tax
 
 
 
 
 
 
 
 
 
 
 
 
58

Net income
 
 
 
 
 
 
 
 
 
 
 
 
$
532

December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
Reinsurance receivables
$
671

 
$
654

 
$
212

 
$
438

 
$
2,315

 
$
—

 
$
4,290

Insurance receivables
969

 
1,103

 
254

 
8

 
2

 
—

 
2,336

Deferred acquisition costs
318

 
223

 
93

 
—

 
—

 
—

 
634

Goodwill
117

 
—

 
31

 
—

 
—

 
—

 
148

Insurance reserves
 
 
 
 
 
 
 
 
 
 
 
 
 

Claim and claim adjustment expenses
5,669

 
8,764

 
1,636

 
3,499

 
2,436

 
—

 
22,004

Unearned premiums
2,020

 
1,409

 
472

 
128

 
—

 
—

 
4,029

Future policy benefits
—

 
—

 
—

 
11,179

 
—

 
—

 
11,179



41

The following table presents operating revenue by line of business for each reportable segment.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Specialty
 
 
 
 
 
 
 
Management & Professional Liability
$
627

 
$
620

 
$
1,251

 
$
1,258

Surety
145

 
136

 
274

 
260

Warranty & Alternative Risks(1)
289

 
137

 
569

 
271

Specialty revenues
1,061

 
893

 
2,094

 
1,789

Commercial
 
 
 
 
 

 
 

Middle Market
521

 
469

 
1,025

 
937

Small Business
120

 
126

 
239

 
222

Other Commercial Insurance
277

 
276

 
554

 
565

Commercial revenues
918

 
871

 
1,818

 
1,724

International
 
 
 
 


 


Canada
63

 
52

 
121

 
103

CNA Europe
91

 
79

 
179

 
151

Hardy
108

 
87

 
212

 
173

International revenues
262

 
218

 
512

 
427

Life & Group revenues
329

 
330

 
664

 
661

Corporate & Other revenues
5

 
5

 
11

 
10

Eliminations
—

 
(1
)
 
(1
)
 
(1
)
Total operating revenues
2,575

 
2,316

 
5,098

 
4,610

Net realized investment gains (losses)
(1
)
 
50

 
11

 
86

Total revenues
$
2,574

 
$
2,366

 
$
5,109

 
$
4,696

(1)
As of January 1, 2018, the Company adopted ASU 2014-09 Revenue Recognition (Topic 606): Revenue from Contracts with Customers. See Note A to the Condensed Consolidated Financial Statements for additional information.

42

Note J. Non-Insurance Revenues from Contracts with Customers
Non-Insurance revenue is recognized when obligations under the terms of a contract with a customer are satisfied; generally this occurs over time as obligations are fulfilled. Revenue is measured as the amount of consideration the Company expects to receive in exchange for providing services.
Deferred Non-Insurance Warranty Revenue
Non-insurance warranty revenue is primarily generated from separately-priced service contracts that provide mechanical breakdown and other coverages to vehicle or consumer goods owners. The warranty contracts generally provide coverage from 1 month to 10 years. For warranty products in which the Company acts as the principal in the transaction, Non-insurance warranty revenues are reported on a gross basis, with amounts billed to customers reported as Non-insurance warranty revenue and commissions paid to agents reported as Non-insurance warranty expense. Non-insurance warranty revenue is reported net of any premiums related to contractual liability coverage issued by the Company's insurance operations. Additionally, the Company provides warranty administration services for dealer and manufacturer obligor warranty products, which include limited warranties and guaranteed automobile protection waivers.
The Company recognizes Non-insurance warranty revenues over the service period in proportion to the actuarially determined expected claims emergence pattern. Customers pay in full at the inception of the warranty contract. A liability for deferred revenue is recorded when cash payments are received or due in advance of the Company's performance. The deferred revenue balance includes amounts which are refundable on a pro rata basis upon cancellation.
The Company had deferred non-insurance warranty revenue balances of $2.9 billion and $3.2 billion reported in Other liabilities as of January 1, 2018 and June 30, 2018. The increase in the deferred revenue balance for the six months ended June 30, 2018 was primarily driven by cash payments received or due in advance of satisfying the Company's performance obligations, offset by cancellations and revenues recognized during the period. For the three and six months ended June 30, 2018, the Company recognized $213 million and $435 million of revenues that were included in the deferred revenue balance as of January 1, 2018. For the three and six months ended June 30, 2018, Non-insurance warranty revenue recognized from performance obligations related to prior periods due to a change in estimate was not material. The Company expects to recognize approximately $493 million of the deferred revenue in the remainder of 2018, $825 million in 2019, $656 million in 2020, and $1.2 billion thereafter.
Cost to Obtain and Fulfill Non-Insurance Warranty Contracts with Customers
Dealers, retailers and agents earn commission for assisting the Company in obtaining non-insurance warranty contracts. Additionally, the Company utilizes a third-party to perform warranty administrator services for its consumer good warranties. These costs are deferred and recorded as Other assets. These costs are amortized to Non-insurance warranty expense consistent with how the related revenue is recognized.
A premium deficiency arises to the extent that estimated future costs associated with these contracts exceed unrecognized revenue. The Company evaluates deferred costs for recoverability as part of our premium deficiency assessment. Anticipated investment income is considered in the determination of the recoverability of deferred costs. If necessary, adjustments to deferred costs and a premium deficiency reserve, if any, are recorded in current period results of operations. No premium deficiency was recognized in the six months ended June 30, 2018.
As of June 30, 2018, capitalized commission costs were $2.3 billion and capitalized administrator service costs were $19 million. For the three and six months ended June 30, 2018, the amount of amortization of capitalized costs was $164 million and $321 million and there was no impairment loss related to the costs capitalized.

43

Item 2. Management's Discussion and Analysis (MD&A) of Financial Condition and Results of Operations
OVERVIEW
The following discussion highlights significant factors affecting the Company. References to “we,” “our,” “us” or like terms refer to the business of CNA. Based on 2016 statutory net written premiums, we are the eighth largest commercial insurer in the United States of America.
The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements included under Part I, Item 1 of this Form 10-Q and Item 1A Risk Factors and Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations, which are included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2017.
We utilize the core income (loss) financial measure to monitor our operations. Core income (loss) is calculated by excluding from net income (loss) the after-tax effects of i) net realized investment gains or losses, ii) income or loss from discontinued operations, iii) any cumulative effects of changes in accounting guidance and iv) deferred tax asset and liability remeasurement as a result of an enacted U.S. Federal tax rate change. The calculation of core income (loss) excludes net realized investment gains or losses because net realized investment gains or losses are generally driven by economic factors that are not necessarily consistent with key drivers of underwriting performance, and are therefore not considered an indication of trends in insurance operations. Management monitors core income (loss) for each business segment to assess segment performance. Presentation of consolidated core income (loss) is deemed to be a non-GAAP financial measure. See further discussion regarding how we manage our business in Note I to the Condensed Consolidated Financial Statements included under Part I, Item 1. For reconciliations of non-GAAP measures to the most comparable GAAP measures and other information, please refer herein and/or to CNA's most recent 10-K on file with the Securities and Exchange Commission.
In evaluating the results of our Specialty, Commercial and International segments, we utilize the loss ratio, the expense ratio, the dividend ratio and the combined ratio. These ratios are calculated using GAAP financial results. The loss ratio is the percentage of net incurred claim and claim adjustment expenses to net earned premiums. The expense ratio is the percentage of insurance underwriting and acquisition expenses, including the amortization of deferred acquisition cost, to net earned premiums. The dividend ratio is the ratio of policyholders' dividends incurred to net earned premiums. The combined ratio is the sum of the loss, expense and dividend ratios. In addition we also utilize renewal premium change, rate, retention and new business in evaluating operating trends. Renewal premium change represents the estimated change in average premium on policies that renew, including rate and exposure changes. Rate represents the average change in price on policies that renew excluding exposure change. Exposure represents the measure of risk used in the pricing of the insurance product. Retention represents the percentage of premium dollars renewed in comparison to the expiring premium dollars from policies available to renew. Renewal premium change, rate and retention presented for the prior year are updated to reflect subsequent activity on policies written in the period. New business represents premiums from policies written with new customers and additional policies written with existing customers.
Changes in estimates of claim and claim adjustment expense reserves, net of reinsurance, for prior years are defined as net prior year loss reserve development within this MD&A. These changes can be favorable or unfavorable. Net prior year loss reserve development does not include the effect of related acquisition expenses. Further information on our reserves is provided in Note E to the Condensed Consolidated Financial Statements included under Part I, Item 1.

44

CRITICAL ACCOUNTING ESTIMATES
The preparation of the Condensed Consolidated Financial Statements in conformity with GAAP requires us 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 amount of revenues and expenses reported during the period. Actual results may differ from those estimates.
Our Condensed Consolidated Financial Statements and accompanying notes have been prepared in accordance with GAAP applied on a consistent basis. We continually evaluate the accounting policies and estimates used to prepare the Condensed Consolidated Financial Statements. In general, our estimates are based on historical experience, evaluation of current trends, information from third-party professionals and various other assumptions that are believed to be reasonable under the known facts and circumstances.
The accounting estimates below are considered by us to be critical to an understanding of our Condensed Consolidated Financial Statements as their application places the most significant demands on our judgment:
•
Insurance Reserves
•
Reinsurance and Insurance Receivables
•
Valuation of Investments and Impairment of Securities
•
Long Term Care Policies
•
Income Taxes
Due to the inherent uncertainties involved with these types of judgments, actual results could differ significantly from estimates and may have a material adverse impact on our results of operations, equity, business, and insurer financial strength and corporate debt ratings. See the Critical Accounting Estimates section of our Management's Discussion and Analysis of Financial Condition and Results of Operations included under Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2017 for further information.


45

CONSOLIDATED OPERATIONS
The following table includes the consolidated results of our operations including our financial measure, Core income (loss). For more detailed components of our business operations and discussion of the core income (loss) financial measure, see the segment sections within this MD&A. For further discussion of Net investment income and Net realized investment results, see the Investments section of this MD&A.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Operating Revenues
 
 
 
 
 
 
 
Net earned premiums
$
1,815

 
$
1,734

 
$
3,600

 
$
3,379

Net investment income
506

 
475

 
996

 
1,020

Non-insurance warranty revenue
248

 
98

 
486

 
191

Other revenues
6

 
9

 
16

 
20

Total operating revenues
2,575

 
2,316

 
5,098

 
4,610

Claims, Benefits and Expenses
 
 
 
 
 
 
 
Net incurred claims and benefits
1,321

 
1,275

 
2,654

 
2,564

Policyholders' dividends
6

 
5

 
12

 
9

Amortization of deferred acquisition costs
359

 
312

 
655

 
617

Other insurance related expenses
236

 
261

 
513

 
515

Non-insurance warranty expense
225

 
72

 
441

 
142

Other expenses
97

 
71

 
158

 
136

Total claims, benefits and expenses
2,244

 
1,996

 
4,433

 
3,983

Core income before income tax
331

 
320

 
665

 
627

Income tax expense on core income
(61
)
 
(81
)
 
(114
)
 
(153
)
Core income
270

 
239

 
551


474

Net realized investment (losses) gains
(1
)
 
50

 
11

 
86

Income tax benefit (expense) on net realized investment (losses) gains
1

 
(17
)
 
(1
)
 
(28
)
Net realized investment gains, after tax
—

 
33

 
10

 
58

Net income
$
270

 
$
272

 
$
561

 
$
532

Three Month Comparison
Core income increased $31 million for the three months ended June 30, 2018 as compared with the same period in 2017. Excluding the favorable effect of the Federal corporate income tax rate change, core income for our Property & Casualty Operations increased approximately $3 million primarily due to higher net investment income driven by higher limited partnership returns. Excluding the unfavorable effect of the Federal corporate income tax rate change which reduced the income tax benefit, core income for our Life & Group segment was consistent with the prior period while core loss for our Corporate & Other segment increased approximately $5 million.
Pretax net catastrophe losses were $26 million and $39 million for the three months ended June 30, 2018 and 2017. Favorable net prior year loss reserve development of $59 million and $55 million was recorded in the three months ended June 30, 2018 and 2017 related to our Specialty, Commercial, International and Corporate & Other segments. Further information on net prior year loss reserve development is in Note E to the Condensed Consolidated Financial Statements included under Part I, Item 1.

46

Six Month Comparison
Core income increased $77 million for the six months ended June 30, 2018 as compared with the same period in 2017. Excluding the favorable effect of the Federal corporate income tax rate change, core income for our Property & Casualty Operations increased approximately $7 million due to improved underwriting results partially offset by lower net investment income driven by lower limited partnership returns. Excluding the unfavorable effect of the Federal corporate income tax rate change, core income for our Life & Group segment increased approximately $23 million while core loss for our Corporate & Other segment increased approximately $17 million.
Pretax net catastrophe losses were $60 million and $73 million for the six months ended June 30, 2018 and 2017. Favorable net prior year loss reserve development of $98 million and $112 million was recorded in the six months ended June 30, 2018 and 2017 related to our Specialty, Commercial, International and Corporate & Other segments. Further information on net prior year loss reserve development is in Note E to the Condensed Consolidated Financial Statements included under Part I, Item 1.

47

SEGMENT RESULTS
The following discusses the results of operations for our business segments. Our property and casualty commercial insurance operations are managed and reported in three business segments: Specialty, Commercial and International, which we refer to collectively as Property & Casualty Operations. Our operations outside of Property & Casualty Operations are managed and reported in two segments: Life & Group and Corporate & Other.



48

Specialty
The following table details the results of operations for Specialty.
Periods ended June 30
Three Months
 
Six Months
(In millions, except ratios, rate, renewal premium change and retention)
2018
 
2017
 
2018
 
2017
Net written premiums
$
688

 
$
701

 
$
1,374

 
$
1,371

Net earned premiums
683

 
678

 
1,355

 
1,332

Net investment income
130

 
117

 
252

 
265

Core income
183

 
131

 
354

 
268

 
 
 
 
 
 
 
 
Other performance metrics:
 
 
 
 
 
 
 
Loss and loss adjustment expense ratio
54.6
%
 
58.1
%
 
55.4
%
 
59.6
%
Expense ratio
32.0

 
32.0

 
31.6

 
32.0

Dividend ratio
0.2

 
0.2

 
0.2

 
0.1

Combined ratio
86.8
%
 
90.3
%
 
87.2
%
 
91.7
%
 
 
 
 
 
 
 
 
Rate
2
%
 
1
%
 
2
%
 
1
%
Renewal premium change
4

 
3

 
3

 
4

Retention
82

 
89

 
84

 
88

New business
$
92

 
$
62

 
$
173

 
$
117

Three Month Comparison
Net written premiums for Specialty decreased $13 million for the three months ended June 30, 2018 as compared with the same period in 2017 driven by a higher level of ceded reinsurance to support growth in management liability and lower retention partially offset by higher new business and positive renewal premium change. The increase in net earned premiums was consistent with the trend in net written premiums in recent quarters.
Core income increased $52 million for the three months ended June 30, 2018 as compared with the same period in 2017. Excluding the favorable effect of the Federal corporate income tax rate change, core income increased approximately $21 million due to improved underwriting results and higher net investment income driven by higher limited partnership returns.
The combined ratio improved 3.5 points for the three months ended June 30, 2018 as compared with the same period in 2017. The loss ratio improved 3.5 points primarily due to higher favorable net prior year loss reserve development and an improved current accident year loss ratio. Net catastrophe losses were $3 million, or 0.5 points of the loss ratio, for the three months ended June 30, 2018, as compared to $5 million, or 0.9 points of the loss ratio, for the three months ended June 30, 2017. The expense ratio for the three months ended June 30, 2018 was consistent with the same period in 2017.
Favorable net prior year loss reserve development of $44 million and $23 million was recorded for the three months ended June 30, 2018 and 2017. Further information on net prior year loss reserve development is in Note E to the Condensed Consolidated Financial Statements included under Part I, Item 1.

49

Six Month Comparison
Net written premiums for Specialty increased $3 million for the six months ended June 30, 2018 as compared with the same period in 2017 driven by higher new business and positive renewal premium change partially offset by a higher level of ceded reinsurance to support growth in management liability and lower retention. The increase in net earned premiums was consistent with the trend in net written premiums.
Core income increased $86 million for the six months ended June 30, 2018 as compared with the same period in 2017. Excluding the favorable effect of the Federal corporate income tax rate change, core income increased approximately $27 million due to improved underwriting results driven by higher favorable net prior year loss reserve development.
The combined ratio improved 4.5 points for the six months ended June 30, 2018 as compared with the same period in 2017. The loss ratio improved 4.2 points primarily due to higher favorable net prior year loss reserve development and an improved current accident year loss ratio. Net catastrophe losses were $6 million, or 0.5 points of the loss ratio, for the six months ended June 30, 2018, as compared to $9 million, or 0.7 points of the loss ratio, for the six months ended June 30, 2017. The expense ratio decreased 0.4 points for the six months ended June 30, 2018 as compared with the same period in 2017 driven by lower IT spend.
Favorable net prior year loss reserve development of $74 million and $35 million was recorded for the six months ended June 30, 2018 and 2017. Further information on net prior year loss reserve development is in Note E to the Condensed Consolidated Financial Statements included under Part I, Item 1.
The following table summarizes the gross and net carried reserves for Specialty.
(In millions)
June 30, 2018
 
December 31, 2017
Gross case reserves
$
1,694

 
$
1,742

Gross IBNR reserves
4,122

 
3,927

Total gross carried claim and claim adjustment expense reserves
$
5,816

 
$
5,669

Net case reserves
$
1,539

 
$
1,600

Net IBNR reserves
3,364

 
3,407

Total net carried claim and claim adjustment expense reserves
$
4,903

 
$
5,007


50

Commercial
The following table details the results of operations for Commercial.
Periods ended June 30
Three Months
 
Six Months
(In millions, except ratios, rate, renewal premium change and retention)
2018
 
2017
 
2018
 
2017
Net written premiums
$
810

 
$
782

 
$
1,642

 
$
1,506

Net earned premiums
753

 
716

 
1,496

 
1,377

Net investment income
157

 
146

 
306

 
329

Core income
143

 
120

 
276

 
231

 
 
 
 
 
 
 
 
Other performance metrics:
 
 
 
 
 
 
 
Loss and loss adjustment expense ratio
62.4
%
 
59.6
%
 
62.7
%
 
61.7
%
Expense ratio
33.5

 
34.4

 
33.4

 
35.8

Dividend ratio
0.7

 
0.6

 
0.7

 
0.5

Combined ratio
96.6
%
 
94.6
%
 
96.8
%
 
98.0
%
 
 
 
 
 
 
 
 
Rate
1
%
 
0
%
 
1
%
 
0
%
Renewal premium change
4

 
3

 
3

 
3

Retention
85

 
86

 
85

 
86

New business
$
157

 
$
154

 
$
338

 
$
294

Three Month Comparison
Net written premiums for Commercial were $28 million higher for the three months ended June 30, 2018 as compared with the same period in 2017 driven by positive renewal premium change and higher new business. The increase in net earned premiums was consistent with the trend in net written premiums.
Core income increased $23 million for the three months ended June 30, 2018 as compared with the same period in 2017. Excluding the favorable effect of the Federal corporate income tax rate change, core income decreased approximately $2 million due to lower favorable net prior year loss reserve development partially offset by higher net investment income driven by improved limited partnership returns.
The combined ratio increased 2.0 points for the three months ended June 30, 2018 as compared with the same period in 2017. The loss ratio increased 2.8 points driven by lower favorable net prior year loss reserve development and a higher number of large property losses. Net catastrophe losses were $19 million, or 2.5 points of the loss ratio, for the three months ended June 30, 2018, as compared to $35 million, or 4.7 points of the loss ratio, for the three months ended June 30, 2017. The expense ratio improved 0.9 points for the three months ended June 30, 2018 as compared with the same period in 2017 driven by lower IT spend, lower employee costs and higher net earned premiums.
Favorable net prior year loss reserve development of $13 million and $34 million was recorded for the three months ended June 30, 2018 and 2017. Further information on net prior year loss reserve development is in Note E to the Condensed Consolidated Financial Statements included under Part I, Item 1.

51

Six Month Comparison
Net written premiums for Commercial were $136 million higher for the six months ended June 30, 2018 as compared with the same period in 2017. The prior period included an unfavorable premium rate adjustment in Small Business which affected both net written premiums and net earned premiums as more fully discussed in Note F to the Condensed Consolidated Financial Statements under Part 1, Item 1. Excluding the Small Business premium rate adjustment, net written premiums increased $90 million driven by higher new business and positive renewal premium change. The increase in net earned premiums was consistent with the trend in net written premiums.
Core income increased $45 million for the six months ended June 30, 2018 as compared with the same period in 2017. Excluding the favorable effect of the Federal corporate income tax rate change and the unfavorable Small Business premium rate adjustment in the prior period, core income decreased approximately $27 million due to lower favorable net prior year loss reserve development.
Excluding the impact of the Small Business premium rate adjustment, the combined ratio increased 1.3 points, driven by 4.1 points of less favorable net prior year loss reserve development. This was largely offset by a 1.4 point improvement in the current accident year loss ratio and a 1.6 point decrease in the expense ratio driven by higher net earned premiums and lower IT spend and employee costs. Net catastrophe losses were $48 million, or 3.2 points of the loss ratio, for the six months ended June 30, 2018, as compared to $62 million, or 4.3 points of the loss ratio, for the six months ended June 30, 2017.
Favorable net prior year loss reserve development of $22 million and $77 million was recorded for the six months ended June 30, 2018 and 2017. Further information on net prior year loss reserve development is in Note E to the Condensed Consolidated Financial Statements included under Part I, Item 1.
The following table summarizes the gross and net carried reserves for Commercial.
(In millions)
June 30, 2018
 
December 31, 2017
Gross case reserves
$
4,227

 
$
4,427

Gross IBNR reserves
4,372
 
4,337

Total gross carried claim and claim adjustment expense reserves
$
8,599

 
$
8,764

Net case reserves
$
3,906

 
$
4,103

Net IBNR reserves
4,043

 
4,033

Total net carried claim and claim adjustment expense reserves
$
7,949

 
$
8,136


52

International
The following table details the results of operations for International.
Periods ended June 30
Three Months
 
Six Months
(In millions, except ratios, rate, renewal premium change and retention)
2018
 
2017
 
2018
 
2017
Net written premiums
$
271

 
$
219

 
$
566

 
$
457

Net earned premiums
248

 
206

 
484

 
403

Net investment income
15

 
13

 
29

 
25

Core (loss) income
(7
)
 
10

 
16

 
30

 
 
 
 
 
 
 
 
Other performance metrics:
 
 
 
 
 
 
 
Loss and loss adjustment expense ratio
66.8
%
 
62.8
%
 
63.7
%
 
60.6
%
Expense ratio
37.9

 
37.3

 
37.1

 
37.1

Combined ratio
104.7
%
 
100.1
%
 
100.8
%
 
97.7
%
 
 
 
 
 
 
 
 
Rate
3
%
 
0
%
 
3
%
 
0
%
Renewal premium change
8

 
3

 
6

 
2

Retention
73

 
82

 
78

 
80

New business
$
83

 
$
73

 
$
176

 
$
138

Three Month Comparison
Net written premiums for International increased $52 million for the three months ended June 30, 2018 as compared with the same period in 2017. Excluding the effect of foreign currency exchange rates, net written premiums increased $42 million or 19% for the three months ended June 30, 2018 as compared with the same period in 2017 driven by positive renewal premium change and higher new business. The increase in net earned premiums was consistent with the trend in net written premiums.
Core results decreased $17 million for the three months ended June 30, 2018 as compared with the same period in 2017 driven by lower underwriting results. The effect of the Federal corporate income tax rate change was not significant.
The combined ratio increased 4.6 points for the three months ended June 30, 2018 as compared with the same period in 2017. The loss ratio increased 4.0 points, primarily due to a higher current accident year loss ratio driven by a higher number of large property losses mainly in Canada. Net catastrophe losses were $4 million, or 1.6 points of the loss ratio, for the three months ended June 30, 2018. There were no net catastrophe losses for the three months ended June 30, 2017. The expense ratio increased 0.6 points for the three months ended June 30, 2018 as compared with the same period in 2017 driven by higher acquisition expenses.
Favorable net prior year loss reserve development of $2 million was recorded for the three months ended June 30, 2018 as compared with unfavorable net prior year loss reserve development of $2 million for the three months ended June 30, 2017. Further information on net prior year loss reserve development is in Note E to the Condensed Consolidated Financial Statements included under Part I, Item 1.

53

Six Month Comparison
Net written premiums for International increased $109 million for the six months ended June 30, 2018 as compared with the same period in 2017. Excluding the effect of foreign currency exchange rates, net written premiums increased $79 million or 16% for the six months ended June 30, 2018 as compared with the same period in 2017 driven by positive renewal premium change and higher new business. The increase in net earned premiums was consistent with the trend in net written premiums.
Core income decreased $14 million for the six months ended June 30, 2018 as compared with the same period in 2017 driven by lower underwriting results. The effect of the Federal corporate income tax rate change was not significant.
The combined ratio increased 3.1 points for the six months ended June 30, 2018 as compared with the same period in 2017. The loss ratio increased 3.1 points, primarily due to a higher current accident year loss ratio driven by a higher number of large property losses mainly in Canada and attritional losses in the U.K. Net catastrophe losses were $6 million, or 1.3 points of the loss ratio, for the six months ended June 30, 2018, as compared to $2 million, or 0.6 points of the loss ratio, for the six months ended June 30, 2017. The expense ratio was consistent for the six months ended June 30, 2018 and 2017.
Favorable net prior year loss reserve development of $2 million and nil was recorded for the six months ended June 30, 2018 and 2017. Further information on net prior year loss reserve development is in Note E to the Condensed Consolidated Financial Statements included under Part I, Item 1.
The following table summarizes the gross and net carried reserves for International.
(In millions)
June 30, 2018
 
December 31, 2017
Gross case reserves
$
831

 
$
744

Gross IBNR reserves
875

 
892

Total gross carried claim and claim adjustment expense reserves
$
1,706

 
$
1,636

Net case reserves
$
674

 
$
640

Net IBNR reserves
780

 
792

Total net carried claim and claim adjustment expense reserves
$
1,454

 
$
1,432


54

Life & Group
The following table details the results of operations for Life & Group.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Net earned premiums
$
131

 
$
135

 
$
265

 
$
268

Net investment income
198

 
195

 
398

 
392

Core loss before income tax
(29
)
 
(31
)
 
(29
)
 
(64
)
Income tax benefit on core loss
19

 
36

 
33

 
73

Core (loss) income
(10
)
 
5

 
4

 
9

Three Month Comparison
Core results decreased $15 million for the three months ended June 30, 2018 as compared with the same period in 2017. Excluding the unfavorable effect of the Federal corporate income tax rate change, core income was consistent with the prior period. Morbidity continues to trend in line with expectations. Persistency continues to benefit from a high proportion of policyholders choosing to reduce benefits in lieu of premium rate increases. However, the favorable persistency trend was offset this quarter when a significant number of policies converted to a fully paid-up status with modest future benefits following the termination of a large group account. The reserves associated with these converted policies were, on average, slightly higher than the previously recorded carried reserves, resulting in a negative financial impact for the three months ended June 30, 2018.
Six Month Comparison
Core income decreased $5 million for the six months ended June 30, 2018 as compared with the same period in 2017. Excluding the unfavorable effect of the Federal corporate income tax rate change, core income increased approximately $23 million. While the drivers of core income for the six month period were generally consistent with the three month summary noted above, the favorability driven by policyholders choosing to reduce benefits in lieu of premium rate increases was greater because the trend positively impacted both quarters in the six month period.

55

Corporate & Other
The following table details the results of operations for Corporate & Other.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Net investment income
$
6

 
$
4

 
$
11

 
$
9

Interest expense
34

 
39

 
68

 
77

Core loss
(39
)
 
(27
)
 
(99
)
 
(64
)
Three Month Comparison
Core loss increased $12 million for the three months ended June 30, 2018 as compared with the same period in 2017. Excluding the unfavorable effect of the Federal corporate income tax rate change, core loss increased approximately $5 million driven by non-recurring costs of $23 million associated with the transition to a new IT infrastructure service provider. This was partially offset by a higher recognition of retroactive reinsurance deferred gain on the LPT due to higher net A&EP claim payments, as compared to the prior year period. The LPT is further discussed in Note E to the Condensed Consolidated Financial Statements included under Part I, Item 1.
Six Month Comparison
Core loss increased $35 million for the six months ended June 30, 2018 as compared with the same period in 2017. Excluding the unfavorable effect of the Federal corporate income tax rate change, core loss increased approximately $17 million driven by non-recurring costs of $23 million associated with the transition to a new IT infrastructure service provider and higher adverse net prior year reserve development recorded in 2018 for A&EP under the LPT, as compared to the prior year period.
The following table summarizes the gross and net carried reserves for Corporate & Other.
(In millions)
June 30, 2018
 
December 31, 2017
Gross case reserves
$
1,199

 
$
1,371

Gross IBNR reserves
1,148

 
1,065

Total gross carried claim and claim adjustment expense reserves
$
2,347

 
$
2,436

Net case reserves
$
92

 
$
94

Net IBNR reserves
109

 
111

Total net carried claim and claim adjustment expense reserves
$
201

 
$
205


56

INVESTMENTS
Net Investment Income
The significant components of Net investment income are presented in the following table. Fixed income securities, as presented, include both fixed maturity and non-redeemable preferred stock.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Fixed income securities:
 
 
 
 
 
 
 
Taxable fixed income securities
$
354

 
$
353

 
$
704

 
$
701

Tax-exempt fixed income securities
100

 
106

 
205

 
214

Total fixed income securities
454

 
459

 
909

 
915

Limited partnership and common stock investments
42

 
16

 
73

 
106

Other, net of investment expense
10

 
—

 
14

 
(1
)
Pretax net investment income
$
506

 
$
475

 
$
996

 
$
1,020

Fixed income securities, after tax
$
375

 
$
333

 
$
752

 
$
664

Net investment income, after tax
416

 
344

 
821

 
733

 
 
 
 
 
 
 
 
Effective income yield for the fixed income securities portfolio, pretax
4.7
%
 
4.8
%
 
4.7
%
 
4.8
%
Effective income yield for the fixed income securities portfolio, after tax
3.9
%
 
3.4
%
 
3.9
%
 
3.4
%
Pretax net investment income increased $31 million for the three months ended June 30, 2018 as compared with the same period in 2017. The increase was driven by limited partnership and common stock investments, which returned 1.8% in 2018 as compared with 0.7% in the prior year period. Net investment income, after tax, increased $72 million for the three months ended June 30, 2018 as compared with the same period in 2017 driven by the lower Federal corporate income tax rate and higher limited partnership returns.
Pretax net investment income decreased $24 million for the six months ended June 30, 2018 as compared with the same period in 2017. The decrease was driven by limited partnership and common stock investments, which returned 3.0% in 2018 as compared with 4.5% in the prior year period. However, despite the decline in limited partnership income, net investment income, after tax, increased $88 million for the six months ended June 30, 2018 as compared with the same period in 2017 driven by the lower Federal corporate income tax rate.


57

Net Realized Investment Gains (Losses)
The components of Net realized investment results are presented in the following table.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2018
 
2017
 
2018
 
2017
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate bonds and other
$
9

 
$
41

 
$
28

 
$
71

States, municipalities and political subdivisions
6

 
4

 
26

 
10

Asset-backed
(11
)
 
(1
)
 
(32
)
 
(5
)
Total fixed maturity securities
4

 
44

 
22

 
76

Non-redeemable preferred stock
(10
)
 
—

 
(25
)
 
—

Short term and other
5

 
6

 
14

 
10

Net realized investment (losses) gains
(1
)
 
50

 
11

 
86

Income tax benefit (expense) on net realized investment (losses) gains
1

 
(17
)
 
(1
)
 
(28
)
Net realized investment gains, after tax
$
—

 
$
33

 
$
10

 
$
58

Pretax net realized investment results decreased $51 million for the three months ended June 30, 2018 as compared with the same period in 2017. The decrease was driven by lower net realized gains on sales of securities and the decline in fair value of non-redeemable preferred stock.
Pretax net realized investment gains decreased $75 million for the six months ended June 30, 2018 as compared with the same period in 2017. The decrease was driven by lower net realized gains on sales of securities and the decline in fair value of non-redeemable preferred stock.
Further information on our realized gains and losses, including our OTTI losses, is set forth in Note C to the Condensed Consolidated Financial Statements included under Part I, Item 1.

58

Portfolio Quality
The following table presents the estimated fair value and net unrealized gains (losses) of our fixed maturity securities by rating distribution.
 
June 30, 2018
 
December 31, 2017

(In millions)
Estimated Fair Value
 
Net Unrealized Gains (Losses)
 
Estimated Fair Value
 
Net Unrealized Gains (Losses)
U.S. Government, Government agencies and Government-sponsored enterprises
$
4,392

 
$
(60
)
 
$
4,514

 
$
21

AAA
3,129

 
256

 
1,954

 
152

AA
6,868

 
538

 
8,982

 
914

A
8,914

 
618

 
9,643

 
952

BBB
13,643

 
461

 
13,554

 
1,093

Non-investment grade
2,849

 
54

 
2,840

 
140

Total
$
39,795

 
$
1,867

 
$
41,487

 
$
3,272

As of June 30, 2018 and December 31, 2017, 3% and 2% of our fixed maturity portfolio was rated internally.
The following table presents available-for-sale fixed maturity securities in a gross unrealized loss position by ratings distribution.
 
June 30, 2018
(In millions)
Estimated Fair Value
 
Gross Unrealized Losses
U.S. Government, Government agencies and Government-sponsored enterprises
$
3,380

 
$
84

AAA
411

 
10

AA
830

 
11

A
2,155

 
44

BBB
5,608

 
159

Non-investment grade
1,111

 
38

Total
$
13,495

 
$
346

The following table presents 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.
 
June 30, 2018
(In millions)
Estimated Fair Value
 
Gross Unrealized Losses
Due in one year or less
$
112

 
$
7

Due after one year through five years
2,198

 
32

Due after five years through ten years
9,532

 
254

Due after ten years
1,653

 
53

Total
$
13,495

 
$
346


59

Duration
A primary objective in the management of the investment portfolio is to optimize return relative to corresponding liabilities and respective liquidity needs. Our views on the current interest rate environment, tax regulations, asset class valuations, specific security issuer and broader industry segment conditions and domestic and global economic conditions, are some of the factors that enter into an investment decision. We also continually monitor exposure to issuers of securities held and broader industry sector exposures and may from time to time adjust such exposures based on our views of a specific issuer or industry sector.
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, we segregate investments for asset/liability management purposes. The segregated investments support the long term care and structured settlement liabilities in the Life & Group segment.
The effective durations of fixed income securities and short term investments are presented in the following table. Amounts presented are net of payable and receivable amounts for securities purchased and sold, but not yet settled.
 
June 30, 2018
 
December 31, 2017
(In millions)
Estimated Fair Value
 
Effective
Duration
(In years)
 
Estimated Fair Value
 
Effective
Duration
(In years)
Investments supporting Life & Group
$
16,260

 
8.2

 
$
16,797

 
8.4

Other investments
25,339

 
4.5

 
26,817

 
4.4

Total
$
41,599

 
5.9

 
$
43,614

 
5.9

The duration of the total portfolio is aligned with the cash flow characteristics of the underlying liabilities.
The investment portfolio is periodically analyzed for changes in duration and related price risk. Additionally, we periodically review the sensitivity of the portfolio to the level of foreign exchange rates and other factors that contribute to market price changes. A summary of these risks and specific analysis on changes is included in the Quantitative and Qualitative Disclosures About Market Risk included under Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2017.
Short Term Investments
The carrying value of the components of the Short term investments are presented in the following table.
(In millions)
June 30, 2018
 
December 31, 2017
Short term investments:
 
 
 
Commercial paper
$
1,019

 
$
905

U.S. Treasury securities
133

 
355

Money market funds
37

 
44

Other
119

 
132

Total short term investments
$
1,308

 
$
1,436


60

LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Our primary operating cash flow sources are premiums and investment income from our insurance subsidiaries. Our primary operating cash flow uses are payments for claims, policy benefits and operating expenses, including interest expense on corporate debt. Additionally, cash may be paid or received for income taxes.
For the six months ended June 30, 2018, net cash provided by operating activities was $354 million as compared with $515 million for the same period in 2017. The decrease in cash provided by operating activities was driven by a lower level of distributions on limited partnerships and higher net claim payments.
Cash flows from investing activities include the purchase and disposition of available-for-sale financial instruments and may include the purchase and sale of businesses, land, buildings, equipment and other assets not generally held for resale.
Net cash provided by investing activities was $439 million for the six months ended June 30, 2018, as compared with $111 million for the same period in 2017. The cash flow from investing activities is affected by various factors such as the anticipated payment of claims, financing activity, asset/liability management and individual security buy and sell decisions made in the normal course of portfolio management.
Cash flows from financing activities may include proceeds from the issuance of debt and equity securities, outflows for stockholder dividends or repayment of debt and outlays to reacquire equity securities.
For the six months ended June 30, 2018, net cash used by financing activities was $855 million as compared with $677 million for the same period in 2017. In the first quarter of 2018, we redeemed the $150 million outstanding aggregate principal balance of our 6.950% senior notes due January 15, 2018.
Common Stock Dividends
Dividends of $2.60 per share on our common stock, including a special dividend of $2.00 per share, were declared and paid during the six months ended June 30, 2018. On July 27, 2018, our Board of Directors declared a quarterly dividend of $0.35 per share, payable August 29, 2018 to stockholders of record on August 13, 2018. The declaration and payment of future dividends to holders of our common stock will be at the discretion of our Board of Directors and will depend on many factors, including our earnings, financial condition, business needs and regulatory constraints.

61

Liquidity
Later this year, management intends to pay down the $30 million of subordinated variable rate debt of Hardy due September 15, 2036. We believe that our present cash flows from operating, investing and financing activities are sufficient to fund our current and expected working capital and debt obligation needs and we do not expect this to change in the near term. There are currently no amounts outstanding under our $250 million senior unsecured revolving credit facility and no borrowings outstanding through our membership in the FHLBC.
Dividends from CCC are subject to the insurance holding company laws of the State of Illinois, the domiciliary state of CCC. Under these laws, ordinary dividends, or dividends that do not require prior approval by the Illinois Department of Insurance (the Department), are determined based on the greater of the prior year's statutory net income or 10% of statutory surplus as of the end of the prior year, as well as timing and amount of dividends paid in the preceding twelve months. Additionally, ordinary dividends may only be paid from earned surplus, which is calculated by removing unrealized gains from unassigned surplus. As of June 30, 2018 CCC was in a positive earned surplus position. The maximum allowable dividend CCC could pay during 2018 that would not be subject to the Department's prior approval is $1,073 million, less dividends paid during the preceding twelve months measured at that point in time. CCC paid dividends of $180 million during the six months ended December 31, 2017 and $770 million during the six months ended June 30, 2018. As of June 30, 2018 CCC is able to pay approximately $123 million of dividends that would not be subject to prior approval of the Department. The actual level of dividends paid in any year is determined after an assessment of available dividend capacity, holding company liquidity and cash needs as well as the impact the dividends will have on the statutory surplus of the applicable insurance company.
We have an effective automatic shelf registration statement under which we may publicly issue debt, equity or hybrid securities from time to time.


62

ACCOUNTING STANDARDS UPDATE
For a discussion of Accounting Standards Updates adopted in the current period and that will be adopted in the future, see Note A to the Condensed Consolidated Financial Statements included under Part I, Item 1.
FORWARD-LOOKING STATEMENTS
This report contains a number of forward-looking statements which relate to anticipated future events rather than actual present conditions or historical events. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and generally include words such as “believes,” “expects,” “intends,” “anticipates,” “estimates” and similar expressions. Forward-looking statements in this report include any and all statements regarding expected developments in our insurance business, including losses and loss reserves for A&EP and other mass tort claims which are more uncertain, and therefore more difficult to estimate than loss reserves respecting traditional property and casualty exposures; the impact of routine ongoing insurance reserve reviews we are conducting; our expectations concerning our revenues, earnings, expenses and investment activities; volatility in investment returns; expected cost savings and other results from our expense reduction activities; and our proposed actions in response to trends in our business. Forward-looking statements, by their nature, are subject to a variety of inherent risks and uncertainties that could cause actual results to differ materially from the results projected in the forward-looking statement. We cannot control many of these risks and uncertainties. These risks and uncertainties include, but are not limited to, the following:
Company-Specific Factors
•
the risks and uncertainties associated with our insurance reserves, as outlined in the Critical Accounting Estimates and the Reserves - Estimates and Uncertainties sections of our Annual Report on Form 10-K, including the sufficiency of the reserves and the possibility for future increases, which would be reflected in the results of operations in the period that the need for such adjustment is determined;
•
the risk that the other parties to the transaction in which, subject to certain limitations, we ceded our legacy A&EP liabilities will not fully perform their obligations to CNA, the uncertainty in estimating loss reserves for A&EP liabilities and the possible continued exposure of CNA to liabilities for A&EP claims that are not covered under the terms of the transaction;
•
the performance of reinsurance companies under reinsurance contracts with us; and
•
the risks and uncertainties associated with potential acquisitions and divestitures, including the consummation of such transactions, the successful integration of acquired operations and the potential for subsequent impairment of goodwill or intangible assets.
Industry and General Market Factors
•
the impact of competitive products, policies and pricing and the competitive environment in which we operate, including changes in our book of business;
•
product and policy availability and demand and market responses, including the level of ability to obtain rate increases and decline or non-renew underpriced accounts, to achieve premium targets and profitability and to realize growth and retention estimates;
•
general economic and business conditions, including recessionary conditions that may decrease the size and number of our insurance customers and create additional losses to our lines of business, especially those that provide management and professional liability insurance, as well as surety bonds, to businesses engaged in real estate, financial services and professional services and inflationary pressures on medical care costs, construction costs and other economic sectors that increase the severity of claims;
•
conditions in the capital and credit markets, including continuing uncertainty and instability in these markets, as well as the overall economy, and their impact on the returns, types, liquidity and valuation of our investments;
•
conditions in the capital and credit markets that may limit our ability to raise significant amounts of capital on favorable terms; and
•
the possibility of changes in our ratings by ratings agencies, including the inability to access certain markets or distribution channels and the required collateralization of future payment obligations as a result of such changes, and changes in rating agency policies and practices.

63

Regulatory Factors
•
regulatory initiatives and compliance with governmental regulations, judicial interpretations within the regulatory framework, including interpretation of policy provisions, decisions regarding coverage and theories of liability, legislative actions that increase claimant activity, trends in litigation and the outcome of any litigation involving us and rulings and changes in tax laws and regulations;
•
regulatory limitations, impositions and restrictions upon us, including with respect to our ability to increase premium rates, and the effects of assessments and other surcharges for guaranty funds and second-injury funds, other mandatory pooling arrangements and future assessments levied on insurance companies; and
•
regulatory limitations and restrictions, including limitations upon our ability to receive dividends from our insurance subsidiaries, imposed by regulatory authorities, including regulatory capital adequacy standards.
Impact of Catastrophic Events and Related Developments
•
weather and other natural physical events, including the severity and frequency of storms, hail, snowfall and other winter conditions, natural disasters such as hurricanes and earthquakes, as well as climate change, including effects on global weather patterns, greenhouse gases, sea, land and air temperatures, sea levels, rain, hail and snow;
•
regulatory requirements imposed by coastal state regulators in the wake of hurricanes or other natural disasters, including limitations on the ability to exit markets or to non-renew, cancel or change terms and conditions in policies, as well as mandatory assessments to fund any shortfalls arising from the inability of quasi-governmental insurers to pay claims;
•
man-made disasters, including the possible occurrence of terrorist attacks, the unpredictability of the nature, targets, severity or frequency of such events, and the effect of the absence or insufficiency of applicable terrorism legislation on coverages; and
•
the occurrence of epidemics.
Referendum on the United Kingdom's Membership in the European Union
•
in 2016, the United Kingdom (U.K.) held a referendum in which voters approved an exit from the European Union (E.U.), commonly referred to as "Brexit." As a result of the referendum, in 2017 the British government formally commenced the process to leave the E.U. and began negotiating the terms of treaties that will govern the U.K.'s future relationship with the E.U. Although the terms of any future treaties are unknown, we believe changes in our international operating platform will be required to allow us to continue to write business in the E.U. after the completion of Brexit. Therefore, we have begun the process of establishing a new European subsidiary in Luxembourg. As a result of these changes, the complexity and cost of regulatory compliance of our European business is likely to increase.
Our forward-looking statements speak only as of the date of the filing of this Quarterly Report on Form 10-Q and we do not undertake any obligation to update or revise any forward-looking statement to reflect events or circumstances after the date of the statement, even if our expectations or any related events or circumstances change.


64

Item 3. Quantitative and Qualitative Disclosures About Market Risk
There were no material changes in our market risk components for the six months ended June 30, 2018. See the Quantitative and Qualitative Disclosures About Market Risk included in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2017 for further information. Additional information related to portfolio duration is discussed in the Investments section of our Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Part I, Item 2.
Item 4. Controls and Procedures
The Company maintains a system of disclosure controls and procedures which are designed to ensure that information required to be disclosed by the Company in reports that it files or submits to the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including this report, is recorded, processed, summarized and reported on a timely basis. These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed under the Exchange Act is accumulated and communicated to the Company's management on a timely basis to allow decisions regarding required disclosure.
As of June 30, 2018, the Company's management, including the Company's Chief Executive Officer (CEO) and Chief Financial Officer (CFO), conducted an evaluation of the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on this evaluation, the CEO and CFO have concluded that the Company's disclosure controls and procedures are effective as of June 30, 2018.
There has been no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15 (f) and 15d-15(f) under the Exchange Act) during the quarter ended June 30, 2018 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

65

PART II. Other Information
Item 1. Legal Proceedings
Information on our legal proceedings is set forth in Note F to the Condensed Consolidated Financial Statements included under Part I, Item 1.
Item 6. Exhibits
See Exhibit Index.


66

SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
CNA Financial Corporation
 
 
 
Dated: July 30, 2018
By
/s/ D. Craig Mense
 
 
D. Craig Mense
Executive Vice President and
Chief Financial Officer
(Duly authorized officer and principal financial officer)


67

EXHIBIT INDEX
Description of Exhibit
Exhibit Number
31.1
 
 
31.2
 
 
32.1
 
 
32.2
 
 
XBRL Instance Document
101.INS
 
 
XBRL Taxonomy Extension Schema
101.SCH
 
 
XBRL Taxonomy Extension Calculation Linkbase
101.CAL
 
 
XBRL Taxonomy Extension Definition Linkbase
101.DEF
 
 
XBRL Taxonomy Label Linkbase
101.LAB
 
 
XBRL Taxonomy Extension Presentation Linkbase
101.PRE


68

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