Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended 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
Table of Contents

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
Table of Contents

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
Table of Contents

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
Table of Contents

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
Table of Contents

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
Table of Contents

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
Table of Contents

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.

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Table of Contents

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.

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Table of Contents

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.

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Table of Contents

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.

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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.

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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
Table of Contents

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
Table of Contents

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
Table of Contents

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
Table of Contents

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
Table of Contents

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
Table of Contents

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
Table of Contents

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
Table of Contents

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

 
—

 
—