CNA FINANCIAL CORP - Annual Report: 2007 (Form 10-K)
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2007
OR
o | 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 | 36-6169860 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
333 S. Wabash | 60604 | |
Chicago, Illinois | (Zip Code) |
|
(Address of principal executive offices) |
(312) 822-5000
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered |
|
Common Stock with a par value of $2.50 per share |
New York Stock Exchange
Chicago Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15 (d) of the Act. Yes o No þ
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 þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer,
accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes o No þ
As of
February 22, 2008, 270,716,622 shares of common stock were outstanding. The aggregate market
value of the common stock held by non-affiliates of the registrant as
of June 30, 2007 was approximately $1,438 million based on the closing price of $47.69 per share of
the common stock on the New York Stock Exchange on June 30, 2007.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the CNA Financial Corporation Proxy Statement prepared for the 2008 annual meeting of
shareholders, pursuant to Regulation 14A, are incorporated by reference into Part III of this
Report.
Table of Contents
PART I
ITEM 1. BUSINESS
CNA Financial Corporation (CNAF) was incorporated in 1967 and is an insurance holding company.
Collectively, CNAF and its subsidiaries are referred to as CNA or the Company. References to
CNA, the Company, we, our, us or like terms refer to the business of CNA and its
subsidiaries. Our property and casualty insurance operations are conducted by Continental Casualty
Company (CCC), incorporated in 1897, and The Continental Insurance Company (CIC), organized in
1853, and affiliates. CIC became a subsidiary of ours in 1995 as a result of the acquisition of
The Continental Corporation (Continental). Loews Corporation (Loews) owned approximately 89% of
our outstanding common stock as of December 31, 2007.
We serve a wide variety of customers, including small, medium and large businesses, associations,
professionals, and groups and individuals with a broad range of insurance and risk management
products and services.
Our insurance products primarily include commercial property and casualty coverages. Our services
include risk management, information services, warranty and claims administration. Our products
and services are marketed through independent agents, brokers, managing general agents and direct
sales.
Our core business, commercial property and casualty insurance operations, is reported in two
business segments: Standard Lines and Specialty Lines. Our non-core operations are managed in two
business segments: Life & Group Non-Core and Corporate & Other Non-Core. These segments are
managed separately because of differences in their product lines and markets. Discussions of each
segment including the products offered, the customers served, the distribution channels used and
competition are set forth in the Managements Discussion and Analysis (MD&A) included under Item 7
and in Note N of the Consolidated Financial Statements included under Item 8.
Competition
The property and casualty insurance industry is highly competitive both as to rate and service.
Our consolidated property and casualty subsidiaries compete not only with other stock insurance
companies, but also with mutual insurance companies, reinsurance companies and other entities for
both producers and customers. We must continuously allocate resources to refine and improve our
insurance products and services.
Rates among insurers vary according to the types of insurers and methods of operation. We compete
for business not only on the basis of rate, but also on the basis of availability of coverage
desired by customers, ratings and quality of service, including claim adjustment services.
There are approximately 2,300 individual companies that sell property and casualty insurance in the
United States. Our consolidated property and casualty subsidiaries ranked as the 13th
largest property and casualty insurance organization and we are the seventh largest commercial
insurance writer in the United States based upon 2006 statutory net written premiums.
Regulation
The insurance industry is subject to comprehensive and detailed regulation and supervision
throughout the United States. Each state has established supervisory agencies with broad
administrative powers relative to licensing insurers and agents, approving policy forms,
establishing reserve requirements, fixing minimum interest rates for accumulation of surrender
values and maximum interest rates of policy loans, prescribing the form and content of statutory
financial reports and regulating solvency and the type, quality and amount of investments
permitted. Such regulatory powers also extend to premium rate regulations, which require that
rates not be excessive, inadequate or unfairly discriminatory. In addition to regulation of
dividends by insurance subsidiaries, intercompany transfers of assets may be subject to prior
notice or approval by the state insurance regulators, depending on the size of such transfers and
payments in relation to the financial position of the insurance affiliates making the transfer or
payment.
Insurers are also required by the states to provide coverage to insureds who would not otherwise be
considered eligible by the insurers. Each state dictates the types of insurance and the level of
coverage that must be provided to such involuntary risks. Our share of these involuntary risks is
mandatory and generally a function of our respective share of the voluntary market by line of
insurance in each state.
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Further, insurance companies are subject to state guaranty fund and other insurance-related
assessments. Guaranty fund assessments are levied by the state departments of insurance to cover
claims of insolvent insurers. Other insurance-related assessments are generally levied by state
agencies to fund various organizations including disaster relief funds, rating bureaus, insurance
departments, and workers compensation second injury funds, or by industry organizations that
assist in the statistical analysis and ratemaking process.
Reform of the U.S. tort liability system is another issue facing the insurance industry. Over the
last decade, many states have passed some type of reform. In recent years, for example,
significant state general tort reforms have been enacted in Georgia, Ohio, Mississippi and South
Carolina. Specific state legislation addressing state asbestos reform has been passed in Ohio,
Georgia, Florida and Texas in past years as well. Although these states legislatures have begun
to address their litigious environments, some reforms are being challenged in the courts and it
will take some time before they are finalized. Even though there has been some tort reform
success, new causes of action and theories of damages continue to be proposed in state court
actions or by legislatures. For example, some state legislatures are considering legislation
addressing direct actions against insurers related to bad faith claims. As a result of this
unpredictability in the law, insurance underwriting and rating are expected to continue to be
difficult in commercial lines, professional liability and some specialty coverages and therefore
could materially adversely affect our results of operations and equity.
Although the federal government and its regulatory agencies do not directly regulate the business
of insurance, federal legislative and regulatory initiatives can impact the insurance industry in a
variety of ways. These initiatives and legislation include tort reform proposals; proposals
addressing natural catastrophe exposures; terrorism risk mechanisms; federal regulation of
insurance; and various tax proposals affecting insurance companies.
In addition, our domestic insurance subsidiaries are subject to risk-based capital requirements.
Risk-based capital is a method developed by the National Association of Insurance Commissioners to
determine the minimum amount of statutory capital appropriate for an insurance company to support
its overall business operations in consideration of its size and risk profile. The formula for
determining the amount of risk-based capital specifies various factors, weighted based on the
perceived degree of risk, which are applied to certain financial balances and financial activity.
The adequacy of a companys actual capital is evaluated by a comparison to the risk-based capital
results, as determined by the formula. Companies below minimum risk-based capital requirements are
classified within certain levels, each of which requires specified corrective action. As of
December 31, 2007 and 2006, all of our domestic insurance subsidiaries exceeded the minimum
risk-based capital requirements.
Subsidiaries with insurance operations outside the United States are also subject to regulation in
the countries in which they operate. We have operations in the United Kingdom, Canada and other
countries.
Employee Relations
As of December 31, 2007, we had approximately 9,400 employees and have experienced satisfactory
labor relations. We have never had work stoppages due to labor disputes.
We have comprehensive benefit plans for substantially all of our employees, including retirement
plans, savings plans, disability programs, group life programs and group healthcare programs. See
Note J of the Consolidated Financial Statements included under Item 8 for further discussion of our
benefit plans.
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Supplementary Insurance Data
The following table sets forth supplementary insurance data.
Supplementary Insurance Data
Years ended December 31 | ||||||||||||
(In millions) | 2007 | 2006 | 2005 | |||||||||
Trade Ratios GAAP basis (a) |
||||||||||||
Loss and loss adjustment expense ratio |
77.7 | % | 75.7 | % | 89.4 | % | ||||||
Expense ratio |
30.0 | 30.0 | 31.2 | |||||||||
Dividend ratio |
0.2 | 0.3 | 0.3 | |||||||||
Combined ratio |
107.9 | % | 106.0 | % | 120.9 | % | ||||||
Trade Ratios Statutory basis (preliminary) (a) |
||||||||||||
Loss and loss adjustment expense ratio |
79.8 | % | 78.7 | % | 92.2 | % | ||||||
Expense ratio |
30.0 | 30.2 | 30.0 | |||||||||
Dividend ratio |
0.3 | 0.2 | 0.5 | |||||||||
Combined ratio |
110.1 | % | 109.1 | % | 122.7 | % | ||||||
Individual Life and Group Life Insurance Inforce |
||||||||||||
Individual life |
$ | 9,204 | $ | 9,866 | $ | 10,711 | ||||||
Group life |
4,886 | 5,787 | 9,838 | |||||||||
Total |
$ | 14,090 | $ | 15,653 | $ | 20,549 | ||||||
Other Data Statutory basis (preliminary) (b) |
||||||||||||
Property and
casualty companies capital and surplus (c) |
$ | 8,511 | $ | 8,137 | $ | 6,940 | ||||||
Life companys capital and surplus |
471 | 687 | 627 | |||||||||
Property and casualty companies written premiums to surplus ratio |
0.8 | 0.9 | 1.0 | |||||||||
Life companys capital and surplus-percent to total liabilities |
28.2 | % | 38.9 | % | 33.1 | % | ||||||
Participating policyholders-percent of gross life insurance inforce |
4.7 | % | 4.4 | % | 3.5 | % |
(a) | Trade ratios reflect the results of our property and casualty insurance subsidiaries. Trade
ratios are industry measures of property and casualty underwriting results. The loss and loss
adjustment expense ratio is the percentage of net incurred claim and claim adjustment expenses
and the expenses incurred related to uncollectible reinsurance receivables to net earned
premiums. The primary difference in this ratio between accounting principles generally
accepted in the United States of America (GAAP) and statutory accounting practices (SAP) is
related to the treatment of active life reserves (ALR) related to long term care insurance
products written in property and casualty insurance subsidiaries. For GAAP, ALR is classified
as claim and claim adjustment expense reserves whereas for SAP, ALR is classified as unearned
premium reserves. The expense ratio, using amounts determined in accordance with GAAP, is the
percentage of underwriting and acquisition expenses (including the amortization of deferred
acquisition expenses) to net earned premiums. The expense ratio, using amounts determined in
accordance with SAP, is the percentage of acquisition and underwriting expenses (with no
deferral of acquisition expenses) to net written premiums. The dividend ratio, using amounts
determined in accordance with GAAP, is the ratio of policyholders dividends incurred to net
earned premiums. The dividend ratio, using amounts determined in accordance with SAP, is the
ratio of policyholders dividends paid to net earned premiums. The combined ratio is the sum
of the loss and loss adjustment expense, expense and dividend ratios. |
|
(b) | Other data is determined in accordance with SAP. Life statutory capital and surplus as a
percent of total liabilities is determined after excluding separate account liabilities and
reclassifying the statutorily required Asset Valuation Reserve to surplus. |
|
(c) | Surplus includes the property and casualty companies equity ownership of the life companys
capital and surplus. |
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The following table displays the distribution of gross written premiums for our operations by
geographic concentration.
Gross Written Premiums
Percent of Total | ||||||||||||
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
California |
9.1 | % | 9.6 | % | 9.0 | % | ||||||
Florida |
7.3 | 7.9 | 7.1 | |||||||||
New York |
6.8 | 7.3 | 7.9 | |||||||||
Texas |
5.9 | 5.9 | 5.7 | |||||||||
Illinois |
3.7 | 4.1 | 4.2 | |||||||||
New Jersey |
3.6 | 4.4 | 3.8 | |||||||||
Missouri |
3.4 | 3.0 | 2.8 | |||||||||
Pennsylvania |
3.2 | 3.4 | 4.2 | |||||||||
Massachusetts |
2.3 | 2.4 | 3.3 | |||||||||
All other states, countries or political subdivisions (a) |
54.7 | 52.0 | 52.0 | |||||||||
Total |
100.0 | % | 100.0 | % | 100.0 | % | ||||||
(a) | No other individual state, country or political subdivision accounts for more than 3.0% of
gross written premiums. |
Approximately 8.4%, 7.1% and 6.1% of our gross written premiums were derived from outside of the
United States for the years ended December 31, 2007, 2006 and 2005. Premiums from any individual
foreign country were not significant.
Property and Casualty Claim and Claim Adjustment Expenses
The following loss reserve development table illustrates the change over time of reserves
established for property and casualty claim and claim adjustment expenses at the end of the
preceding ten calendar years for our property and casualty insurance operations. The table
excludes our life subsidiary(ies), and as such, the carried reserves will not agree to the
Consolidated Financial Statements included under Item 8. The first section shows the reserves as
originally reported at the end of the stated year. The second section, reading down, shows the
cumulative amounts paid as of the end of successive years with respect to the originally reported
reserve liability. The third section, reading down, shows re-estimates of the originally recorded
reserves as of the end of each successive year, which is the result of our property and casualty
insurance subsidiaries expanded awareness of additional facts and circumstances that pertain to
the unsettled claims. The last section compares the latest re-estimated reserves to the reserves
originally established, and indicates whether the original reserves were adequate or inadequate to
cover the estimated costs of unsettled claims.
The loss reserve development table for property and casualty companies is cumulative and,
therefore, ending balances should not be added since the amount at the end of each calendar year
includes activity for both the current and prior years. Additionally, the development amounts in
the table below are the amounts prior to consideration of any related reinsurance bad debt
allowance impacts.
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Schedule of Loss Reserve Development
Calendar Year Ended | ||||||||||||||||||||||||||||||||||||||||||||
(In millions) | 1997 | 1998 | 1999 (a) | 2000 | 2001 (b) | 2002 (c) | 2003 | 2004 | 2005 | 2006 | 2007 | |||||||||||||||||||||||||||||||||
Originally reported gross
reserves for unpaid claim
and claim adjustment
expenses |
$ | 28,731 | $ | 28,506 | $ | 26,850 | $ | 26,510 | $ | 29,649 | $ | 25,719 | $ | 31,284 | $ | 31,204 | $ | 30,694 | $ | 29,459 | $ | 28,415 | ||||||||||||||||||||||
Originally reported ceded
recoverable |
5,056 | 5,182 | 6,091 | 7,333 | 11,703 | 10,490 | 13,847 | 13,682 | 10,438 | 8,078 | 6,945 | |||||||||||||||||||||||||||||||||
Originally reported net
reserves for unpaid claim
and claim adjustment
expenses |
$ | 23,675 | $ | 23,324 | $ | 20,759 | $ | 19,177 | $ | 17,946 | $ | 15,229 | $ | 17,437 | $ | 17,522 | $ | 20,256 | $ | 21,381 | $ | 21,470 | ||||||||||||||||||||||
Cumulative net paid as of: |
||||||||||||||||||||||||||||||||||||||||||||
One year later |
$ | 5,954 | $ | 7,321 | $ | 6,547 | $ | 7,686 | $ | 5,981 | $ | 5,373 | $ | 4,382 | $ | 2,651 | $ | 3,442 | $ | 8,713 | $ | | ||||||||||||||||||||||
Two years later |
11,394 | 12,241 | 11,937 | 11,992 | 10,355 | 8,768 | 6,104 | 4,963 | 7,022 | | | |||||||||||||||||||||||||||||||||
Three years later |
14,423 | 16,020 | 15,256 | 15,291 | 12,954 | 9,747 | 7,780 | 7,825 | | | | |||||||||||||||||||||||||||||||||
Four years later |
17,042 | 18,271 | 18,151 | 17,333 | 13,244 | 10,870 | 10,085 | | | | | |||||||||||||||||||||||||||||||||
Five years later |
18,568 | 20,779 | 19,686 | 17,775 | 13,922 | 12,814 | | | | | | |||||||||||||||||||||||||||||||||
Six years later |
20,723 | 21,970 | 20,206 | 18,970 | 15,493 | | | | | | | |||||||||||||||||||||||||||||||||
Seven years later |
21,649 | 22,564 | 21,231 | 20,297 | | | | | | | | |||||||||||||||||||||||||||||||||
Eight years later |
22,077 | 23,453 | 22,373 | | | | | | | | | |||||||||||||||||||||||||||||||||
Nine years later |
22,800 | 24,426 | | | | | | | | | | |||||||||||||||||||||||||||||||||
Ten years later |
23,491 | | | | | | | | | | | |||||||||||||||||||||||||||||||||
Net reserves re-estimated
as of: |
||||||||||||||||||||||||||||||||||||||||||||
End of initial year |
$ | 23,675 | $ | 23,324 | $ | 20,759 | $ | 19,177 | $ | 17,946 | $ | 15,229 | $ | 17,437 | $ | 17,522 | $ | 20,256 | $ | 21,381 | $ | 21,470 | ||||||||||||||||||||||
One year later |
23,904 | 24,306 | 21,163 | 21,502 | 17,980 | 17,650 | 17,671 | 18,513 | 20,588 | 21,601 | | |||||||||||||||||||||||||||||||||
Two years later |
24,106 | 24,134 | 23,217 | 21,555 | 20,533 | 18,248 | 19,120 | 19,044 | 20,975 | | | |||||||||||||||||||||||||||||||||
Three years later |
23,776 | 26,038 | 23,081 | 24,058 | 21,109 | 19,814 | 19,760 | 19,631 | | | | |||||||||||||||||||||||||||||||||
Four years later |
25,067 | 25,711 | 25,590 | 24,587 | 22,547 | 20,384 | 20,425 | | | | | |||||||||||||||||||||||||||||||||
Five years later |
24,636 | 27,754 | 26,000 | 25,594 | 22,983 | 21,076 | | | | | | |||||||||||||||||||||||||||||||||
Six years later |
26,338 | 28,078 | 26,625 | 26,023 | 23,603 | | | | | | | |||||||||||||||||||||||||||||||||
Seven years later |
26,537 | 28,437 | 27,009 | 26,585 | | | | | | | | |||||||||||||||||||||||||||||||||
Eight years later |
26,770 | 28,705 | 27,541 | | | | | | | | | |||||||||||||||||||||||||||||||||
Nine years later |
26,997 | 29,211 | | | | | | | | | | |||||||||||||||||||||||||||||||||
Ten years later |
27,317 | | | | | | | | | | | |||||||||||||||||||||||||||||||||
Total net (deficiency)
redundancy |
$ | (3,642 | ) | $ | (5,887 | ) | $ | (6,782 | ) | $ | (7,408 | ) | $ | (5,657 | ) | $ | (5,847 | ) | $ | (2,988 | ) | $ | (2,109 | ) | $ | (719 | ) | $ | (220 | ) | $ | | ||||||||||||
Reconciliation to gross
re-estimated reserves: |
||||||||||||||||||||||||||||||||||||||||||||
Net reserves re-estimated |
$ | 27,317 | $ | 29,211 | $ | 27,541 | $ | 26,585 | $ | 23,603 | $ | 21,076 | $ | 20,425 | $ | 19,631 | $ | 20,975 | $ | 21,601 | $ | | ||||||||||||||||||||||
Re-estimated ceded
recoverable |
7,221 | 7,939 | 10,283 | 11,047 | 16,487 | 15,846 | 14,257 | 13,112 | 10,505 | 8,230 | | |||||||||||||||||||||||||||||||||
Total gross re-estimated
reserves |
$ | 34,538 | $ | 37,150 | $ | 37,824 | $ | 37,632 | $ | 40,090 | $ | 36,922 | $ | 34,682 | $ | 32,743 | $ | 31,480 | $ | 29,831 | $ | | ||||||||||||||||||||||
Net (deficiency)
redundancy related to: |
||||||||||||||||||||||||||||||||||||||||||||
Asbestos claims |
$ | (2,367 | ) | $ | (2,125 | ) | $ | (1,549 | ) | $ | (1,485 | ) | $ | (713 | ) | $ | (712 | ) | $ | (71 | ) | $ | (17 | ) | $ | (7 | ) | $ | (6 | ) | $ | | ||||||||||||
Environmental claims |
(541 | ) | (533 | ) | (533 | ) | (476 | ) | (129 | ) | (123 | ) | (51 | ) | (51 | ) | (1 | ) | (1 | ) | | |||||||||||||||||||||||
Total asbestos and
environmental |
(2,908 | ) | (2,658 | ) | (2,082 | ) | (1,961 | ) | (842 | ) | (835 | ) | (122 | ) | (68 | ) | (8 | ) | (7 | ) | | |||||||||||||||||||||||
Other claims |
(734 | ) | (3,229 | ) | (4,700 | ) | (5,447 | ) | (4,815 | ) | (5,012 | ) | (2,866 | ) | (2,041 | ) | (711 | ) | (213 | ) | | |||||||||||||||||||||||
Total net (deficiency)
redundancy |
$ | (3,642 | ) | $ | (5,887 | ) | $ | (6,782 | ) | $ | (7,408 | ) | $ | (5,657 | ) | $ | (5,847 | ) | $ | (2,988 | ) | $ | (2,109 | ) | $ | (719 | ) | $ | (220 | ) | $ | | ||||||||||||
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(a) | Ceded recoverable includes reserves transferred under retroactive reinsurance agreements of
$784 million as of December 31, 1999. |
|
(b) | Effective January 1, 2001, we established a new life insurance company, CNA Group Life
Assurance Company (CNAGLA). Further, on January 1, 2001 $1,055 million of reserves were
transferred from CCC to CNAGLA. |
|
(c) | Effective October 31, 2002, we sold CNA Reinsurance Company Limited. As a result of the
sale, net reserves were reduced by $1,316 million. |
Additional information regarding our property and casualty claim and claim adjustment expense
reserves and reserve development is set forth in the MD&A included under Item 7 and in
Notes A and F of the Consolidated Financial Statements included under Item 8.
Investments
Information on our investments is set forth in the MD&A included under Item 7 and in
Notes A, B, C and D of the Consolidated Financial Statements included under Item 8.
Available Information
We file annual, quarterly and current reports, proxy statements and other documents with the
Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 (Exchange Act).
The public may read and copy any materials that we file with the SEC at the SECs Public Reference
Room at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the
operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also
maintains an Internet site that contains reports, proxy and information statements, and other
information regarding issuers, including CNA, that file electronically with the SEC. The public
can obtain any documents that we file with the SEC at http://www.sec.gov.
We also make available free of charge on or through our internet website (http://www.cna.com) our
Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and
amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act as soon as reasonably practicable after we electronically file such material with, or furnish
it to, the SEC. Copies of these reports may also be obtained, free of charge, upon written request
to: CNA Financial Corporation, 333 S. Wabash Avenue, Chicago, IL 60604, Attn. Jonathan D. Kantor,
Executive Vice President, General Counsel and Secretary.
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ITEM 1A. RISK FACTORS
Our business faces many risks. We have described below some of the more significant risks which we
face. There may be additional risks that we do not yet know of or that we do not currently
perceive to be significant that may also impact our business. Each of the risks and uncertainties
described below could lead to events or circumstances that have a material adverse effect on our
business, results of operations, financial condition or equity. You should carefully consider and
evaluate all of the information included in this Report and any subsequent reports we may file with
the Securities and Exchange Commission or make available to the public before investing in any
securities we issue.
If we determine that loss reserves are insufficient to cover our estimated ultimate unpaid
liability for claims, we may need to increase our loss reserves.
We maintain loss reserves to cover our estimated ultimate unpaid liability for claims and claim
adjustment expenses for reported and unreported claims and for future policy benefits. Reserves
represent our best estimate at a given point in time. Insurance reserves are not an exact
calculation of liability but instead are complex estimates derived by us, generally utilizing a
variety of reserve estimation techniques from numerous assumptions and expectations about future
events, many of which are highly uncertain, such as estimates of claims severity, frequency of
claims, mortality, morbidity, expected interest rates, inflation, claims handling, case reserving
policies and procedures, underwriting and pricing policies, changes in the legal and regulatory
environment and the lag time between the occurrence of an insured event and the time of its
ultimate settlement. Many of these uncertainties are not precisely quantifiable and require
significant judgment on our part. As trends in underlying claims develop, particularly in
so-called long tail or long duration coverages, we are sometimes required to add to our reserves.
This is called unfavorable development and results in a charge to our earnings in the amount of
the added reserves, recorded in the period the change in estimate is made. These charges can be
substantial and can have a material adverse effect on our results of operations and equity.
Additional information on our reserves is included in MD&A under Item 7 and Note F to the
Consolidated Financial Statements included under Item 8.
We are subject to the uncertain effects of emerging or potential claims and coverage issues that
arise as industry practices and legal, judicial, social and other environmental conditions change.
These issues have had, and may continue to have, a negative effect on our business by either
extending coverage beyond the original underwriting intent or by increasing the number or size of
claims, resulting in further increases in our reserves which can have a material adverse effect on
our results of operations and equity. The effects of these and other unforeseen emerging claim and
coverage issues are extremely hard to predict. Examples of emerging or potential claims and
coverage issues include:
| increases in the number and size of claims relating to injuries from medical products; |
| the effects of accounting and financial reporting scandals and other major corporate
governance failures, which have resulted in an increase in the number and size of claims,
including director and officer and errors and omissions insurance claims; |
| class action litigation relating to claims handling and other practices; |
| construction defect claims, including claims for a broad range of additional insured
endorsements on policies; |
| clergy abuse claims, including passage of legislation to reopen or extend various statutes
of limitations; and |
| mass tort claims, including bodily injury claims related to silica, welding rods, benzene,
lead and various other chemical exposure claims. |
In light of the many uncertainties associated with establishing the estimates and making the
assumptions necessary to establish reserve levels, we review and change our reserve estimates in a
regular and ongoing process as experience develops and further claims are reported and settled. In
addition, we periodically undergo state regulatory financial examinations, including review and
analysis of our reserves. If estimated reserves are insufficient for any reason, the required
increase in reserves would be recorded as a charge against our earnings for the period in which
reserves are determined to be insufficient. These charges could be substantial and could
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materially adversely affect our results of operations, equity, business and insurer financial
strength and debt ratings.
Loss reserves for asbestos and environmental pollution are especially difficult to estimate and may
result in more frequent and larger additions to these reserves.
Our experience has been that establishing reserves for casualty coverages relating to asbestos and
environmental pollution (which we refer to as A&E) claim and claim adjustment expenses are subject
to uncertainties that are greater than those presented by other claims. Estimating the ultimate
cost of both reported and unreported claims are subject to a higher degree of variability due to a
number of additional factors including, among others, the following:
| coverage issues including whether certain costs are covered under the policies and whether
policy limits apply; |
| inconsistent court decisions and developing legal theories; |
| continuing aggressive tactics of plaintiffs lawyers; |
| the risks and lack of predictability inherent in major litigation; |
| changes in the volume of asbestos and environmental pollution claims; |
| the impact of the exhaustion of primary limits and the resulting increase in claims on any
umbrella or excess policies we have issued; |
| the number and outcome of direct actions against us; |
| our ability to recover reinsurance for these claims; and |
| changes in the legal and legislative environment in which we operate. |
As a result of this higher degree of variability, we have necessarily supplemented traditional
actuarial methods and techniques with additional estimating techniques and methodologies, many of
which involve significant judgment on our part. Consequently, we may periodically need to record
changes in our claim and claim adjustment expense reserves in the future in these areas in amounts
that could materially adversely affect our results of operations, equity, business and insurer
financial strength and debt ratings. Additional information on A&E claims is included in MD&A
under Item 7 and Note F to the Consolidated Financial Statements included under Item 8.
Environmental pollution claims. The estimation of reserves for environmental pollution claims
is complicated by the assertion by many policyholders of claims for defense costs and
indemnification. We and others in the insurance industry are disputing coverage for many such
claims. Key coverage issues in these claims include the following:
| whether cleanup costs are considered damages under the policies (and accordingly whether we
would be liable for these costs); |
| the trigger of coverage and the allocation of liability among triggered policies; |
| the applicability of pollution exclusions and owned property exclusions; |
| the potential for joint and several liability; and |
| the definition of an occurrence. |
To date, courts have been inconsistent in their rulings on these issues, thus adding to the
uncertainty of the outcome of many of these claims.
Further, the scope of federal and state statutes and regulations determining liability and
insurance coverage for environmental pollution liabilities have been the subject of extensive
litigation. In many cases, courts have expanded the scope of coverage and liability for cleanup
costs beyond the original intent of our insurance policies. Additionally, the standards for cleanup
in environmental pollution matters are unclear, the number of sites potentially subject to cleanup
under applicable laws is unknown, and the impact of various proposals to reform existing statutes
and regulations is difficult to predict.
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Asbestos claims. The estimation of reserves for asbestos claims is particularly difficult for
many of the same reasons discussed above for environmental pollution claims, as well as the
following:
| inconsistency of court decisions and jury attitudes, as well as future court decisions; |
| specific policy provisions; |
| allocation of liability among insurers and insureds; |
| missing policies and proof of coverage; |
| the proliferation of bankruptcy proceedings and attendant uncertainties; |
| novel theories asserted by policyholders and their legal counsel; |
| the targeting of a broader range of businesses and entities as defendants; |
| uncertainties in predicting the number of future claims and which other insureds may be
targeted in the future; |
| volatility in claim numbers and settlement demands; |
| increases in the number of non-impaired claimants and the extent to which they can be
precluded from making claims; |
| the efforts by insureds to obtain coverage that is not subject to aggregate limits; |
| the long latency period between asbestos exposure and disease manifestation, as well as the
resulting potential for involvement of multiple policy periods for individual claims; |
| medical inflation trends; |
| the mix of asbestos-related diseases presented; and |
| the ability to recover reinsurance. |
In addition, a number of our insureds have asserted that their claims for insurance are not subject
to aggregate limits on coverage. If these insureds are successful in this regard, our potential
liability for their claims would be unlimited. Some of these insureds contend that their asbestos
claims fall within the so-called non-products liability coverage within their policies, rather
than the products liability coverage, and that this non-products liability coverage is not
subject to any aggregate limit. It is difficult to predict the extent to which these claims will
succeed and, as a result, the ultimate size of these claims.
Catastrophe losses are unpredictable.
Catastrophe losses are an inevitable part of our business. Various events can cause catastrophe
losses, including hurricanes, windstorms, earthquakes, hail, explosions, severe winter weather, and
fires, and their frequency and severity are inherently unpredictable. In addition, longer-term
natural catastrophe trends may be changing and new types of catastrophe losses may be developing
due to climate change, a phenomenon that has been associated with extreme weather events linked to
rising temperatures, and includes effects on global weather patterns, greenhouse gases, sea, land
and air temperatures, sea levels, rain, and snow. For example, in 2005, we experienced substantial
losses from Hurricanes Katrina, Rita and Wilma. The extent of our losses from catastrophes is a
function of both the total amount of our insured exposures in the affected areas and the severity
of the events themselves. In addition, as in the case of catastrophe losses generally, it can take
a long time for the ultimate cost to us to be finally determined. As our claim experience develops
on a particular catastrophe, we may be required to adjust our reserves, or take unfavorable
development, to reflect our revised estimates of the total cost of claims. We believe we could
incur significant catastrophe losses in the future. Therefore, our results of operations, equity,
business and insurer financial strength and debt ratings could be materially adversely impacted.
Additional information on catastrophe losses is included in the MD&A under Item 7 and Note F to the
Consolidated Financial Statements included under Item 8.
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Our key assumptions used to determine reserves and deferred acquisition costs for our long term
care product offerings could vary significantly from actual experience.
Our reserves and deferred acquisition costs for our long term care product offerings are based on
certain key assumptions including morbidity, which is the frequency and severity of illness,
sickness and diseases contracted, policy persistency, which is the percentage of policies remaining
in force, interest rates and future health care cost trends. If actual experience differs from
these assumptions, the deferred acquisition asset may not be fully realized and the reserves may
not be adequate, requiring us to add to reserves, or take unfavorable development. Therefore, our
results of operations, equity, business and insurer financial strength and debt ratings could be
materially adversely impacted.
We continue to face exposure to losses arising from terrorist acts, despite the passage of the
Terrorism Risk Insurance Program Reauthorization Act of 2007.
The Terrorism Risk Insurance Program Reauthorization Act of 2007 extended, until December 31, 2014,
the program established within the U.S. Department of Treasury by the Terrorism Risk Insurance Act
of 2002. This program requires insurers to offer terrorism coverage and the federal government to
share in insured losses arising from acts of terrorism. Given the unpredictability of the nature,
targets, severity and frequency of potential terrorist acts, this program does not provide complete
protection for future losses derived from acts of terrorism. Further, the laws of certain states
restrict our ability to mitigate this residual exposure. For example, some states mandate property
insurance coverage of damage from fire following a loss, thereby prohibiting us from excluding
terrorism exposure. In addition, some states generally prohibit us from excluding terrorism
exposure from our primary workers compensation policies. Consequently, there is substantial
uncertainty as to our ability to contain our terrorism exposure effectively since we continue to
issue forms of coverage, in particular, workers compensation, that are exposed to risk of loss
from a terrorism act. As a result, our results of operations, equity, business and insurer
financial strength and debt ratings could be materially adversely impacted.
High levels of retained overhead expenses associated with business lines in run-off negatively
impact our operating results.
During the past several years, we ceased offering certain insurance products relating principally
to our life, group and reinsurance segments. Many of these business lines were sold, others have
been placed in run-off and, as a result, revenue has decreased. Our results of operations have
been materially adversely affected by the high levels of retained overhead expenses associated with
these run-off operations, and will continue to be so affected if we are not successful in
eliminating or reducing these costs.
Our premium writings and profitability are affected by the availability and cost of reinsurance.
We purchase reinsurance to help manage our exposure to risk. Under our reinsurance arrangements,
another insurer assumes a specified portion of our claim and claim adjustment expenses in exchange
for a specified portion of policy premiums. Market conditions determine the availability and cost
of the reinsurance protection we purchase, which affects the level of our business and
profitability, as well as the level and types of risk we retain. If we are unable to obtain
sufficient reinsurance at a cost we deem acceptable, we may be unwilling to bear the increased risk
and would reduce the level of our underwriting commitments. Therefore, our financial results of
operations could be materially adversely impacted. Additional information on reinsurance is
included in Note H to the Consolidated Financial Statements included under Item 8.
We may not be able to collect amounts owed to us by reinsurers.
We have significant amounts recoverable from reinsurers which are reported as receivables in our
balance sheets and are estimated in a manner consistent with claim and claim adjustment expense
reserves or future policy benefits reserves. The ceding of insurance does not, however, discharge
our primary liability for claims. As a result, we are subject to credit risk relating to our
ability to recover amounts due from reinsurers. Certain of our reinsurance carriers have
experienced deteriorating financial conditions or have been downgraded by rating agencies. In
addition, reinsurers could dispute amounts which we believe are due to us. If we are not able to
collect the amounts due to us from reinsurers, our claims expenses will be higher which could
materially adversely affect our results of operations, equity, business and insurer financial
strength and debt ratings. Additional information on reinsurance is included in Note H to the
Consolidated Financial Statements included under Item 8.
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Rating agencies may downgrade their ratings of us and thereby adversely affect our ability to write
insurance at competitive rates or at all.
Ratings are an important factor in establishing the competitive position of insurance companies.
Our insurance company subsidiaries, as well as our public debt, are rated by rating agencies,
namely, A.M. Best Company, Fitch Ratings, Moodys Investors Service and Standard & Poors. Ratings
reflect the rating agencys opinions of an insurance companys financial strength, capital
adequacy, operating performance, strategic position and ability to meet its obligations to
policyholders and debtholders.
Due to the intense competitive environment in which we operate, the uncertainty in determining
reserves and the potential for us to take material unfavorable development in the future, and
possible changes in the methodology or criteria applied by the rating agencies, the rating agencies
may take action to lower our ratings in the future. If our property and casualty insurance
financial strength ratings are downgraded below current levels, our business and results of
operations could be materially adversely affected. The severity of the impact on our business is
dependent on the level of downgrade and, for certain products, which rating agency takes the rating
action. Among the adverse effects in the event of such downgrades would be the inability to obtain
a material volume of business from certain major insurance brokers, the inability to sell a
material volume of our insurance products to certain markets, and the required collateralization of
certain future payment obligations or reserves.
In addition, it is possible that a lowering of the debt ratings of Loews Corporation by certain of
the rating agencies could result in an adverse impact on our ratings, independent of any change in
our circumstances. We have entered into several settlement agreements and assumed reinsurance
contracts that require collateralization of future payment obligations and assumed reserves if our
ratings or other specific criteria fall below certain thresholds. The ratings triggers are
generally more than one level below our current ratings. Additional information on our ratings is
included in the MD&A under Item 7.
We are subject to extensive federal, state and local governmental regulations that restrict our
ability to do business and generate revenues.
The insurance industry is subject to comprehensive and detailed regulation and supervision
throughout the United States. Most insurance regulations are designed to protect the interests of
our policyholders rather than our investors. Each state in which we do business has established
supervisory agencies that regulate the manner in which we do business. Their regulations relate
to, among other things, the following:
| standards of solvency including risk-based capital measurements; |
| restrictions on the nature, quality and concentration of investments; |
| restrictions on our ability to withdraw from unprofitable lines of insurance or
unprofitable market areas; |
| the required use of certain methods of accounting and reporting; |
| the establishment of reserves for unearned premiums, losses and other purposes; |
| potential assessments for funds necessary to settle covered claims against impaired,
insolvent or failed private or quasi-governmental insurers; |
| licensing of insurers and agents; |
| approval of policy forms; |
| limitations on the ability of our insurance subsidiaries to pay dividends to us; and |
| limitations on the ability to non-renew, cancel or change terms and conditions in policies. |
Regulatory powers also extend to premium rate regulations which require that rates not be
excessive, inadequate or unfairly discriminatory. The states in which we do business also require
us to provide coverage to persons whom we would not otherwise consider eligible. Each state
dictates the types of insurance and the level of coverage that must be provided to such involuntary
risks. Our share of these involuntary risks is mandatory and generally a function of our
respective share of the voluntary market by line of insurance in each state.
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We are subject to capital adequacy requirements and, if we do not meet these requirements,
regulatory agencies may restrict or prohibit us from operating our business.
Insurance companies such as us are subject to risk-based capital standards set by state regulators
to help identify companies that merit further regulatory attention. These standards apply
specified risk factors to various asset, premium and reserve components of our statutory capital
and surplus reported in our statutory basis of accounting financial statements. Current rules
require companies to maintain statutory capital and surplus at a specified minimum level determined
using the risk-based capital formula. If we do not meet these minimum requirements, state
regulators may restrict or prohibit us from operating our business. If we are required to record a
material charge against earnings in connection with a change in estimates or circumstances, we may
violate these minimum capital adequacy requirements unless we are able to raise sufficient
additional capital. Examples of events leading us to record a material charge against earnings
include impairment of our investments or unexpectedly poor claims experience.
Our insurance subsidiaries, upon whom we depend for dividends in order to fund our working capital
needs, are limited by state regulators in their ability to pay dividends.
We are a holding company and are dependent upon dividends, loans and other sources of cash from our
subsidiaries in order to meet our obligations. Dividend payments, however, must be approved by the
subsidiaries domiciliary state departments of insurance and are generally limited to amounts
determined by formula which varies by state. The formula for the majority of the states is the
greater of 10% of the prior year statutory surplus or the prior year statutory net income, less the
aggregate of all dividends paid during the twelve months prior to the date of payment. Some
states, however, have an additional stipulation that dividends cannot exceed the prior years
earned surplus. If we are restricted, by regulatory rule or otherwise, from paying or receiving
inter-company dividends, we may not be able to fund our working capital needs and debt service
requirements from available cash. As a result, we would need to look to other sources of capital
which may be more expensive or may not be available at all.
We received subpoenas, interrogatories and inquiries relating to insurance brokers and agents,
contingent commissions and bidding practices, and certain finite-risk insurance products.
Along with other companies in the industry, we received subpoenas, interrogatories and inquiries
from and have produced documents and/or provided information to: (i) California, Connecticut,
Delaware, Florida, Hawaii, Illinois, Michigan, Minnesota, New Jersey, New York, North Carolina,
Ohio, Pennsylvania, South Carolina, West Virginia and the Canadian Council of Insurance Regulators
concerning investigations into practices including contingent compensation arrangements, fictitious
quotes, and tying arrangements; (ii) the SEC, the New York State Attorney General, the United
States Attorney for the Southern District of New York, the Connecticut Attorney General, the
Connecticut Department of Insurance, the Delaware Department of Insurance, the Georgia Office of
Insurance and Safety Fire Commissioner and the California Department of Insurance concerning
reinsurance products and finite insurance products purchased and sold by us; (iii) the
Massachusetts Attorney General and the Connecticut Attorney General concerning investigations into
anti-competitive practices; and (iv) the New York State Attorney General concerning declinations of
attorney malpractice insurance.
The SEC and representatives of the United States Attorneys Office for the Southern District of New
York conducted interviews with several of our current and former executives relating to the
restatement of our financial results for 2004, including our relationship with and accounting for
transactions with an affiliate that were the basis for the restatement. We have also provided the
SEC with information relating to our restatement in 2006 of prior period results. It is possible
that our analyses of, or accounting treatment for, finite reinsurance contracts or discontinued
operations could be questioned or disputed by regulatory authorities.
Our investment portfolio, which is a key component of our overall profitability, may suffer reduced
returns or losses, in the event of changing interest rates or adverse credit conditions in the
capital markets.
Investment returns are an important part of our overall profitability. General economic
conditions, changes in financial markets such as fluctuations in interest rates, long term periods
of low interest rates, credit conditions and currency, commodity and stock prices, including the
short and long-term effects of losses produced or threatened in relation to sub-prime residential
mortgage-backed securities, and many other factors beyond our control can adversely affect the
returns and the overall value of our investments and the realization of
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investment income. In addition, any defaults in the payments due to us for our investments,
especially with respect to fixed maturity securities, could reduce our investment income and could
cause us to incur investment losses. Further, we invest a portion of our assets in equity
securities and limited partnerships, which may be subject to greater volatility than our fixed
income investments. In some cases, limited partnerships use leverage and are thereby subject to
even greater volatility. Although limited partnership investments generally provide higher
expected return, they present greater risk and are more illiquid than our fixed income investments.
As a result of all of these factors, we may not realize an adequate return on our investments, may
incur losses on sales of our investments, and may be required to write down the value of our
investments. Therefore, our results of operations, equity, business and insurer financial strength
and debt ratings could be materially adversely impacted.
We
have incurred and may incur further investment losses and may incur
underwriting losses, relating to the sub-prime crisis and the
related credit crisis.
We face
sub-prime valuation and credit exposure risks within our investment portfolio through our holdings
in corporate asset-backed structured securities and collateralized mortgage obligations (CMOs)
which are typically collateralized with residential mortgages. During the course of 2007, the
market value of some of these securities decreased as a result of the increase in delinquency rates
on the underlying mortgages and a decrease in the value of the homes held as collateral for the
investment. This deterioration of the collateral underlying the securities caused downgrades by
rating agencies, decreased liquidity, and led to some securities
going into default and has led to a material adverse impact on
financial markets generally. The potential
for higher delinquency and default rates may continue to adversely impact our sub-prime market
valuations. In addition, the process of validating fair values
provided by third parties for securities that are not regularly
traded requires significant judgment on our part. Accordingly, we may
conclude that other-than-temporary write downs of these securities are required or we may
experience unanticipated losses in other sectors of our overall investment portfolio.
Consequently, our results of operations, equity, business and insurer
financial strength and debt ratings could be materially adversely
impacted.
We provide management and professional liability insurance and surety bonds to businesses engaged
in finance, professional services and real estate. Many of these businesses have exposure directly
or indirectly to the sub-prime crisis and the related credit crisis. As a result, we may
experience unanticipated underwriting losses with respect to these
lines of business. Consequently, our results of operations, equity, business and insurer financial strength and debt
ratings could be materially adversely impacted.
We face intense competition in our industry and may be adversely affected by the cyclical nature of
the property and casualty business.
All aspects of the insurance industry are highly competitive and we must continuously allocate
resources to refine and improve our insurance products and services. We compete with a large
number of stock and mutual insurance companies and other entities for both distributors and
customers. Insurers compete on the basis of factors including products, price, services, ratings
and financial strength. We may lose business to competitors offering competitive insurance
products at lower prices. The property and casualty market is cyclical and has experienced periods
characterized by relatively high levels of price competition, less restrictive underwriting
standards and relatively low premium rates, followed by periods of relatively lower levels of
competition, more selective underwriting standards and relatively high premium rates. As a result,
our premium levels, expense ratio, results of operations, equity, business and insurer financial
strength and debt ratings could be materially adversely impacted.
We may suffer losses from non-routine litigation and arbitration matters which may exceed the
reserves we have established.
We face substantial risks of litigation and arbitration beyond ordinary course claims and A&E
matters, which may contain assertions in excess of amounts covered by reserves that we have
established. These matters may be difficult to assess or quantify and may seek recovery of very
large or indeterminate amounts that include punitive or treble damages. Accordingly, unfavorable
results in these proceedings could have a material adverse impact on our results of operations,
equity, business and insurer financial strength and debt ratings.
Additional information on litigation is included in the MD&A under Item 7 and Note G to the
Consolidated Financial Statements included under Item 8.
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We are dependent on a small number of key executives and other key personnel to operate our
business successfully.
Our success substantially depends upon our ability to attract and retain high quality key
executives and other employees. We believe there are only a limited number of available qualified
executives in the business lines in which we compete. We rely substantially upon the services of
our executive officers to implement our business strategy. The loss of the services of any members
of our management team or the inability to attract and retain other talented personnel could impede
the implementation of our business strategies. We do not maintain key man life insurance policies
with respect to any of our employees.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
The 333 S. Wabash Avenue building, located in Chicago, Illinois and owned by CCC, a wholly-owned
subsidiary of CNAF, serves as our home office. Our subsidiaries own or lease office space in
various cities throughout the United States and in other countries. The following table sets forth
certain information with respect to our principal office locations.
Amount (Square Feet) of Building | ||||
Owned and Occupied or Leased | ||||
Location | and Occupied by CNA | Principal Usage | ||
333 S. Wabash Avenue, Chicago, Illinois |
904,990 | Principal executive offices of CNAF | ||
401 Penn Street, Reading, Pennsylvania |
171,406 | Property and casualty insurance offices | ||
2405 Lucien Way, Maitland, Florida |
147,815 | Property and casualty insurance offices | ||
40 Wall Street, New York, New York |
110,131 | Property and casualty insurance offices | ||
675 Placentia Avenue, Brea, California |
78,655 | Property and casualty insurance offices | ||
600 N. Pearl Street, Dallas, Texas |
75,544 | Property and casualty insurance offices | ||
4267 Meridian Parkway, Aurora, Illinois |
70,004 | Data Center | ||
1249 South River Road, Cranbury, New Jersey |
67,853 | Property and casualty insurance offices | ||
3175 Satellite Boulevard, Duluth, Georgia |
48,696 | Property and casualty insurance offices | ||
405 Howard Street, San Francisco, California |
47,195 | Property and casualty insurance offices |
We lease the office space described above except for the Chicago, Illinois building, the Reading,
Pennsylvania building and the Aurora, Illinois building, which are owned. We consider that our
properties are generally in good condition, are well maintained and are suitable and adequate to
carry on our business.
ITEM 3. LEGAL PROCEEDINGS
Information on our legal proceedings is set forth in Notes F and G of the Consolidated Financial
Statements included under Item 8.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
Our common stock is listed on the New York Stock Exchange, the Chicago Stock Exchange and is traded
on the Philadelphia Stock Exchange, under the symbol CNA.
As of
February 22, 2008, we had 270,716,622 shares of common stock outstanding. Approximately 89%
of our outstanding common stock is owned by Loews. We had 1,965 stockholders of record as of
February 22, 2008 according to the records maintained by our transfer agent.
The table below shows the high and low sales prices for our common stock based on the New York
Stock Exchange Composite Transactions.
Common Stock Information
2007 | 2006 | |||||||||||||||||||||||
Dividends | Dividends | |||||||||||||||||||||||
High | Low | Declared | High | Low | Declared | |||||||||||||||||||
Quarter: |
||||||||||||||||||||||||
First |
$ | 44.29 | $ | 39.09 | $ | | $ | 33.60 | $ | 29.88 | $ | | ||||||||||||
Second |
51.96 | 42.96 | 0.10 | 33.20 | 30.90 | | ||||||||||||||||||
Third |
49.18 | 37.12 | 0.10 | 36.04 | 33.05 | | ||||||||||||||||||
Fourth |
41.84 | 32.26 | 0.15 | 40.32 | 36.19 | |
The following graph compares the total return of our common stock, the Standard & Poors (S&P) 500
Index and the S&P 500 Property & Casualty Insurance Index for the five year period from December
31, 2002 through December 31, 2007. The graph assumes that the value of the investment in our
common stock and for each index was $100 on December 31, 2002 and that dividends were reinvested.
Stock Price Performance Graph
Company / Index | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | ||||||||||||||||||
CNA Financial Corporation |
100.00 | 94.14 | 104.49 | 127.85 | 157.50 | 132.85 | ||||||||||||||||||
S&P 500 Index |
100.00 | 128.68 | 142.69 | 149.70 | 173.34 | 182.86 | ||||||||||||||||||
S&P 500 Property & Casualty Insurance Index |
100.00 | 126.41 | 139.58 | 160.68 | 181.36 | 156.04 |
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ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial data. The table should be read in conjunction with
Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations and
Item 8 Financial Statements and Supplementary Data of this Form 10-K.
Selected Financial Data
As of and for the Years Ended | ||||||||||||||||||||
December 31 | ||||||||||||||||||||
(In millions, except per share data) | 2007 | 2006 | 2005 | 2004 | 2003 | |||||||||||||||
Results of Operations: |
||||||||||||||||||||
Revenues |
$ | 9,885 | $ | 10,376 | $ | 9,862 | $ | 9,924 | $ | 11,715 | ||||||||||
Income (loss) from continuing operations |
$ | 857 | $ | 1,137 | $ | 243 | $ | 446 | $ | (1,419 | ) | |||||||||
Income (loss) from discontinued
operations, net of tax |
(6 | ) | (29 | ) | 21 | (21 | ) | 2 | ||||||||||||
Net income (loss) |
$ | 851 | $ | 1,108 | $ | 264 | $ | 425 | $ | (1,417 | ) | |||||||||
Basic Earnings (Loss) Per Share: |
||||||||||||||||||||
Income (loss) from continuing operations |
$ | 3.15 | $ | 4.17 | $ | 0.68 | $ | 1.49 | $ | (6.52 | ) | |||||||||
Income (loss) from discontinued operations |
(0.02 | ) | (0.11 | ) | 0.08 | (0.09 | ) | 0.01 | ||||||||||||
Basic earnings (loss) per share available
to common stockholders |
$ | 3.13 | $ | 4.06 | $ | 0.76 | $ | 1.40 | $ | (6.51 | ) | |||||||||
Diluted Earnings (Loss) Per Share: |
||||||||||||||||||||
Income (loss) from continuing operations |
$ | 3.15 | $ | 4.16 | $ | 0.68 | $ | 1.49 | $ | (6.52 | ) | |||||||||
Income (loss) from discontinued operations |
(0.02 | ) | (0.11 | ) | 0.08 | (0.09 | ) | 0.01 | ||||||||||||
Diluted earnings (loss) per share
available to common stockholders |
$ | 3.13 | $ | 4.05 | $ | 0.76 | $ | 1.40 | $ | (6.51 | ) | |||||||||
Dividends declared per common share |
$ | 0.35 | $ | | $ | | $ | | $ | | ||||||||||
Financial Condition: |
||||||||||||||||||||
Total investments |
$ | 41,762 | $ | 44,096 | $ | 39,695 | $ | 39,231 | $ | 38,100 | ||||||||||
Total assets |
56,732 | 60,283 | 59,016 | 62,496 | 68,296 | |||||||||||||||
Insurance reserves |
40,222 | 41,080 | 42,436 | 43,653 | 45,494 | |||||||||||||||
Long and short term debt |
2,157 | 2,156 | 1,690 | 2,257 | 1,904 | |||||||||||||||
Stockholders equity |
10,150 | 9,768 | 8,950 | 8,974 | 8,735 | |||||||||||||||
Book value per share |
$ | 37.36 | $ | 36.03 | $ | 31.26 | $ | 31.63 | $ | 30.95 | ||||||||||
Statutory Surplus (preliminary): |
||||||||||||||||||||
Property and casualty companies (a) |
$ | 8,511 | $ | 8,137 | $ | 6,940 | $ | 6,998 | $ | 6,170 | ||||||||||
Life company(ies) |
471 | 687 | 627 | 1,177 | 707 |
(a) | Surplus includes the property and casualty companies equity ownership of the life
company(ies) capital and surplus. |
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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The following discussion should be read in conjunction with Item 1A Risk Factors, Item 6 Selected
Financial Data and Item 8 Financial Statements and Supplementary Data of this Form 10-K.
Index to this MD&A
Managements discussion and analysis of financial condition and results of operations is comprised
of the following sections:
Page No. | ||
Consolidated Operations |
20 | |
Critical Accounting Estimates |
22 | |
Reserves Estimates and Uncertainties |
24 | |
Reinsurance |
29 | |
Restructuring |
30 | |
Segment Results |
30 | |
Standard Lines |
31 | |
Specialty Lines |
33 | |
Life & Group Non-Core |
36 | |
Corporate & Other Non-Core |
37 | |
Asbestos and Environmental Pollution (A&E) Reserves |
38 | |
Investments |
45 | |
Net Investment Income |
45 | |
Net Realized Investment Gains (Losses) |
46 | |
Valuation and Impairment of Investments |
49 | |
Asset-Backed and Sub-prime Mortgage Exposure |
52 | |
Short Term Investments |
53 | |
Liquidity and Capital Resources |
54 | |
Cash Flows |
54 | |
Commitments, Contingencies, and Guarantees |
55 | |
Off-Balance Sheet Arrangements |
55 | |
Dividends |
56 | |
Share Repurchase Program |
56 | |
Regulatory Matters |
56 | |
Ratings |
56 | |
Accounting Pronouncements |
57 | |
Forward-Looking Statements |
58 |
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CONSOLIDATED OPERATIONS
Results of Operations
The following table includes the consolidated results of our operations. For more detailed
components of our business operations and the net operating income financial measure, see the
segment discussions within this MD&A.
Years ended December 31 | ||||||||||||
(In millions, except per share data) | 2007 | 2006 | 2005 | |||||||||
Revenues |
||||||||||||
Net earned premiums |
$ | 7,484 | $ | 7,603 | $ | 7,569 | ||||||
Net investment income |
2,433 | 2,412 | 1,892 | |||||||||
Other revenues |
279 | 275 | 411 | |||||||||
Total operating revenues |
10,196 | 10,290 | 9,872 | |||||||||
Claims, Benefits and Expenses |
||||||||||||
Net incurred claims and benefits |
5,995 | 6,025 | 6,975 | |||||||||
Policyholders dividends |
14 | 22 | 24 | |||||||||
Amortization of deferred acquisition costs |
1,520 | 1,534 | 1,543 | |||||||||
Other insurance related expenses |
733 | 757 | 829 | |||||||||
Restructuring and other related charges |
| (13 | ) | | ||||||||
Other expenses |
401 | 401 | 329 | |||||||||
Total claims, benefits and expenses |
8,663 | 8,726 | 9,700 | |||||||||
Operating income from continuing operations before income tax and
minority interest |
1,533 | 1,564 | 172 | |||||||||
Income tax (expense) benefit on operating income |
(425 | ) | (450 | ) | 105 | |||||||
Minority interest |
(48 | ) | (44 | ) | (24 | ) | ||||||
Net operating income from continuing operations |
1,060 | 1,070 | 253 | |||||||||
Realized investment gains (losses), net of participating
policyholders and minority interests |
(311 | ) | 86 | (10 | ) | |||||||
Income tax (expense) benefit on realized investment gains (losses) |
108 | (19 | ) | | ||||||||
Income from continuing operations |
857 | 1,137 | 243 | |||||||||
Income (loss) from discontinued operations, net of income tax (expense)
benefit of $0, $7 and $(2) |
(6 | ) | (29 | ) | 21 | |||||||
Net income |
$ | 851 | $ | 1,108 | $ | 264 | ||||||
Basic Earnings per Share |
||||||||||||
Income from continuing operations |
$ | 3.15 | $ | 4.17 | $ | 0.68 | ||||||
Income (loss) from discontinued operations |
(0.02 | ) | (0.11 | ) | 0.08 | |||||||
Basic earnings per share available to common stockholders |
$ | 3.13 | $ | 4.06 | $ | 0.76 | ||||||
Diluted Earnings per Share |
||||||||||||
Income from continuing operations |
$ | 3.15 | $ | 4.16 | $ | 0.68 | ||||||
Income (loss) from discontinued operations |
(0.02 | ) | (0.11 | ) | 0.08 | |||||||
Diluted earnings per share available to common stockholders |
$ | 3.13 | $ | 4.05 | $ | 0.76 | ||||||
Weighted Average Outstanding Common Stock and Common Stock Equivalents |
||||||||||||
Basic |
271.5 | 262.1 | 256.0 | |||||||||
Diluted |
271.8 | 262.3 | 256.0 | |||||||||
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2007 Compared with 2006
Net income decreased $257 million in 2007 as compared with 2006. This decrease was primarily due
to decreased net realized investment results.
Net realized investment results decreased by $270 million in 2007 compared with 2006. This
decrease was primarily driven by higher impairment losses. See the Investments section of this
MD&A for further discussion of net investment income and net realized investment results.
Net operating income from continuing operations in 2007 decreased $10 million as compared with
2006. The decrease in net operating income primarily related to the after-tax loss of $108 million
related to the settlement of the IGI contingency as discussed in the Life & Group Non-core segment
discussion of this MD&A and decreased current accident year underwriting results in our Standard
and Specialty Lines segments. The decreased net operating income was partially offset by favorable
net prior year development in 2007 as compared to unfavorable net prior year development in 2006
and increased net investment income. The increased net investment income included a decline of net
investment income in the trading portfolio of $93 million, a significant portion of which was
offset by a corresponding decrease in the policyholders funds reserves supported by the trading
portfolio.
Favorable net prior year development of $73 million was recorded in 2007 related to our Standard
Lines, Specialty Lines and Corporate & Other Non-core segments. This amount consisted of $38
million of favorable claim and allocated claim adjustment expense reserve development and
$35 million of favorable premium development. Unfavorable net prior year development of $172
million was recorded in 2006 related to our Standard Lines, Specialty Lines and Corporate & Other
Non-core segments. This amount consisted of $233 million of unfavorable claim and allocated claim
adjustment expense reserve development and $61 million of favorable premium development. Further
information on Net Prior Year Development for 2007 and 2006 is included in Note F of the
Consolidated Financial Statements included under Item 8.
Net earned premiums decreased $119 million in 2007 as compared with 2006, including a $178 million
decrease related to Standard Lines and a $73 million increase related to Specialty Lines. See the
Segment Results section of this MD&A for further discussion.
Results from discontinued operations improved $23 million in 2007 as compared to 2006. The loss in
2007 was primarily driven by unfavorable net prior year development. Results in 2006 reflected a
$29 million impairment loss related to the 2007 sale of a portion of the run-off business. Further
information on this impairment loss is included in Note P of the Consolidated Financial Statement
included under Item 8.
2006 Compared with 2005
Net income increased $844 million in 2006 as compared with 2005. This increase was primarily due
to increased net operating income and net realized investment results. These favorable impacts
were partially offset by unfavorable results from discontinued operations. See the Investments
section of this MD&A for further discussion of net investment income and net realized investment
results.
Net operating income from continuing operations increased $817 million in 2006 as compared with
2005. Favorably impacting net operating income was increased net investment income and
significantly lower unfavorable net prior year development as discussed below. The 2005 results
included a $334 million after-tax impact of catastrophes resulting from Hurricanes Katrina, Wilma,
Rita, Dennis and Ophelia, net of anticipated reinsurance recoveries. Additionally, the 2005
results included a $115 million benefit related to a federal income tax settlement and release of
federal income tax reserves.
Unfavorable net prior year development of $172 million was recorded in 2006 related to our Standard
Lines, Specialty Lines and Corporate & Other Non-Core segments. This amount consisted of
$233 million of unfavorable claim and allocated claim adjustment expense reserve development and
$61 million of favorable premium development. Unfavorable net prior year development of
$812 million was recorded in 2005 related to our Standard Lines, Specialty Lines and Corporate &
Other Non-Core segments. This amount consisted of $897 million of unfavorable claim and allocated
claim adjustment expense reserve development and $85 million
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of favorable premium development. Further information on Net Prior Year Development for 2006 and
2005 is included in Note F of the Consolidated Financial Statements included under Item 8.
During 2006 and 2005, we commuted several significant reinsurance contracts that resulted in
unfavorable development of $110 million and $433 million, which is included in the development
above, and which were partially offset by the release of previously established allowance for
uncollectible reinsurance. These commutations resulted in an unfavorable impact of $31 million
after-tax and $259 million after-tax in 2006 and 2005. These contracts contained interest
crediting provisions and maintenance charges. Interest charges associated with the reinsurance
contracts commuted were $9 million after-tax and $55 million after-tax in 2006 and 2005. The 2005
amount includes the interest charges associated with the contract commuted in 2006. There will be
no further interest crediting charges or other charges related to these commuted contracts in
future periods.
Net earned premiums increased $34 million in 2006 as compared with 2005, including a $44 million
increase related to the Specialty Lines segment and a $39 million increase related to the Standard
Lines segment. Net earned premiums for the Life & Group Non-Core segment decreased $63 million.
See the Segment Results section of this MD&A for further discussion.
Loss from discontinued operations was $29 million for the year ended December 31, 2006. Results in
2006 reflected a $29 million impairment loss related to the 2007 sale of a portion of the run-off
business. The 2006 results were also impacted by an increase in unallocated loss adjustment
expense reserves and bad debt provision for reinsurance receivables. These items were partially
offset by the release of tax reserves and net investment income.
Critical Accounting Estimates
The preparation of the Consolidated Financial Statements in conformity with accounting principles
generally accepted in the United States of America (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 Consolidated Financial Statements and the
amounts of revenues and expenses reported during the period. Actual results may differ from those
estimates.
Our 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 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 discussed below are considered by us to be critical to an understanding of
our Consolidated Financial Statements as their application places the most significant demands on
our judgment. Note A of the Consolidated Financial Statements included under Item 8 should be read
in conjunction with this section to assist with obtaining an understanding of the underlying
accounting policies related to these estimates. 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 and/or equity.
Insurance Reserves
Insurance reserves are established for both short and long-duration insurance contracts.
Short-duration contracts are primarily related to property and casualty insurance policies where
the reserving process is based on actuarial estimates of the amount of loss, including amounts for
known and unknown claims. Long-duration contracts typically include traditional life insurance,
payout annuities and long term care products and are estimated using actuarial estimates about
mortality, morbidity and persistency as well as assumptions about expected investment returns. The
reserve for unearned premiums on property and casualty and accident and health contracts represents
the portion of premiums written related to the unexpired terms of coverage. The inherent risks
associated with the reserving process are discussed in the Reserves Estimates and Uncertainties
section below.
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Reinsurance
Amounts recoverable from reinsurers are estimated in a manner consistent with claim and claim
adjustment expense reserves or future policy benefits reserves and are reported as receivables in
the Consolidated Balance Sheets. The ceding of insurance does not discharge us of our primary
liability under insurance contracts written by us. An exposure exists with respect to property and
casualty and life reinsurance ceded to the extent that any reinsurer is unable to meet its
obligations or disputes the liabilities assumed under reinsurance agreements. An estimated
allowance for doubtful accounts is recorded on the basis of periodic evaluations of balances due
from reinsurers, reinsurer solvency, our past experience and current economic conditions. Further
information on our reinsurance program is included in Note H of the Consolidated Financial
Statements included under Item 8.
Valuation of Investments and Impairment of Securities
Invested assets are exposed to various risks, such as interest rate, market and credit risks. Due
to the level of risk associated with certain invested assets and the level of uncertainty related
to changes in the value of these assets, it is possible that changes in risks in the near term
could have an adverse material impact on our results of operations or equity.
Our investment portfolio is subject to market declines below amortized cost that may be
other-than-temporary. We have an Impairment Committee, which reviews the investment portfolio on a
quarterly basis, with ongoing analysis as new information becomes available. Any decline that is
determined to be other-than-temporary is recorded as an other-than-temporary impairment loss in the
results of operations in the period in which the determination occurred. Further information on
our process for evaluating impairments is included in Note B of the Consolidated Financial
Statements included under Item 8.
Long Term Care Products
Reserves and deferred acquisition costs for our long term care products are based on certain
assumptions including morbidity, policy persistency and interest rates. The recoverability of
deferred acquisition costs and the adequacy of the reserves are contingent on actual experience
related to these key assumptions and other factors such as future health care cost trends. If
actual experience differs from these assumptions, the deferred acquisition costs may not be fully
realized and the reserves may not be adequate, requiring us to add to reserves, or take unfavorable
development. Therefore, our financial results could be adversely impacted.
Pension and Postretirement Benefit Obligations
We make a significant number of assumptions in estimating the liabilities and costs related to our
pension and postretirement benefit obligations to employees under our benefit plans. The
assumptions that most impact these costs are the discount rate, the expected return on plan assets
and the rate of compensation increases. These assumptions are evaluated relative to current market
factors such as inflation, interest rates and fiscal and monetary policies. Changes in these
assumptions can have a material impact on pension obligations and pension expense.
In determining the discount rate assumption, we utilized current market information, including a
discounted cash flow analysis of our pension and postretirement obligations and general movements
in the current market environment. In particular, the basis for our discount rate selection was
fixed income debt securities that receive one of the two highest ratings given by a recognized
rating agency. In 2007 and historically, the Moodys Aa Corporate Bond Index was the benchmark for
discount rate selection. The index is used as the basis for the change in discount rate from the
last measurement date. Additionally, we have supplemented our discount rate decision with a yield
curve analysis. The yield curve was applied to expected future retirement plan payments to adjust
the discount rate to reflect the cash flow characteristics of the plans. The yield curve is a
hypothetical double A yield curve represented by a series of annualized discount rates reflecting
bond issues having a rating of Aa or better by Moodys Investors Service, Inc. or a rating of AA or
better by Standard & Poors. Based on all available information, it was determined that 6.00% and
5.875% were the appropriate discount rates as of December 31, 2007 to calculate our accrued pension
and postretirement liabilities, respectively. Accordingly, the 6.00% and 5.875% rates will also be
used to determine our 2008 pension and postretirement expense. At December 31, 2006, the discount
rates used to calculate our accrued pension and postretirement liabilities were 5.750% and 5.625%,
respectively.
Further information on our pension and postretirement benefit obligations is included in Note J of
the Consolidated Financial Statements included under Item 8.
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Legal Proceedings
We are involved in various legal proceedings that have arisen during the ordinary course of
business. We evaluate the facts and circumstances of each situation, and when we determine it is
necessary, a liability is estimated and recorded. Further information on our legal proceedings and
related contingent liabilities is provided in Notes F and G of the Consolidated Financial
Statements included under Item 8.
Reserves - Estimates and Uncertainties
We maintain reserves to cover our estimated ultimate unpaid liability for claim and claim
adjustment expenses, including the estimated cost of the claims adjudication process, for claims
that have been reported but not yet settled (case reserves) and claims that have been incurred but
not reported (IBNR). Claim and claim adjustment expense reserves are reflected as liabilities and
are included on the Consolidated Balance Sheets under the heading Insurance Reserves.
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. The carried case and
IBNR reserves are provided in the Segment Results section of this MD&A and in Note F of the
Consolidated Financial Statements included under Item 8.
The level of reserves we maintain represents our best estimate, as of a particular point in time,
of what the ultimate settlement and administration of claims will cost based on our assessment of
facts and circumstances known at that time. Reserves are not an exact calculation of liability but
instead are complex estimates that we derive, generally utilizing a variety of actuarial reserve
estimation techniques, from numerous assumptions and expectations about future events, both
internal and external, many of which are highly uncertain.
We are subject to the uncertain effects of emerging or potential claims and coverage issues that
arise as industry practices and legal, judicial, social and other environmental conditions change.
These issues have had, and may continue to have, a negative effect on our business by either
extending coverage beyond the original underwriting intent or by increasing the number or size of
claims. Examples of emerging or potential claims and coverage issues include:
| increases in the number and size of claims relating to injuries from medical products; |
| the effects of accounting and financial reporting scandals and other major corporate
governance failures, which have resulted in an increase in the number and size of claims,
including directors and officers (D&O) and errors and omissions (E&O) insurance claims; |
| class action litigation relating to claims handling and other practices; |
| construction defect claims, including claims for a broad range of additional insured
endorsements on policies; |
| clergy abuse claims, including passage of legislation to reopen or extend various statutes
of limitations; and |
| mass tort claims, including bodily injury claims related to silica, welding rods, benzene,
lead and various other chemical exposure claims. |
Our experience has been that establishing reserves for casualty coverages relating to asbestos and
environmental pollution (A&E) claim and claim adjustment expenses are subject to uncertainties that
are greater than those presented by other claims. Estimating the ultimate cost of both reported
and unreported A&E claims are subject to a higher degree of variability due to a number of
additional factors, including among others:
| coverage issues, including whether certain costs are covered under the policies and whether
policy limits apply; |
| inconsistent court decisions and developing legal theories; |
| continuing aggressive tactics of plaintiffs lawyers; |
| the risks and lack of predictability inherent in major litigation; |
| changes in the volume of A&E claims; |
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| the impact of the exhaustion of primary limits and the resulting increase in claims on any
umbrella or excess policies we have issued; |
| the number and outcome of direct actions against us; and |
| our ability to recover reinsurance for A&E claims. |
It is also not possible to predict changes in the legal and legislative environment and the impact
on the future development of A&E claims. This development will be affected by future court
decisions and interpretations, as well as changes in applicable legislation. It is difficult to
predict the ultimate outcome of large coverage disputes until settlement negotiations near
completion and significant legal questions are resolved or, failing settlement, until the dispute
is adjudicated. This is particularly the case with policyholders in bankruptcy where negotiations
often involve a large number of claimants and other parties and require court approval to be
effective. A further uncertainty exists as to whether a national privately financed trust to
replace litigation of asbestos claims with payments to claimants from the trust will be established
and approved through federal legislation, and, if established and approved, whether it will contain
funding requirements in excess of our carried loss reserves.
Traditional actuarial methods and techniques employed to estimate the ultimate cost of claims for
more traditional property and casualty exposures are less precise in estimating claim and claim
adjustment reserves for A&E, particularly in an environment of emerging or potential claims and
coverage issues that arise from industry practices and legal, judicial and social conditions.
Therefore, these traditional actuarial methods and techniques are necessarily supplemented with
additional estimation techniques and methodologies, many of which involve significant judgments
that are required of management. For A&E, we regularly monitor our exposures, including reviews of
loss activity, regulatory developments and court rulings. In addition, we perform a comprehensive
ground up analysis on our exposures annually. Our actuaries, in conjunction with our specialized
claim unit, use various modeling techniques to estimate our overall exposure to known accounts. We
use this information and additional modeling techniques to develop loss distributions and claim
reporting patterns to determine reserves for accounts that will report A&E exposure in the future.
Estimating the average claim size requires analysis of the impact of large losses and claim cost
trend based on changes in the cost of repairing or replacing property, changes in the cost of legal
fees, judicial decisions, legislative changes, and other factors. Due to the inherent
uncertainties in estimating reserves for A&E claim and claim adjustment expenses and the degree of
variability due to, among other things, the factors described above, we may be required to record
material changes in our claim and claim adjustment expense reserves in the future, should new
information become available or other developments emerge. See the A&E Reserves section of this
MD&A and Note F of the Consolidated Financial Statements included under Item 8 for additional
information relating to A&E claims and reserves.
The impact of these and other unforeseen emerging or potential claims and coverage issues is
difficult to predict and could materially adversely affect the adequacy of our claim and claim
adjustment expense reserves and could lead to future reserve additions. See the Segment Results
sections of this MD&A and Note F of the Consolidated Financial Statements included under Item 8 for
a discussion of changes in reserve estimates and the impact on our results of operations.
Establishing Reserve Estimates
In developing claim and claim adjustment expense (loss or losses) reserve estimates, our
actuaries perform detailed reserve analyses that are staggered throughout the year. The data is
organized at a product level. A product can be a line of business covering a subset of insureds
such as commercial automobile liability for small and middle market customers, it can encompass
several lines of business provided to a specific set of customers such as dentists, or it can be a
particular type of claim such as construction defect. Every product is analyzed at least once
during the year, and many products are analyzed multiple times. The analyses generally review
losses gross of ceded reinsurance and apply the ceded reinsurance terms to the gross estimates to
establish estimates net of reinsurance. In addition to the detailed analyses, we review actual
loss emergence for all products each quarter.
The detailed analyses use a variety of generally accepted actuarial methods and techniques to
produce a number of estimates of ultimate loss. We determine a point estimate of ultimate loss by
reviewing the various estimates and assigning weight to each estimate given the characteristics of
the product being reviewed. The reserve
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estimate is the difference between the estimated ultimate loss and the losses paid to date. The
difference between the estimated ultimate loss and the case incurred loss (paid loss plus case
reserve) is IBNR. IBNR calculated as such includes a provision for development on known cases
(supplemental development) as well as a provision for claims that have occurred but have not yet
been reported (pure IBNR).
Most of our business can be characterized as long-tail. For long-tail business, it will generally
be several years between the time the business is written and the time when all claims are
settled. Our long-tail exposures include commercial automobile liability, workers compensation,
general liability, medical malpractice, other professional liability coverages, assumed reinsurance
run-off and products liability. Short-tail exposures include property, commercial automobile
physical damage, marine and warranty. Each of our property/casualty segments, Standard Lines,
Specialty Lines and Corporate & Other Non-Core, contain both long-tail and short-tail exposures.
The methods used to project ultimate loss for both long-tail and short-tail exposures include, but
are not limited to, the following:
| Paid Development, |
| Incurred Development, |
| Loss Ratio, |
| Bornhuetter-Ferguson Using Premiums and Paid Loss, |
| Bornhuetter-Ferguson Using Premiums and Incurred Loss, and |
| Average Loss. |
The paid development method estimates ultimate losses by reviewing paid loss patterns and applying
them to accident years with further expected changes in paid loss. Selection of the paid loss
pattern requires analysis of several factors including the impact of inflation on claims costs, the
rate at which claims professionals make claim payments and close claims, the impact of judicial
decisions, the impact of underwriting changes, the impact of large claim payments and other
factors. Claim cost inflation itself requires evaluation of changes in the cost of repairing or
replacing property, changes in the cost of medical care, changes in the cost of wage replacement,
judicial decisions, legislative changes and other factors. Because this method assumes that losses
are paid at a consistent rate, changes in any of these factors can impact the results. Since the
method does not rely on case reserves, it is not directly influenced by changes in the adequacy of
case reserves.
For many products, paid loss data for recent periods may be too immature or erratic for accurate
predictions. This situation often exists for long-tail exposures. In addition, changes in the
factors described above may result in inconsistent payment patterns. Finally, estimating the paid
loss pattern subsequent to the most mature point available in the data analyzed often involves
considerable uncertainty for long-tail products such as workers compensation.
The incurred development method is similar to the paid development method, but it uses case
incurred losses instead of paid losses. Since the method uses more data (case reserves in addition
to paid losses) than the paid development method, the incurred development patterns may be less
variable than paid patterns. However, selection of the incurred loss pattern requires analysis of
all of the factors above. In addition, the inclusion of case reserves can lead to distortions if
changes in case reserving practices have taken place, and the use of case incurred losses may not
eliminate the issues associated with estimating the incurred loss pattern subsequent to the most
mature point available.
The loss ratio method multiplies premiums by an expected loss ratio to produce ultimate loss
estimates for each accident year. This method may be useful if loss development patterns are
inconsistent, losses emerge very slowly, or there is relatively little loss history from which to
estimate future losses. The selection of the expected loss ratio requires analysis of loss ratios
from earlier accident years or pricing studies and analysis of inflationary trends, frequency
trends, rate changes, underwriting changes, and other applicable factors.
The Bornhuetter-Ferguson using premiums and paid loss method is a combination of the paid
development approach and the loss ratio approach. The method normally determines expected loss
ratios similar to the approach used to estimate the expected loss ratio for the loss ratio method
and requires analysis of the same factors described above. The method assumes that only future
losses will develop at the expected loss ratio
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level. The percent of paid loss to ultimate loss implied from the paid development method is used
to determine what percentage of ultimate loss is yet to be paid. The use of the pattern from the
paid development method requires consideration of all factors listed in the description of the paid
development method. The estimate of losses yet to be paid is added to current paid losses to
estimate the ultimate loss for each year. This method will react very slowly if actual ultimate
loss ratios are different from expectations due to changes not accounted for by the expected loss
ratio calculation.
The Bornhuetter-Ferguson using premiums and incurred loss method is similar to the
Bornhuetter-Ferguson using premiums and paid loss method except that it uses case incurred losses.
The use of case incurred losses instead of paid losses can result in development patterns that are
less variable than paid patterns. However, the inclusion of case reserves can lead to distortions
if changes in case reserving have taken place, and the method requires analysis of all the factors
that need to be reviewed for the loss ratio and incurred development methods.
The average loss method multiplies a projected number of ultimate claims by an estimated ultimate
average loss for each accident year to produce ultimate loss estimates. Since projections of the
ultimate number of claims are often less variable than projections of ultimate loss, this method
can provide more reliable results for products where loss development patterns are inconsistent or
too variable to be relied on exclusively. In addition, this method can more directly account for
changes in coverage that impact the number and size of claims. However, this method can be
difficult to apply to situations where very large claims or a substantial number of unusual claims
result in volatile average claim sizes. Projecting the ultimate number of claims requires analysis
of several factors including the rate at which policyholders report claims to us, the impact of
judicial decisions, the impact of underwriting changes and other factors. Estimating the ultimate
average loss requires analysis of the impact of large losses and claim cost trend based on changes
in the cost of repairing or replacing property, changes in the cost of medical care, changes in the
cost of wage replacement, judicial decisions, legislative changes and other factors.
For other more complex products where the above methods may not produce reliable indications, we
use additional methods tailored to the characteristics of the specific situation. Such products
include construction defect losses and A&E.
For construction defect losses, our actuaries organize losses by report year. Report year groups
claims by the year in which they were reported. To estimate losses from claims that have not been
reported, various extrapolation techniques are applied to the pattern of claims that have been
reported to estimate the number of claims yet to be reported. This process requires analysis of
several factors including the rate at which policyholders report claims to us, the impact of
judicial decisions, the impact of underwriting changes and other factors. An average claim size is
determined from past experience and applied to the number of unreported claims to estimate reserves
for these claims.
For many exposures, especially those that can be considered long-tail, a particular accident year
may not have a sufficient volume of paid losses to produce a statistically reliable estimate of
ultimate losses. In such a case, our actuaries typically assign more weight to the incurred
development method than to the paid development method. As claims continue to settle and the
volume of paid loss increases, the actuaries may assign additional weight to the paid development
method. For most of our products, even the incurred losses for accident years that are early in
the claim settlement process will not be of sufficient volume to produce a reliable estimate of
ultimate losses. In these cases, we will not assign any weight to the paid and incurred
development methods. We will use loss ratio, Bornhuetter-Ferguson and average loss methods. For
short-tail exposures, the paid and incurred development methods can often be relied on sooner
primarily because our history includes a sufficient number of years to cover the entire period over
which paid and incurred losses are expected to change. However, we may also use loss ratio,
Bornhuetter-Ferguson and average loss methods for short-tail exposures.
Periodic Reserve Reviews
The reserve analyses performed by our actuaries result in point estimates. Each quarter, the
results of the detailed reserve reviews are summarized and discussed with our senior management to
determine the best estimate of reserves. This group considers many factors in making this
decision. The factors include, but are not limited to, the historical pattern and volatility of
the actuarial indications, the sensitivity of the actuarial indications to changes in paid and
incurred loss patterns, the consistency of claims handling processes, the consistency of case
reserving practices, changes in our pricing and underwriting, and overall pricing and underwriting
trends in the insurance market.
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Our recorded reserves reflect our best estimate as of a particular point in time based upon known
facts, current law and our judgment. The carried reserve may differ from the actuarial point
estimate as the result of our consideration of the factors noted above as well as the potential
volatility of the projections associated with the specific product being analyzed and other factors
impacting claims costs that may not be quantifiable through traditional actuarial analysis. This
process results in managements best estimate which is then recorded as the loss reserve.
Currently, our reserves are slightly higher than the actuarial point estimate. We do not establish
a specific provision for uncertainty. For Standard and Specialty Lines, the difference between our
reserves and the actuarial point estimate is primarily due to the three most recent accident
years. The claim data from these accident years is very immature. We believe it is prudent to
wait until actual experience confirms that the loss reserves should be adjusted. For Corporate &
Other Non-Core, the carried reserve is slightly higher than the actuarial point estimate. For A&E
exposures, we feel it is prudent, based on the history of developments in this area and the
volatility associated with the reserves, to be above the point estimate until the ultimate outcome
of the issues associated with these exposures is clearer.
The key assumptions fundamental to the reserving process are often different for various products
and accident years. Some of these assumptions are explicit assumptions that are required of a
particular method, but most of the assumptions are implicit and cannot be precisely quantified. An
example of an explicit assumption is the pattern employed in the paid development method. However,
the assumed pattern is itself based on several implicit assumptions such as the impact of inflation
on medical costs and the rate at which claim professionals close claims. As a result, the effect
on reserve estimates of a particular change in assumptions usually cannot be specifically
quantified, and changes in these assumptions cannot be tracked over time.
Our recorded reserves are managements best estimate. In order to provide an indication of the
variability associated with our net reserves, the following discussion provides a sensitivity
analysis that shows the approximate estimated impact of variations in the most significant factor
affecting our reserve estimates for particular types of business. These significant factors are
the ones that could most likely materially impact the reserves. This discussion covers the major
types of business for which we believe a material deviation to our reserves is reasonably possible.
There can be no assurance that actual experience will be consistent with the current assumptions
or with the variation indicated by the discussion. In addition, there can be no assurance that
other factors and assumptions will not have a material impact on our reserves.
Within Standard Lines, the two types of business for which we believe a material deviation to our
net reserves is reasonably possible are workers compensation and general liability.
For Standard Lines workers compensation, since many years will pass from the time the business is
written until all claim payments have been made, claim cost inflation on claim payments is the most
significant factor affecting workers compensation reserve estimates. Workers compensation claim
cost inflation is driven by the cost of medical care, the cost of wage replacement, expected
claimant lifetimes, judicial decisions, legislative changes and other factors. If estimated
workers compensation claim cost inflation increases by one point for the entire period over which
claim payments will be made, we estimate that our net reserves would increase by approximately
$450 million. If estimated workers compensation claim cost inflation decreases by one point for
the entire period over which claim payments will be made, we estimate that our net reserves would
decrease by approximately $400 million. Our net reserves for Standard Lines workers compensation
were approximately $4.5 billion at December 31, 2007.
For Standard Lines general liability, the predominant method used for estimating reserves is the
incurred development method. Changes in the cost to repair or replace property, the cost of
medical care, the cost of wage replacement, judicial decisions, legislation and other factors all
impact the pattern selected in this method. The pattern selected results in the incurred
development factor that estimates future changes in case incurred loss. If the estimated incurred
development factor for general liability increases by 13%, we estimate that our net reserves would
increase by approximately $300 million. If the estimated incurred development factor for general
liability decreases by 9%, we estimate that our net reserves would decrease by approximately $200
million. Our net reserves for Standard Lines general liability were approximately $3.5 billion at
December 31, 2007.
Within Specialty Lines, we believe a material deviation to our net reserves is reasonably possible
for professional liability and related business in the U.S. Specialty Lines group. This business
includes
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professional liability coverages provided to various professional firms, including architects,
realtors, small and mid-sized accounting firms, law firms and technology firms. This business also
includes D&O, employment practices, fiduciary and fidelity coverages as well as insurance products
serving the healthcare delivery system. The most significant factor affecting reserve estimates
for this business is claim severity. Claim severity is driven by the cost of medical care, the
cost of wage replacement, legal fees, judicial decisions, legislation and other factors.
Underwriting and claim handling decisions such as the classes of business written and individual
claim settlement decisions can also impact claim severity. If the estimated claim severity
increases by 7%, we estimate that the net reserves would increase by approximately $300 million.
If the estimated claim severity decreases by 2%, we estimate that net reserves would decrease by
approximately $100 million. Our net reserves for this business were approximately $4.4 billion at
December 31, 2007.
Within Corporate & Other Non-Core, the two types of business for which we believe a material
deviation to our net reserves is reasonably possible are CNA Re and A&E.
For CNA Re, the predominant method used for estimating reserves is the incurred development method.
Changes in the cost to repair or replace property, the cost of medical care, the cost of wage
replacement, the rate at which ceding companies report claims, judicial decisions, legislation and
other factors all impact the incurred development pattern for CNA Re. The pattern selected results
in the incurred development factor that estimates future changes in case incurred loss. If the
estimated incurred development factor for CNA Re increases by 22%, we estimate that our net
reserves for CNA Re would increase by approximately $150 million. If the estimated incurred
development factor for CNA Re decreases by 22%, we estimate that our net reserves would decrease by
approximately $150 million. Our net reserves for CNA Re were approximately $1.0 billion at
December 31, 2007.
For A&E, the most significant factor affecting reserve estimates is overall account size trend.
Overall account size trend for A&E reflects the combined impact of economic trends (inflation),
changes in the types of defendants involved, the expected mix of asbestos disease types, judicial
decisions, legislation and other factors. If the estimated overall account size trend for A&E
increases by 4 points, we estimate that our A&E net reserves would increase by approximately $350
million. If the estimated overall account size trend for A&E decreases by 4 points, we estimate
that our A&E net reserves would decrease by approximately $250 million. Our net reserves for A&E
were approximately $1.6 billion at December 31, 2007.
Given the factors described above, it is not possible to quantify precisely the ultimate exposure
represented by claims and related litigation. As a result, we regularly review the adequacy of our
reserves and reassess our reserve estimates as historical loss experience develops, additional
claims are reported and settled and additional information becomes available in subsequent periods.
In light of the many uncertainties associated with establishing the estimates and making the
assumptions necessary to establish reserve levels, we review our reserve estimates on a regular
basis and make adjustments in the period that the need for such adjustments is determined. These
reviews have resulted in our identification of information and trends that have caused us to
increase our reserves in prior periods and could lead to the identification of a need for
additional material increases in claim and claim adjustment expense reserves, which could
materially adversely affect our results of operations, equity, business and insurer financial
strength and debt ratings. See the Ratings section of this MD&A for further information regarding
our financial strength and debt ratings.
Reinsurance
Due to significant catastrophes during 2005, the cost of our catastrophe reinsurance program has
increased. Our catastrophe reinsurance protection cost us $93 million and $79 million in 2007 and
2006, neither of which included reinstatement premiums. Currently, the 2008 catastrophe
reinsurance program will cost us $55 million before the impact of any reinstatement premiums.
The terms of our 2008 catastrophe programs are different than those of our 2007 programs. The
Corporate Property Catastrophe treaty provides coverage for the accumulation of losses between $300
million and $900 million arising out of a single catastrophe occurrence in the United States, its
territories and possessions, and Canada. Our co-participation is 35% of the first $100 million
layer of the coverage provided and 5% of the remaining layers. Additional protection above $900 million may be purchased in
either the traditional reinsurance or financial markets prior to June 1, 2008 depending on market
conditions.
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Further information on our reinsurance program is included in Note H of the Consolidated Financial
Statements included under Item 8.
Restructuring
In 2001, we finalized and approved a plan related to restructuring the property and casualty
segments and Life & Group Non-Core segment, discontinuation of our variable life and annuity
business and consolidation of real estate locations. During 2006, we reevaluated the sufficiency
of the remaining accrual, which related to lease termination costs, and determined that the
liability was no longer required as we had completed our lease obligations. As a result, the
excess remaining accrual was released in 2006, resulting in income of $8 million after-tax for the
year ended December 31, 2006.
Segment Results
The following discusses the results of continuing operations for our operating segments.
CNAs core property and casualty commercial insurance operations are reported in two business
segments: Standard Lines and Specialty Lines. As a result of our realignment of management
responsibilities in the fourth quarter of 2007, we have revised our property and casualty segments
as if the current segment changes occurred as of the beginning of the earliest period presented.
Standard Lines includes standard property and casualty coverages sold to small businesses and
middle market entities and organizations in the U.S. primarily through an independent agency
distribution system. Standard Lines also includes commercial insurance and risk management
products sold to large corporations in the U.S. primarily through insurance brokers. Specialty
Lines provides a broad array of professional, financial and specialty property and casualty
products and services, including excess and surplus lines, primarily through insurance brokers and
managing general underwriters. Specialty Lines also includes insurance coverages sold globally
through our foreign operations (CNA Global). Previously, excess and surplus lines and CNA Global
were included in Standard Lines.
Standard Lines previously included other revenues and expenses related to claim services provided
by CNA ClaimPlus, Inc. to other units within the Standard Lines segment because these revenues and
expenses were eliminated at the consolidated level. These amounts are now eliminated within
Standard Lines for all periods presented.
Our property and casualty field structure consists of 33 branch locations across the country
organized into 2 territories. Each branch provides the marketing, underwriting and risk control
expertise on the entire portfolio of products. The Centralized Processing Operation for small and
middle-market customers, located in Maitland, Florida, handles policy processing, billing and
collection activities, and also acts as a call center to optimize customer service. The claims
structure consists of a centralized claim center designed to efficiently handle property damage and
medical only claims and 14 claim office locations around the country handling the more complex
claims.
We utilize the net operating income financial measure to monitor our operations. Net operating
income is calculated by excluding from net income the after-tax effects of 1) net realized
investment gains or losses, 2) income or loss from discontinued operations and 3) any cumulative
effects of changes in accounting principles. See further discussion regarding how we manage our
business in Note N of the Consolidated Financial Statements included under Item 8. In evaluating
the results of our Standard Lines and Specialty Lines 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 costs, 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.
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STANDARD LINES
Business Overview
Standard Lines works with an independent agency distribution system and network of brokers to
market a broad range of property and casualty insurance products and services primarily to small,
middle-market and large businesses and organizations domestically. The Standard Lines operating
model focuses on underwriting performance, relationships with selected distribution sources and
understanding customer needs. Property products provide standard and excess property coverages, as
well as marine coverage, and boiler and machinery. Casualty products provide standard casualty
insurance products such as workers compensation, general and product liability and commercial auto
coverage through traditional products. Most insurance programs are provided on a guaranteed cost
basis; however, we have the capability to offer specialized, loss-sensitive insurance programs to
those customers viewed as higher risk and less predictable in exposure.
These property and casualty products are offered as part of our Business and Commercial insurance
groups. Our Business insurance group serves our smaller commercial accounts and the Commercial
insurance group serves our middle markets and our larger risks. In addition, Standard Lines
provides total risk management services relating to claim and information services to the large
commercial insurance marketplace, through a wholly-owned subsidiary, CNA ClaimPlus, Inc., a third
party administrator.
The following table details results of operations for Standard Lines.
Results of Operations
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions) | ||||||||||||
Net written premiums |
$ | 3,267 | $ | 3,598 | $ | 3,473 | ||||||
Net earned premiums |
3,379 | 3,557 | 3,518 | |||||||||
Net investment income |
878 | 840 | 632 | |||||||||
Net operating income (loss) |
602 | 446 | (87 | ) | ||||||||
Net realized investment gains (losses), after-tax |
(97 | ) | 48 | 19 | ||||||||
Net income (loss) |
505 | 494 | (68 | ) | ||||||||
Ratios |
||||||||||||
Loss and loss adjustment expense |
67.4 | % | 72.5 | % | 90.3 | % | ||||||
Expense |
32.5 | 31.6 | 32.7 | |||||||||
Dividend |
0.2 | 0.5 | 0.6 | |||||||||
Combined |
100.1 | % | 104.6 | % | 123.6 | % | ||||||
2007 Compared with 2006
Net written premiums for Standard Lines decreased $331 million in 2007 as compared with 2006,
primarily due to decreased production. The decreased production reflects our disciplined
participation in the current competitive market. The competitive market conditions are expected to
put ongoing pressure on premium and income levels, and the expense ratio. Net earned premiums
decreased $178 million in 2007 as compared with 2006, consistent with the decreased premiums
written.
Standard Lines averaged rate decreases of 4% for 2007, as compared to flat rates for 2006 for the
contracts that renewed during those periods. Retention rates of 79% and 81% were achieved for
those contracts that were available for renewal in each period.
Net income increased $11 million in 2007 as compared with 2006. This increase was primarily
attributable to improved net operating income, offset by decreased net realized investment results.
See the Investments section of this MD&A for further discussion of net investment income and net
realized investment results.
Net operating income increased $156 million in 2007 as compared with 2006. This increase was
primarily driven by favorable net prior year development in 2007 as compared to unfavorable net
prior year development in 2006 and increased net investment income. These favorable impacts were
partially offset by decreased current accident year underwriting results including increased
catastrophe losses. Catastrophe losses were $48 million after-tax in 2007, as compared to $35
million after-tax in 2006.
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The combined ratio improved 4.5 points in 2007 as compared with 2006. The loss ratio improved 5.1
points primarily due to favorable net prior year development in 2007 as compared to unfavorable net
prior year development in 2006. This favorable impact was partially offset by higher current
accident year loss ratios primarily related to the decline in rates.
The dividend ratio improved 0.3 points in 2007 as compared with 2006 due to favorable dividend
development in the workers compensation line of business.
The expense ratio increased 0.9 points in 2007 as compared with 2006, primarily reflecting the
impact of declining earned premiums.
Favorable net prior year development of $123 million was recorded in 2007, including $104 million
of favorable claim and allocated claim adjustment expense reserve development and $19 million of
favorable premium development. Unfavorable net prior year development of $150 million, including
$208 million of unfavorable claim and allocated claim adjustment expense reserve development and
$58 million of favorable premium development, was recorded in 2006. Further information on
Standard Lines Net Prior Year Development for 2007 and 2006 is included in Note F of the
Consolidated Financial Statements included under Item 8.
The following table summarizes the gross and net carried reserves as of December 31, 2007 and 2006
for Standard Lines.
Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
Claim and Claim Adjustment Expense Reserves
December 31 | 2007 | 2006 | ||||||
(In millions) | ||||||||
Gross Case Reserves |
$ | 5,988 | $ | 5,826 | ||||
Gross IBNR Reserves |
6,060 | 6,691 | ||||||
Total Gross Carried Claim and Claim Adjustment Expense Reserves |
$ | 12,048 | $ | 12,517 | ||||
Net Case Reserves |
$ | 4,750 | $ | 4,571 | ||||
Net IBNR Reserves |
5,170 | 5,543 | ||||||
Total Net Carried Claim and Claim Adjustment Expense Reserves |
$ | 9,920 | $ | 10,114 | ||||
2006 Compared with 2005
Net written premiums for Standard Lines increased $125 million in 2006 as compared with 2005. This
increase was primarily driven by favorable new business, rate and retention in the property
products. Net earned premiums increased $39 million in 2006 as compared with 2005, consistent with
the increased premiums written.
Standard Lines averaged flat rates for 2006, as compared to decreases of 2% for 2005 for the
contracts that renewed during those periods. Retention rates of 81% and 76% were achieved for
those contracts that were up for renewal in each period.
Net results increased $562 million in 2006 as compared with 2005. This increase was attributable
to increases in net operating results and net realized investment gains. See the Investments
section of this MD&A for further discussion of net investment income and net realized investment
gains.
Net operating results increased $533 million in 2006 as compared with 2005. This increase was
primarily driven by significantly reduced catastrophe losses in 2006, an increase in net investment
income and a decrease in unfavorable net prior year development as discussed below. The 2006 net
operating results included catastrophe impacts of $31 million after-tax. The 2005 net operating
results included catastrophe impacts of $318 million after-tax related to Hurricanes Katrina,
Wilma, Rita, Dennis and Ophelia, net of reinsurance recoveries.
The combined ratio improved 19.0 points in 2006 as compared with 2005. The loss ratio improved
17.8 points due to decreased unfavorable net prior year development as discussed below and
decreased catastrophe losses in 2006. The 2006 and 2005 loss ratios included 1.5 and 13.9 points
related to the impact of catastrophes.
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The expense ratio improved 1.1 points in 2006 as compared with 2005. This improvement was
primarily due to a decrease in the provision for insurance bad debt. In addition, the 2005 ratio
included increased ceded commissions as a result of an unfavorable arbitration ruling related to
two reinsurance treaties. Changes in estimates for premium taxes partially offset these favorable
impacts.
Unfavorable net prior year development of $150 million was recorded in 2006, including $208 million
of unfavorable claim and allocated claim adjustment expense reserve development and $58 million of
favorable premium development. Unfavorable net prior year development of $403 million, including
$433 million of unfavorable claim and allocated claim adjustment expense reserve development and
$30 million of favorable premium development, was recorded in 2005. Further information on
Standard Lines Net Prior Year Development for 2006 and 2005 is included in Note F of the
Consolidated Financial Statements included under Item 8.
During 2006 and 2005, we commuted several significant reinsurance contracts that resulted in
unfavorable development of $110 million and $255 million, which is included in the development
above, and which was partially offset by the release of previously established allowance for
uncollectible reinsurance. These commutations resulted in an unfavorable after-tax impact of $31
million and $152 million in 2006 and 2005. Several of the commuted contracts contained interest
crediting provisions. The interest charges associated with the reinsurance contracts commuted were
$9 million after-tax and $40 million after-tax in 2006 and 2005. The 2005 amount includes the
interest charges associated with the contract commuted in 2006. There will be no further interest
crediting charges related to these commuted contracts in future periods.
SPECIALTY LINES
Business Overview
Specialty Lines provides professional, financial and specialty property and casualty products and
services, both domestically and abroad, through a network of brokers, managing general underwriters
and independent agencies. Specialty Lines provides solutions for managing the risks of its
clients, including architects, lawyers, accountants, healthcare professionals, financial
intermediaries and public and private companies. Product offerings also include surety and
fidelity bonds, and vehicle warranty services.
Specialty Lines includes the following business groups:
U.S. Specialty Lines provides management and professional liability insurance and risk management
services and other specialized property and casualty coverages, primarily in the United States.
This group provides professional liability coverages to various professional firms, including
architects, realtors, small and mid-sized accounting firms, law firms and technology firms. U.S.
Specialty Lines also provides D&O, employment practices, fiduciary and fidelity coverages.
Specific areas of focus include small and mid-size firms as well as privately held firms and
not-for-profit organizations where tailored products for this client segment are offered. Products
within U.S. Specialty Lines are distributed through brokers, agents and managing general
underwriters.
U.S. Specialty Lines, through CNA HealthPro, also offers insurance products to serve the healthcare
delivery system. Products, which include professional liability as well as associated standard
property and casualty coverages, are distributed on a national basis through a variety of channels
including brokers, agents and managing general underwriters. Key customer segments include long
term care facilities, allied healthcare providers, life sciences, dental professionals and mid-size
and large healthcare facilities and delivery systems.
Also included in U.S. Specialty Lines is Excess and Surplus (E&S). E&S provides specialized
insurance and other financial products for selected commercial risks on both an individual customer
and program basis. Customers insured by E&S are generally viewed as higher risk and less
predictable in exposure than those covered by standard insurance markets. E&Ss products are
distributed throughout the United States through specialist producers, program agents and brokers.
Surety consists primarily of CNA Surety and its insurance subsidiaries and offers small, medium and
large contract and commercial surety bonds. CNA Surety provides surety and fidelity bonds in all
50 states through a combined network of independent agencies. CNA owns approximately 62% of CNA
Surety.
Warranty provides vehicle warranty service contracts that protect individuals from the financial
burden associated with mechanical breakdown.
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CNA Global consists of subsidiaries operating in Europe, Latin America, Canada and Hawaii. These
affiliates offer property and casualty insurance to small and medium size businesses and capitalize
on strategic indigenous opportunities.
The following table details results of operations for Specialty Lines.
Results of Operations
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions) | ||||||||||||
Net written premiums |
$ | 3,506 | $ | 3,431 | $ | 3,372 | ||||||
Net earned premiums |
3,484 | 3,411 | 3,367 | |||||||||
Net investment income |
621 | 554 | 416 | |||||||||
Net operating income |
619 | 635 | 382 | |||||||||
Net realized investment gains (losses), after-tax |
(53 | ) | 25 | 2 | ||||||||
Net income |
566 | 660 | 384 | |||||||||
Ratios |
||||||||||||
Loss and loss adjustment expense |
62.8 | % | 60.4 | % | 68.3 | % | ||||||
Expense |
26.7 | 27.4 | 27.4 | |||||||||
Dividend |
0.2 | 0.1 | 0.1 | |||||||||
Combined |
89.7 | % | 87.9 | % | 95.8 | % | ||||||
2007 Compared with 2006
Net written premiums for Specialty Lines increased $75 million in 2007 as compared with 2006.
Premiums written were unfavorably impacted by decreased production as compared with the same period
in 2006. The decreased production reflects our disciplined participation in the current
competitive market. The competitive market conditions are expected to put ongoing pressure on
premium and income levels, and the expense ratio. This unfavorable impact was more than offset by
decreased ceded premiums. The U.S. Specialty Lines reinsurance structure was primarily quota share
reinsurance through April 2007. We elected not to renew this coverage upon its expiration. With
our current diversification in the previously reinsured lines of business and our management of the
gross limits on the business written, we did not believe the cost of renewing the program was
commensurate with its projected benefit. Net earned premiums increased $73 million as compared
with the same period in 2006, consistent with the increased net premiums written.
Specialty Lines averaged rate decreases of 3% for 2007, as compared to decreases of 1% for 2006 for
the contracts that renewed during those periods. Retention rates of 83% and 85% were achieved for
those contracts that were up for renewal in each period.
Net income decreased $94 million in 2007 as compared with 2006. This decrease was primarily
attributable to decreases in net realized investment results. See the Investments section of this
MD&A for further discussion of net investment income and net realized investment results.
Net operating income decreased $16 million in 2007 as compared with 2006. This decrease was
primarily driven by decreased current accident year underwriting results and less favorable net
prior year development. These decreases were partially offset by increased net investment income
and favorable experience in the warranty line of business.
The combined ratio increased 1.8 points in 2007 as compared with 2006. The loss ratio increased
2.4 points, primarily due to higher current accident year losses related to the decline in rates
and less favorable net prior year development as discussed below.
The expense ratio improved 0.7 points in 2007 as compared with 2006. This improvement was
primarily due to a favorable change in estimate related to dealer profit commissions in the
warranty line of business.
Favorable net prior year development of $36 million was recorded in 2007, including $25 million of
favorable claim and allocated claim adjustment expense reserve development and $11 million of
favorable premium development. Favorable net prior year development of $66 million, including $61
million of favorable claim and allocated claim adjustment expense reserve development and $5
million of favorable premium
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development, was recorded in 2006. Further information on Specialty
Lines Net Prior Year Development for 2007 and 2006 is included in Note F of the Consolidated
Financial Statements included under Item 8.
The following table summarizes the gross and net carried reserves as of December 31, 2007
and 2006 for Specialty Lines.
Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
Claim and Claim Adjustment Expense Reserves
December 31 | 2007 | 2006 | ||||||
(In millions) | ||||||||
Gross Case Reserves |
$ | 2,585 | $ | 2,635 | ||||
Gross IBNR Reserves |
5,818 | 5,311 | ||||||
Total Gross Carried Claim and Claim Adjustment Expense Reserves |
$ | 8,403 | $ | 7,946 | ||||
Net Case Reserves |
$ | 2,090 | $ | 2,013 | ||||
Net IBNR Reserves |
4,527 | 4,010 | ||||||
Total Net Carried Claim and Claim Adjustment Expense Reserves |
$ | 6,617 | $ | 6,023 | ||||
2006 Compared with 2005
Net written premiums for Specialty Lines increased $59 million in 2006 as compared with 2005. This
increase was primarily due to improved production across certain lines of business. Net earned
premiums increased $44 million in 2006 as compared with 2005, consistent with the increased premium
written.
Specialty Lines averaged rate decreases of 1% for 2006, as compared to increases of 1% for 2005 for
the contracts that renewed during those periods. Retention rates of 85% and 84% were achieved for
those contracts that were up for renewal in each period.
Net income increased $276 million in 2006 as compared with 2005. This increase was attributable to
increases in net operating income and net realized investment gains. See the Investments section
of this MD&A for further discussion of net investment income and net realized investment results.
Net operating income increased $253 million in 2006 as compared with 2005. This improvement was
primarily driven by an increase in net investment income, a decrease in net prior year development
as discussed below and reduced catastrophe impacts in 2006. Catastrophe impacts were $1 million
after-tax for the year ended December 31, 2006, as compared to $16 million after-tax for the year
ended December 31, 2005. The 2005 results also included a $59 million loss, after the impact of
taxes and minority interests, in the surety line of business related to a large national
contractor. Further information related to the large national contractor is included in Note R of
the Consolidated Financial Statements included under Item 8.
The combined ratio improved 7.9 points in 2006 as compared with 2005. The loss ratio improved
7.9 points, due to decreased net prior year development as discussed below and improved current
accident year impacts. The 2005 loss ratio was unfavorably impacted by surety losses of $110
million, before the impacts of minority interest, related to a national contractor as discussed
above. Partially offsetting this favorable impact was less favorable current accident year loss
ratios across several other lines of business in 2006.
Favorable net prior year development of $66 million was recorded in 2006, including $61 million of
favorable claim and allocated claim adjustment expense reserve development and $5 million of
favorable premium development. Unfavorable net prior year development of $103 million, including
$173 million of unfavorable claim and allocated claim adjustment expense reserve development and
$70 million of favorable premium
development, was recorded in 2005. Further information on Specialty Lines Net Prior Year
Development for 2006 and 2005 is included in Note F of the Consolidated Financial Statements
included under Item 8.
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LIFE & GROUP NON-CORE
Business Overview
The Life & Group Non-Core segment primarily includes the results of the life and group lines of
business that have either been sold or placed in run-off. We continue to service our existing
individual long term care commitments, our payout annuity business and our pension deposit
business. We also manage a block of group reinsurance and life settlement contracts. These
businesses are being managed as a run-off operation. Our group long term care and indexed group
annuity contracts, while considered non-core, continue to be actively marketed.
The following table summarizes the results of operations for Life & Group Non-Core.
Results of Operations
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions) | ||||||||||||
Net earned premiums |
$ | 618 | $ | 641 | $ | 704 | ||||||
Net investment income |
622 | 698 | 593 | |||||||||
Net operating loss |
(159 | ) | (14 | ) | (51 | ) | ||||||
Net realized investment losses, after-tax |
(36 | ) | (33 | ) | (19 | ) | ||||||
Net loss |
(195 | ) | (47 | ) | (70 | ) |
2007 Compared with 2006
Net earned premiums for Life & Group Non-Core decreased $23 million in 2007 as compared with 2006.
The 2007 and 2006 net earned premiums relate primarily to the group and individual long term care
businesses.
The net loss increased $148 million in 2007 as compared with 2006. The increase in net loss was
primarily due to the after-tax loss of $108 million related to the settlement of the IGI
contingency. The IGI contingency related to reinsurance arrangements with respect to personal
accident insurance coverages provided between 1997 and 1999 which were the subject of arbitration
proceedings. We reached agreement in 2007 to settle the arbitration matter for a one-time payment
of $250 million, which resulted in an incurred loss, net of reinsurance, of $167 million pretax.
The decreased net investment income included a decline of net investment income in the trading
portfolio of $92 million, a significant portion of which was offset by a corresponding decrease in
the policyholders funds reserves supported by the trading portfolio. The trading portfolio
supports our pension deposit business, which experienced a decline in net results of $33 million in
2007 compared to 2006. See the Investments section of this MD&A for further discussion of net
investment income and net realized investment results.
2006 Compared with 2005
Net earned premiums for Life & Group Non-Core decreased $63 million in 2006 as compared with 2005.
Net loss decreased $23 million in 2006 as compared with 2005, driven by increased net investment
income. A significant portion of the increase in net investment income was offset by a
corresponding increase in the policyholders funds reserves supported by the trading portfolio.
The portion not offset by the policyholders funds reserves increased by $25 million. Also
impacting net loss was $15 million of income related to the resolution of contingencies and the
absence of a $17 million provision recorded in 2005 for estimated indemnification liabilities
related to the sold individual life business. Partially offsetting these favorable impacts were
increased net realized investment losses and the absence of income related to agreements with
buyers of sold businesses, which ended as of December 31, 2005. In addition, the 2005 net results
included a change in estimate, which reduced a prior accrual of state premium taxes. See the
Investments section of this MD&A for further discussion of net investment income and net realized
investment results.
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CORPORATE & OTHER NON-CORE
Overview
Corporate & Other Non-Core primarily includes certain corporate expenses, including interest on
corporate debt, and the results of certain property and casualty business primarily in run-off,
including CNA Re. This segment also includes the results related to the centralized adjusting and
settlement of A&E claims.
The following table summarizes the results of operations for the Corporate & Other Non-Core
segment, including intrasegment eliminations.
Results of Operations
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions) | ||||||||||||
Net investment income |
$ | 312 | $ | 320 | $ | 251 | ||||||
Revenues |
298 | 355 | 376 | |||||||||
Net operating income (loss) |
(2 | ) | 3 | 9 | ||||||||
Net realized investment gains (losses), after-tax |
(17 | ) | 27 | (12 | ) | |||||||
Net income (loss) |
(19 | ) | 30 | (3 | ) |
2007 Compared with 2006
Revenues decreased $57 million in 2007 as compared with 2006. Revenues were unfavorably impacted
by decreased net realized investment results. See the Investments section of this MD&A for further
discussion of net investment income and net realized investment results.
Net results decreased $49 million in 2007 as compared with 2006. The decrease in net results was
primarily due to decreased revenues as discussed above, increased current accident year losses
related to certain mass torts and an increase in interest costs on corporate debt. In addition,
the 2006 results included a release of a restructuring accrual. These unfavorable impacts were
partially offset by a change in estimate related to federal taxes and lower expenses.
Unfavorable net prior year development of $86 million was recorded during 2007, including $91
million of unfavorable net prior year claim and allocated claim adjustment expense reserve
development and $5 million of favorable premium development. Unfavorable net prior year
development of $88 million was recorded in 2006, including $86 million of unfavorable net prior
year claim and allocated claim adjustment expense reserve development and $2 million of unfavorable
premium development. Further information on Corporate & Other Non-Cores Net Prior Year
Development for 2007 and 2006 is included in Note F of the Consolidated Financial Statements
included under Item 8.
The following table summarizes the gross and net carried reserves as of December 31, 2007 and 2006
for Corporate & Other Non-Core.
Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
Claim and Claim Adjustment Expense Reserves
December 31 | 2007 | 2006 | ||||||
(In millions) | ||||||||
Gross Case Reserves |
$ | 2,159 | $ | 2,511 | ||||
Gross IBNR Reserves |
2,951 | 3,528 | ||||||
Total Gross Carried Claim and Claim Adjustment Expense Reserves |
$ | 5,110 | $ | 6,039 | ||||
Net Case Reserves |
$ | 1,328 | $ | 1,453 | ||||
Net IBNR Reserves |
1,787 | 1,999 | ||||||
Total Net Carried Claim and Claim Adjustment Expense Reserves |
$ | 3,115 | $ | 3,452 | ||||
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2006 Compared with 2005
Revenues decreased $21 million in 2006 as compared with 2005. Revenues in 2006 and 2005 included
interest income related to federal income tax settlements of $4 million and $121 million as further
discussed in Note E to the Consolidated Financial Statements included under Item 8. This decrease
was substantially offset by increased net investment income and improved net realized investment
results. See the Investments section of this MD&A for further discussion of net investment income
and net realized investment results.
Net results increased $33 million in 2006 as compared with 2005. The improvement was primarily
driven by a decrease in unfavorable net prior year development as discussed further below.
Offsetting this favorable impact was an increase in current accident year losses related to certain
mass torts, discontinuation of royalty income related to a sold business and increased interest
costs related to the issuance of $750 million of senior notes in August 2006.
Unfavorable net prior year development of $88 million was recorded during 2006, including $86
million of unfavorable net prior year claim and allocated claim adjustment expense reserve
development and $2 million of unfavorable premium development. Unfavorable net prior year
development of $306 million was recorded in 2005, including $291 million of unfavorable net prior
year claim and allocated claim adjustment expense reserve development and $15 million of
unfavorable premium development. Further information on Corporate & Other Non-Cores Net Prior
Year Development for 2006 and 2005 is included in Note F of the Consolidated Financial Statements
included under Item 8.
During 2005, we commuted several significant reinsurance contracts that resulted in unfavorable
development of $118 million, which is included in the development above. These commutations
resulted in unfavorable impacts of $71 million after-tax in 2005. These contracts contained
interest crediting provisions and maintenance charges. Interest charges associated with the
reinsurance contracts commuted were $13 million after-tax in 2005. There will be no further
interest crediting charges or other charges related to these commuted contracts in future periods.
A&E Reserves
Our property and casualty insurance subsidiaries have actual and potential exposures related to
asbestos and environmental pollution (A&E) claims.
Establishing reserves for A&E claim and claim adjustment expenses is subject to uncertainties that
are greater than those presented by other claims. Traditional actuarial methods and techniques
employed to estimate the ultimate cost of claims for more traditional property and casualty
exposures are less precise in estimating claim and claim adjustment expense reserves for A&E,
particularly in an environment of emerging or potential claims and coverage issues that arise from
industry practices and legal, judicial, and social conditions. Therefore, these traditional
actuarial methods and techniques are necessarily supplemented with additional estimating techniques
and methodologies, many of which involve significant judgments that are required on our part.
Accordingly, a high degree of uncertainty remains for our ultimate liability for A&E claim and
claim adjustment expenses.
In addition to the difficulties described above, estimating the ultimate cost of both reported and
unreported A&E claims is subject to a higher degree of variability due to a number of additional
factors, including among others: the number and outcome of direct actions against us; coverage
issues, including whether certain costs are covered under the policies and whether policy limits
apply; allocation of liability among numerous parties, some of whom may be in bankruptcy
proceedings, and in particular the application of joint and several liability to specific
insurers on a risk; inconsistent court decisions and developing legal theories; continuing
aggressive tactics of plaintiffs lawyers; the risks and lack of predictability inherent in major
litigation; enactment of state and federal legislation to address asbestos claims; the potential
for increases and decreases in A&E claims which cannot now be anticipated; the potential for
increases and decreases in costs to defend A&E claims; the possibility of expanding theories of
liability against our policyholders in A&E matters; possible exhaustion of underlying umbrella and
excess coverage; and future developments pertaining to our ability to recover reinsurance for A&E
claims.
Due to the inherent uncertainties in estimating claim and claim adjustment expense reserves for A&E
and due to the significant uncertainties described related to A&E claims, our ultimate liability
for these cases, both individually and in aggregate, may exceed the recorded reserves. Any such
potential additional liability, or any range of potential additional amounts, cannot be reasonably
estimated currently, but could be material to our
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business, results of operations, equity, and insurer financial strength and debt ratings. Due to,
among other things, the factors described above, it may be necessary for us to record material
changes in our A&E claim and claim adjustment expense reserves in the future, should new
information become available or other developments emerge.
We have annually performed ground up reviews of all open A&E claims to evaluate the adequacy of our
A&E reserves. In performing our comprehensive ground up analysis, we consider input from our
professionals with direct responsibility for the claims, inside and outside counsel with
responsibility for our representation and our actuarial staff. These professionals consider, among
many factors, the policyholders present and predicted future exposures, including such factors as
claims volume, trial conditions, prior settlement history, settlement demands and defense costs;
the impact of asbestos defendant bankruptcies on the policyholder; facts or allegations regarding
the policies we issued or are alleged to have issued, including such factors as aggregate or per
occurrence limits, whether the policy is primary, umbrella or excess, and the existence of
policyholder retentions and/or deductibles; the policyholders allegations; the existence of other
insurance; and reinsurance arrangements.
Further information on A&E claim and claim adjustment expense reserves and net prior year
development is included in Note F of the Consolidated Financial Statements included under Item 8.
The following table provides data related to our A&E claim and claim adjustment expense reserves.
A&E Reserves
December 31, 2007 | December 31, 2006 | |||||||||||||||
Environmental | Environmental | |||||||||||||||
Asbestos | Pollution | Asbestos | Pollution | |||||||||||||
(In millions) | ||||||||||||||||
Gross reserves |
$ | 2,352 | $ | 367 | $ | 2,635 | $ | 427 | ||||||||
Ceded reserves |
(1,030 | ) | (125 | ) | (1,183 | ) | (142 | ) | ||||||||
Net reserves |
$ | 1,322 | $ | 242 | $ | 1,452 | $ | 285 | ||||||||
Asbestos
In the past several years, we experienced, at certain points in time, significant increases in
claim counts for asbestos-related claims. The factors that led to these increases included, among
other things, intensive advertising campaigns by lawyers for asbestos claimants, mass medical
screening programs sponsored by plaintiff lawyers and the addition of new defendants such as the
distributors and installers of products containing asbestos. In recent years, the rate of new
filings has decreased. Various challenges to mass screening claimants have been successful.
Historically, the majority of asbestos bodily injury claims have been filed by persons exhibiting
few, if any, disease symptoms. Studies have concluded that the percentage of unimpaired claimants
to total claimants ranges between 66% and up to 90%. Some courts and some state statutes mandate
that so-called unimpaired claimants may not recover unless at some point the claimants condition
worsens to the point of impairment. Some plaintiffs classified as unimpaired continue to
challenge those orders and statutes. Therefore, the ultimate impact of the orders and statutes on
future asbestos claims remains uncertain.
Despite the decrease in new claim filings in recent years, there are several factors, in our view,
negatively impacting asbestos claim trends. Plaintiff attorneys who previously sued entities that
are now bankrupt continue to seek other viable targets. As plaintiff attorneys named additional
defendants to new and existing asbestos bodily injury lawsuits, we experienced an increase in the
total number of policyholders with current asbestos claims. Companies with few or no previous
asbestos claims are becoming targets in asbestos litigation and, although they may have little or
no liability, nevertheless must be defended. Additionally, plaintiff attorneys and trustees for
future claimants are demanding that policy limits be paid lump-sum into the bankruptcy asbestos
trusts prior to presentation of valid claims and medical proof of these claims. Various challenges
to these practices have succeeded in litigation, and are continuing to be litigated. Plaintiff
attorneys and trustees for future claimants are also attempting to devise claims payment procedures
for bankruptcy trusts that would allow asbestos claims to be paid under lax standards for injury,
exposure and causation. This also
presents the potential for exhausting policy limits in an accelerated fashion. Challenges to these
practices are being mounted, though the ultimate impact or success of these tactics remains
uncertain.
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We have resolved a number of our large asbestos accounts by negotiating settlement agreements.
Structured settlement agreements provide for payments over multiple years as set forth in each
individual agreement.
In 1985, 47 asbestos producers and their insurers, including The Continental Insurance Company
(CIC), executed the Wellington Agreement. The agreement was intended to resolve all issues and
litigation related to coverage for asbestos exposures. Under this agreement, signatory insurers
committed scheduled policy limits and made the limits available to pay asbestos claims based upon
coverage blocks designated by the policyholders in 1985, subject to extension by policyholders.
CIC was a signatory insurer to the Wellington Agreement.
We have also used coverage in place agreements to resolve large asbestos exposures. Coverage in
place agreements are typically agreements between us and our policyholders identifying the policies
and the terms for payment of asbestos related liabilities. Claim payments are contingent on
presentation of adequate documentation showing exposure during the policy periods and other
documentation supporting the demand for claim payment. Coverage in place agreements may have
annual payment caps. Coverage in place agreements are evaluated based on claims filings trends and
severities.
We categorize active asbestos accounts as large or small accounts. We define a large account as an
active account with more than $100 thousand of cumulative paid losses. We have made resolving
large accounts a significant management priority. Small accounts are defined as active accounts
with $100 thousand or less of cumulative paid losses. Approximately 81% and 83% of our total
active asbestos accounts are classified as small accounts at December 31, 2007 and 2006.
We also evaluate our asbestos liabilities arising from our assumed reinsurance business and our
participation in various pools, including Excess & Casualty Reinsurance Association (ECRA).
IBNR reserves relate to potential development on accounts that have not settled and potential
future claims from unidentified policyholders.
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The tables below depict our overall pending asbestos accounts and associated reserves at December
31, 2007 and 2006. On February 2, 2007, we paid $31 million to the Owens Corning Fibreboard Trust
pursuant to our 1993 settlement with Fibreboard.
Pending Asbestos Accounts and Associated Reserves
Net Paid Losses | Net Asbestos | Percent of | ||||||||||||||
Number of | in 2007 | Reserves | Asbestos | |||||||||||||
Policyholders | (In millions) | (In millions) | Net Reserves | |||||||||||||
December 31, 2007 | ||||||||||||||||
Policyholders with settlement agreements |
||||||||||||||||
Structured settlements |
14 | $ | 29 | $ | 151 | 11 | % | |||||||||
Wellington |
3 | 1 | 12 | 1 | ||||||||||||
Coverage in place |
34 | 38 | 100 | 8 | ||||||||||||
Total with settlement agreements |
51 | 68 | 263 | 20 | ||||||||||||
Other policyholders with active accounts |
||||||||||||||||
Large asbestos accounts |
233 | 45 | 237 | 18 | ||||||||||||
Small asbestos accounts |
1,005 | 15 | 93 | 7 | ||||||||||||
Total other policyholders |
1,238 | 60 | 330 | 25 | ||||||||||||
Assumed reinsurance and pools |
| 8 | 133 | 10 | ||||||||||||
Unassigned IBNR |
| | 596 | 45 | ||||||||||||
Total |
1,289 | $ | 136 | $ | 1,322 | 100 | % | |||||||||
Pending Asbestos Accounts and Associated Reserves
Net Paid | ||||||||||||||||
(Recovered) Losses | Net Asbestos | Percent of | ||||||||||||||
Number of | in 2006 | Reserves | Asbestos | |||||||||||||
December 31, 2006 | Policyholders | (In millions) | (In millions) | Net Reserves | ||||||||||||
Policyholders with settlement agreements |
||||||||||||||||
Structured settlements |
15 | $ | 22 | $ | 171 | 12 | % | |||||||||
Wellington |
3 | (1 | ) | 14 | 1 | |||||||||||
Coverage in place |
38 | (18 | ) | 132 | 9 | |||||||||||
Total with settlement agreements |
56 | 3 | 317 | 22 | ||||||||||||
Other policyholders with active accounts |
||||||||||||||||
Large asbestos accounts |
220 | 76 | 254 | 17 | ||||||||||||
Small asbestos accounts |
1,080 | 17 | 101 | 7 | ||||||||||||
Total other policyholders |
1,300 | 93 | 355 | 24 | ||||||||||||
Assumed reinsurance and pools |
| 6 | 141 | 10 | ||||||||||||
Unassigned IBNR |
| | 639 | 44 | ||||||||||||
Total |
1,356 | $ | 102 | $ | 1,452 | 100 | % | |||||||||
Some asbestos-related defendants have asserted that their insurance policies are not subject to
aggregate limits on coverage. We have such claims from a number of insureds. Some of these claims
involve insureds facing exhaustion of products liability aggregate limits in their policies, who
have asserted that their asbestos-related claims fall within so-called non-products liability
coverage contained within their policies rather than products liability coverage, and that the
claimed non-products coverage is not subject to any aggregate limit. It is difficult to predict
the ultimate size of any of the claims for coverage purportedly not subject to aggregate limits or
predict to what extent, if any, the attempts to assert non-products claims outside the products
liability aggregate will succeed. Our policies also contain other limits applicable to these
claims and we have additional coverage defenses to certain claims. We have attempted to manage our
asbestos exposure by aggressively
seeking to settle claims on acceptable terms. There can be no assurance that any of these
settlement efforts will
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be successful, or that any such claims can be settled on terms acceptable
to us. Where we cannot settle a claim on acceptable terms, we aggressively litigate the claim.
However, adverse developments with respect to such matters could have a material adverse effect on
our results of operations and/or equity.
As a result of the uncertainties and complexities involved, reserves for asbestos claims cannot be
estimated with traditional actuarial techniques that rely on historical accident year loss
development factors. In establishing asbestos reserves, we evaluate the exposure presented by each
insured. As part of this evaluation, we consider the available insurance coverage; limits and
deductibles; the potential role of other insurance, particularly underlying coverage below any of
our excess liability policies; and applicable coverage defenses, including asbestos exclusions.
Estimation of asbestos-related claim and claim adjustment expense reserves involves a high degree
of judgment on our part and consideration of many complex factors, including: inconsistency of
court decisions, jury attitudes and future court decisions; specific policy provisions; allocation
of liability among insurers and insureds; missing policies and proof of coverage; the proliferation
of bankruptcy proceedings and attendant uncertainties; novel theories asserted by policyholders and
their counsel; the targeting of a broader range of businesses and entities as defendants; the
uncertainty as to which other insureds may be targeted in the future and the uncertainties inherent
in predicting the number of future claims; volatility in claim numbers and settlement demands;
increases in the number of non-impaired claimants and the extent to which they can be precluded
from making claims; the efforts by insureds to obtain coverage not subject to aggregate limits;
long latency period between asbestos exposure and disease manifestation and the resulting potential
for involvement of multiple policy periods for individual claims; medical inflation trends; the mix
of asbestos-related diseases presented and the ability to recover reinsurance.
We are involved in significant asbestos-related claim litigation, which is described in Note F of
the Consolidated Financial Statements included under Item 8.
Environmental Pollution
Environmental pollution cleanup is the subject of both federal and state regulation. By some
estimates, there are thousands of potential waste sites subject to cleanup. The insurance industry
has been involved in extensive litigation regarding coverage issues. Judicial interpretations in
many cases have expanded the scope of coverage and liability beyond the original intent of the
policies. The Comprehensive Environmental Response Compensation and Liability Act of 1980
(Superfund) and comparable state statutes (mini-Superfunds) govern the cleanup and restoration of
toxic waste sites and formalize the concept of legal liability for cleanup and restoration by
Potentially Responsible Parties (PRPs). Superfund and the mini-Superfunds establish mechanisms
to pay for cleanup of waste sites if PRPs fail to do so and assign liability to PRPs. The extent
of liability to be allocated to a PRP is dependent upon a variety of factors. Further, the number
of waste sites subject to cleanup is unknown. To date, approximately 1,500 cleanup sites have been
identified by the Environmental Protection Agency (EPA) and included on its National Priorities
List (NPL). State authorities have designated many cleanup sites as well.
Many policyholders have made claims against us for defense costs and indemnification in connection
with environmental pollution matters. The vast majority of these claims relate to accident years
1989 and prior, which coincides with our adoption of the Simplified Commercial General Liability
coverage form, which includes what is referred to in the industry as absolute pollution exclusion.
We and the insurance industry are disputing coverage for many such claims. Key coverage issues
include whether cleanup costs are considered damages under the policies, trigger of coverage,
allocation of liability among triggered policies, applicability of pollution exclusions and owned
property exclusions, the potential for joint and several liability and the definition of an
occurrence. To date, courts have been inconsistent in their rulings on these issues.
We have made resolution of large environmental pollution exposures a management priority. We have
resolved a number of our large environmental accounts by negotiating settlement agreements. In our
settlements, we sought to resolve those exposures and obtain the broadest release language to avoid
future claims from the same policyholders seeking coverage for sites or claims that had not emerged
at the time we settled with our policyholder. While the terms of each settlement agreement vary,
we sought to obtain broad environmental releases that include known and unknown sites, claims and
policies. The broad scope of the release provisions contained in those settlement agreements
should, in many cases, prevent future exposure from settled policyholders. It remains uncertain,
however, whether a court interpreting the language of the settlement agreements will adhere to the
intent of the parties and uphold the broad scope of language of the agreements.
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We classify our environmental pollution accounts into several categories, which include structured
settlements, coverage in place agreements and active accounts. Structured settlement agreements
provide for payments over multiple years as set forth in each individual agreement.
We have also used coverage in place agreements to resolve pollution exposures. Coverage in place
agreements are typically agreements between us and our policyholders identifying the policies and
the terms for payment of pollution related liabilities. Claim payments are contingent on
presentation of adequate documentation of damages during the policy periods and other documentation
supporting the demand for claim payment. Coverage in place agreements may have annual payment
caps.
We categorize active accounts as large or small accounts in the pollution area. We define a large
account as an active account with more than $100 thousand cumulative paid losses. We have made
closing large accounts a significant management priority. Small accounts are defined as active
accounts with $100 thousand or less cumulative paid losses. Approximately 73% and 75% of our total
active pollution accounts are classified as small accounts at December 31, 2007 and 2006.
We also evaluate our environmental pollution exposures arising from our assumed reinsurance and our
participation in various pools, including ECRA.
We carry unassigned IBNR reserves for environmental pollution. These reserves relate to potential
development on accounts that have not settled and potential future claims from unidentified
policyholders.
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The tables below depict our overall pending environmental pollution accounts and associated
reserves at December 31, 2007 and 2006.
Pending Environmental Pollution Accounts and Associated Reserves
Net | ||||||||||||||||
Environmental | Percent of | |||||||||||||||
Net Paid Losses | Pollution | Environmental | ||||||||||||||
Number of | in 2007 | Reserves | Pollution Net | |||||||||||||
December 31, 2007 | Policyholders | (In millions) | (In millions) | Reserve | ||||||||||||
Policyholders with settlement agreements |
||||||||||||||||
Structured settlements |
10 | $ | 9 | $ | 6 | 2 | % | |||||||||
Coverage in place |
18 | 8 | 14 | 6 | ||||||||||||
Total with settlement agreements |
28 | 17 | 20 | 8 | ||||||||||||
Other policyholders with active accounts |
||||||||||||||||
Large pollution accounts |
112 | 17 | 53 | 22 | ||||||||||||
Small pollution accounts |
298 | 9 | 42 | 17 | ||||||||||||
Total other policyholders |
410 | 26 | 95 | 39 | ||||||||||||
Assumed reinsurance and pools |
| 1 | 31 | 13 | ||||||||||||
Unassigned IBNR |
| | 96 | 40 | ||||||||||||
Total |
438 | $ | 44 | $ | 242 | 100 | % | |||||||||
Pending Environmental Pollution Accounts and Associated Reserves
Net | ||||||||||||||||
Environmental | Percent of | |||||||||||||||
Net Paid Losses | Pollution | Environmental | ||||||||||||||
Number of | in 2006 | Reserves | Pollution Net | |||||||||||||
December 31, 2006 | Policyholders | (In millions) | (In millions) | Reserve | ||||||||||||
Policyholders with settlement agreements |
||||||||||||||||
Structured settlements |
11 | $ | 16 | $ | 9 | 3 | % | |||||||||
Coverage in place |
18 | 5 | 14 | 5 | ||||||||||||
Total with settlement agreements |
29 | 21 | 23 | 8 | ||||||||||||
Other policyholders with active accounts |
||||||||||||||||
Large pollution accounts |
115 | 20 | 58 | 20 | ||||||||||||
Small pollution accounts |
346 | 9 | 46 | 17 | ||||||||||||
Total other policyholders |
461 | 29 | 104 | 37 | ||||||||||||
Assumed reinsurance and pools |
| 1 | 32 | 11 | ||||||||||||
Unassigned IBNR |
| | 126 | 44 | ||||||||||||
Total |
490 | $ | 51 | $ | 285 | 100 | % | |||||||||
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INVESTMENTS
Net Investment Income
The significant components of net investment income are presented in the following table.
Net Investment Income
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions) | ||||||||||||
Fixed maturity securities |
$ | 2,047 | $ | 1,842 | $ | 1,608 | ||||||
Short term investments |
186 | 248 | 147 | |||||||||
Limited partnerships |
183 | 288 | 254 | |||||||||
Equity securities |
25 | 23 | 25 | |||||||||
Income from trading portfolio (a) |
10 | 103 | 47 | |||||||||
Interest on funds withheld and other deposits |
(1 | ) | (68 | ) | (166 | ) | ||||||
Other |
36 | 18 | 20 | |||||||||
Gross investment income |
2,486 | 2,454 | 1,935 | |||||||||
Investment expense |
(53 | ) | (42 | ) | (43 | ) | ||||||
Net investment income |
$ | 2,433 | $ | 2,412 | $ | 1,892 | ||||||
(a) | The change in net unrealized losses on trading securities included in net investment income
was $15 million and $7 million for the years ended December 31, 2007 and 2005. There was no
change in net unrealized gains (losses) on trading securities included in net investment
income for the year ended December 31, 2006. |
Net investment income increased by $21 million for 2007 compared with 2006. The improvement was
primarily driven by an increase in the overall invested asset base and a reduction of interest
expense on funds withheld and other deposits as discussed further below. These increases were
substantially offset by decreases in limited partnership income and results from the trading
portfolio. The decreased income from the trading portfolio was largely offset by a corresponding
decrease in the policyholders funds reserves supported by the trading portfolio, which is included
in Insurance claims and policyholders benefits on the Consolidated Statements of Operations.
Net investment income increased by $520 million for 2006 compared with 2005. The improvement was
primarily driven by interest rate increases across fixed maturity securities and short term
investments, an increase in the overall invested asset base resulting from improved cash flow and a
reduction of interest expense on funds withheld and other deposits as discussed further below.
Also impacting net investment income was increased income from the trading portfolio of
approximately $56 million. The increased income from the trading portfolio was largely offset by a
corresponding increase in the policyholders funds reserves supported by the trading portfolio.
During 2006 and 2005, we commuted several significant finite reinsurance contracts which contained
interest crediting provisions. The pretax interest expense on funds withheld related to these
significant commuted contracts was $14 million and $84 million for the years ended December 31,
2006 and 2005, and was reflected as a component of Net investment income in our Consolidated
Statements of Operations. The 2005 amount included interest charges associated with the contract
commuted in 2006. As of December 31, 2006, no further interest expense was due on the funds
withheld on the commuted contracts. See Note H of the Consolidated Financial Statements included
under Item 8 for additional information related to interest costs on funds withheld and other
deposits.
The bond segment of the investment portfolio yielded 5.8%, 5.6% and 4.9% for the years ended
December 31, 2007, 2006 and 2005.
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Net Realized Investment Gains (Losses)
The components of net realized investment results for available-for-sale securities are presented
in the following table.
Net Realized Investment Gains (Losses)
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions) | ||||||||||||
Fixed maturity securities: |
||||||||||||
U.S. Government bonds |
$ | 86 | $ | 62 | $ | (33 | ) | |||||
Corporate and other taxable bonds |
(183 | ) | (98 | ) | (86 | ) | ||||||
Tax-exempt bonds |
3 | 53 | 12 | |||||||||
Asset-backed bonds |
(343 | ) | (9 | ) | 14 | |||||||
Redeemable preferred stock |
(41 | ) | (3 | ) | 3 | |||||||
Total fixed maturity securities |
(478 | ) | 5 | (90 | ) | |||||||
Equity securities |
117 | 16 | 38 | |||||||||
Derivative securities |
32 | 18 | 49 | |||||||||
Short term investments |
7 | (5 | ) | | ||||||||
Other |
9 | 53 | (10 | ) | ||||||||
Realized investment gains (losses) before allocation to
participating policyholders and minority interests |
(313 | ) | 87 | (13 | ) | |||||||
Allocated to participating policyholders and minority interests |
2 | (1 | ) | 3 | ||||||||
Realized investment gains (losses), net of participating
policyholders and minority interests |
(311 | ) | 86 | (10 | ) | |||||||
Income tax (expense) benefit |
108 | (19 | ) | | ||||||||
Net realized investment gains (losses), net of participating
policyholders and minority interests |
$ | (203 | ) | $ | 67 | $ | (10 | ) | ||||
Net realized investment results decreased by $270 million for 2007 compared with 2006. The
decrease in net realized investment results was primarily driven by an increase in
other-than-temporary impairment (OTTI) losses related to securities for which we did not assert an
intent to hold until an anticipated recovery in value. For 2007, OTTI losses of $481 million were
recorded primarily within asset-backed bonds and corporate and other taxable bonds sectors. The
judgment as to whether an impairment is other-than-temporary incorporates many factors including
the likelihood of a security recovering to cost, our intent and ability to hold the security until
recovery, general market conditions, specific sector views and significant changes in expected cash
flows. The Impairment Committees decision to record an OTTI loss is primarily based on whether
the securitys fair value is likely to recover to its amortized cost in light of all of the factors
considered over the expected holding period. Current factors and market conditions that
contributed to recording impairments included significant credit spread widening in fixed income
sectors and market disruptions surrounding sub-prime residential mortgage concerns. In some
instances, an OTTI loss was recorded because, in the Impairment Committees judgment, recovery to
cost is not likely. The majority of the OTTI losses recorded in 2007 were due to our lack of
intent to hold until an anticipated recovery of cost or maturity. For 2007, 9% of the OTTI losses
were taken on common and preferred stocks and 41% were taken on below investment grade securities.
Further information on our OTTI process is set forth in Note B of the Consolidated Financial
Statements included under Item 8.
Net realized investment results increased by $77 million for 2006 compared with 2005. The increase
in net realized investment results was primarily driven by improved results in fixed maturity
securities, partially offset by increases in interest rate related OTTI losses for which we did not
assert an intent to hold until an anticipated recovery in value. OTTI losses of $112 million were
recorded in 2006 primarily in the corporate and other taxable bonds sector. Other realized
investment gains for the year ended December 31, 2006, included a $37 million pretax gain related
to a settlement received as a result of bankruptcy litigation of a major telecommunications
corporation. OTTI losses of $70 million were recorded in 2005 across various sectors, including an
OTTI loss of $22 million related to loans made under a credit facility to a national contractor,
that
were classified as fixed maturities. For additional information on loans to the national
contractor, see Note R of the Consolidated Financial Statements.
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A primary objective in the management of the fixed maturity and equity portfolios is to optimize
return relative to underlying 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 the 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
underlying liabilities and the ability to align the duration of the portfolio to those liabilities
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 long term in nature, we segregate investments for asset/liability
management purposes.
The segregated investments support liabilities primarily in the Life & Group Non-Core segment
including annuities, structured benefit settlements and long term care products. The remaining
investments are managed to support the Standard Lines, Specialty Lines and Corporate & Other
Non-Core segments.
The effective durations of fixed maturity securities, short term investments and interest rate
derivatives are presented in the table below. Short term investments are net of securities lending
collateral and account payable and receivable amounts for securities purchased and sold, but not
yet settled. The segregated investments had an effective duration of 10.7 years and 9.8 years at
December 31, 2007 and 2006. The remaining interest sensitive investments had an effective duration
of 3.3 years and 3.2 years at December 31, 2007 and 2006. The overall effective duration was 5.1
years and 4.7 years at December 31, 2007 and 2006.
Effective Durations
December 31, 2007 | December 31, 2006 | |||||||||||||||
Effective Duration | Effective Duration | |||||||||||||||
Fair Value | (In years) | Fair Value | (In years) | |||||||||||||
(In millions) | ||||||||||||||||
Segregated investments |
$ | 9,211 | 10.7 | $ | 8,524 | 9.8 | ||||||||||
Other interest sensitive investments |
29,406 | 3.3 | 30,178 | 3.2 | ||||||||||||
Total |
$ | 38,617 | 5.1 | $ | 38,702 | 4.7 | ||||||||||
The investment portfolio is periodically analyzed for changes in duration and related price change
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 Item 7A Quantitative and Qualitative
Disclosures About Market Risk included herein.
We invest in certain derivative financial instruments primarily to reduce our exposure to market
risk (principally interest rate, equity price and foreign currency risk) and credit risk (risk of
nonperformance of underlying obligor). Derivative securities are recorded at fair value at the
reporting date. We also use derivatives to mitigate market risk by purchasing Standard and Poors
500 Index futures in a notional amount equal to the contract liability relating to Life & Group
Non-Core indexed group annuity contracts. We provided collateral to satisfy margin deposits on
exchange-traded derivatives totaling $35 million as of December 31, 2007. For over-the-counter
derivative transactions we utilize International Swaps and Derivatives Association Master
Agreements that specify certain limits over which collateral is exchanged. As of December 31,
2007, we provided $29 million of cash as collateral for over-the-counter derivative instruments.
We classify our fixed maturity and equity securities as either available-for-sale or trading, and
as such, they are carried at fair value. The amortized cost of fixed maturity securities is
adjusted for amortization of premiums and accretion of discounts to maturity, which is included in
net investment income. Changes in fair value related to available-for-sale securities are reported
as a component of other comprehensive income. Changes in fair value of trading securities are
reported within net investment income. See Note A of the Consolidated Financial Statements
included under Item 8 for additional information on the valuation of investments.
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The following table provides further detail of pretax gross realized investment gains and losses,
which include OTTI losses, on available-for-sale fixed maturity and equity securities.
Realized Investment Gains (Losses)
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions) | ||||||||||||
Net realized investment gains (losses) on fixed maturity and equity securities: |
||||||||||||
Fixed maturity securities: |
||||||||||||
Gross realized gains |
$ | 486 | $ | 382 | $ | 361 | ||||||
Gross realized losses |
(964 | ) | (377 | ) | (451 | ) | ||||||
Net realized investment gains (losses) on fixed maturity securities |
(478 | ) | 5 | (90 | ) | |||||||
Equity securities: |
||||||||||||
Gross realized gains |
146 | 24 | 73 | |||||||||
Gross realized losses |
(29 | ) | (8 | ) | (35 | ) | ||||||
Net realized investment gains on equity securities |
117 | 16 | 38 | |||||||||
Net realized investment gains (losses) on fixed maturity and equity securities |
$ | (361 | ) | $ | 21 | $ | (52 | ) | ||||
The following table provides details of the largest realized investment losses from sales of
securities aggregated by issuer including: the fair value of the securities at date of sale, the
amount of the loss recorded and the period of time that the securities had been in an unrealized
loss position prior to sale. The period of time that the securities had been in an unrealized loss
position prior to sale can vary due to the timing of individual security purchases. Also included
is a narrative providing the industry sector along with the facts and circumstances giving rise to
the loss.
Largest Realized Investment Losses from Securities Sold at a Loss
Year ended December 31, 2007
Fair | Months in | |||||||||||
Value at | Unrealized | |||||||||||
Date of | Loss | Loss Prior | ||||||||||
Issuer Description and Discussion | Sale | On Sale | To Sale (a) | |||||||||
(In millions) | ||||||||||||
Various notes and bonds issued by
the United States Treasury.
Securities sold due to outlook on
interest rates. |
$ | 12,815 | $ | 98 | 0-6 | |||||||
Mortgage backed pass through
securities sold based on view of
interest rate changes. |
394 | 9 | 0-6 | |||||||||
Issuer provides financing to
residential real estate markets and
commercial consumers including
originators and developers in
various markets. The losses were
due to the continued deterioration
in the real estate markets. |
80 | 9 | 0-12 | |||||||||
Bank and financial issuer that came
under pressure due to mortgage
market disruption. |
36 | 5 | 0-6 | |||||||||
State specific general obligation
municipal bonds sold to reduce
exposure due to change in outlook. |
513 | 5 | 0-6 | |||||||||
$ | 13,838 | $ | 126 | |||||||||
(a) | Represents the range of consecutive months the various positions were in an
unrealized loss prior to sale. 0-12+ means certain
positions were less than 12 months, while others were greater than 12 months. |
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Valuation and Impairment of Investments
The following table details the carrying value of our general account investments.
Carrying Value of General Account Investments
December 31 | 2007 | % | 2006 | % | ||||||||||||
(In millions) | ||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||
U.S. Treasury securities and obligations of government agencies |
$ | 687 | 2 | % | $ | 5,138 | 12 | % | ||||||||
Asset-backed securities |
11,409 | 27 | 13,677 | 31 | ||||||||||||
States, municipalities and political subdivisions tax-exempt |
7,675 | 18 | 5,146 | 12 | ||||||||||||
Corporate securities |
8,952 | 22 | 7,132 | 16 | ||||||||||||
Other debt securities |
4,299 | 10 | 3,642 | 8 | ||||||||||||
Redeemable preferred stock |
1,058 | 3 | 912 | 2 | ||||||||||||
Total fixed maturity securities available-for-sale |
34,080 | 82 | 35,647 | 81 | ||||||||||||
Fixed maturity securities trading: |
||||||||||||||||
U.S. Treasury securities and obligations of government agencies |
5 | | 2 | | ||||||||||||
Asset-backed securities |
31 | | 55 | | ||||||||||||
Corporate securities |
123 | | 133 | 1 | ||||||||||||
Other debt securities |
18 | | 14 | | ||||||||||||
Total fixed maturity securities trading |
177 | | 204 | 1 | ||||||||||||
Equity securities available-for-sale: |
||||||||||||||||
Common stock |
452 | 1 | 452 | 1 | ||||||||||||
Preferred stock |
116 | | 145 | | ||||||||||||
Total equity securities available-for-sale |
568 | 1 | 597 | 1 | ||||||||||||
Total equity securities trading |
| | 60 | | ||||||||||||
Short term investments available-for-sale |
4,497 | 11 | 5,538 | 13 | ||||||||||||
Short term investments trading |
180 | 1 | 172 | | ||||||||||||
Limited partnerships |
2,214 | 5 | 1,852 | 4 | ||||||||||||
Other investments |
46 | | 26 | | ||||||||||||
Total general account investments |
$ | 41,762 | 100 | % | $ | 44,096 | 100 | % | ||||||||
A significant judgment in the valuation of investments is the determination of when an OTTI has
occurred. We analyze securities on at least a quarterly basis. Part of this analysis is to
monitor the length of time and severity of the decline below amortized cost for those securities in
an unrealized loss position. Information on our OTTI process is set forth in Note B of the
Consolidated Financial Statements included under Item 8.
Investments in the general account had a net unrealized gain of $74 million at December 31, 2007
compared with a net unrealized gain of $966 million at December 31, 2006. The unrealized position
at December 31, 2007 was comprised of a net unrealized loss of $131 million for fixed maturities, a
net unrealized gain of $202 million for equity securities and a net unrealized gain of $3 million
for short term securities. The unrealized position at December 31, 2006 was comprised of a net
unrealized gain of $716 million for fixed maturities, a net unrealized gain of $249 million for
equity securities, and a net unrealized gain of $1 million for short term securities. See Note B
of the Consolidated Financial Statements included under Item 8 for further detail on the unrealized
position of our general account investment portfolio.
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The following table provides the composition of fixed maturity securities available-for-sale in a
gross unrealized loss position at December 31, 2007 by maturity profile. Securities not due at a
single date are allocated based on weighted average life.
Maturity Profile
Percent of | Percent of | |||||||
Market | Unrealized | |||||||
Value | Loss | |||||||
Due in one year or less |
6 | % | 3 | % | ||||
Due after one year through five years |
43 | 40 | ||||||
Due after five years through ten years |
22 | 23 | ||||||
Due after ten years |
29 | 34 | ||||||
Total |
100 | % | 100 | % | ||||
Our non-investment grade fixed maturity securities available-for-sale as of December 31, 2007 that
were in a gross unrealized loss position had a fair value of $1,708 million. The following tables
summarize the fair value and gross unrealized loss of non-investment grade securities categorized
by the length of time those securities have been in a continuous unrealized loss position and
further categorized by the severity of the unrealized loss position in 10% increments as of
December 31, 2007 and 2006.
Unrealized Loss Aging for Non-investment Grade Securities
Fair Value as a Percentage of Amortized Cost | ||||||||||||||||||||||||
Gross | ||||||||||||||||||||||||
Estimated | Unrealized | |||||||||||||||||||||||
December 31, 2007 | Fair Value | 90-99% | 80-89% | 70-79% | <70% | Loss | ||||||||||||||||||
(In millions) | ||||||||||||||||||||||||
Fixed maturity securities: |
||||||||||||||||||||||||
0-6 months |
$ | 1,549 | $ | 57 | $ | 16 | $ | 3 | $ | | $ | 76 | ||||||||||||
7-12 months |
125 | 7 | 1 | | | 8 | ||||||||||||||||||
13-24 months |
26 | 1 | 1 | 1 | 1 | 4 | ||||||||||||||||||
Greater than 24 months |
8 | | 2 | | | 2 | ||||||||||||||||||
Total non-investment grade |
$ | 1,708 | $ | 65 | $ | 20 | $ | 4 | $ | 1 | $ | 90 | ||||||||||||
Unrealized Loss Aging for Non-investment Grade Securities
Fair Value as a Percentage of Amortized Cost | ||||||||||||||||||||||||
Gross | ||||||||||||||||||||||||
Estimated | Unrealized | |||||||||||||||||||||||
December 31, 2006 | Fair Value | 90-99% | 80-89% | 70-79% | <70% | Loss | ||||||||||||||||||
(In millions) | ||||||||||||||||||||||||
Fixed maturity securities: |
||||||||||||||||||||||||
0-6 months |
$ | 509 | $ | 2 | $ | | $ | | $ | | $ | 2 | ||||||||||||
7-12 months |
87 | 1 | 1 | | | 2 | ||||||||||||||||||
13-24 months |
24 | | | | | | ||||||||||||||||||
Greater than 24 months |
2 | | | | | | ||||||||||||||||||
Total non-investment grade |
$ | 622 | $ | 3 | $ | 1 | $ | | $ | | $ | 4 | ||||||||||||
As part of the ongoing OTTI monitoring process, we evaluated the facts and circumstances based on
available information for each of the non-investment grade securities and determined that the
securities presented in the above tables were temporarily impaired when evaluated at December 31,
2007 or 2006. This determination was based on a number of factors that we regularly consider
including, but not limited to: the issuers ability to meet current and future interest and
principal payments, an evaluation of the issuers financial
condition and near term prospects, our assessment of the sector outlook and estimates of the fair
value of any underlying collateral. In all cases where a decline in value is judged to be
temporary, we have the intent and ability to hold these securities for a period of time sufficient
to recover the amortized cost of our investment through an anticipated recovery in the fair value
of such securities or by holding the securities to maturity. In many cases, the securities held
are matched to liabilities as part of ongoing asset/liability duration management. As such, we
continually assess our ability to hold securities for a time sufficient to recover any temporary
loss in value or
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until maturity. We believe we have sufficient levels of liquidity so as to not impact the
asset/liability management process.
Our equity securities classified as available-for-sale as of December 31, 2007 that were in a gross
unrealized loss position had a fair value of $102 million and gross unrealized losses of $12
million. Under the same process as followed for fixed maturity securities, we monitor the equity
securities for other-than-temporary declines in value. In all cases where a decline in value is
judged to be temporary, we have the intent and ability to hold these securities for a period of
time sufficient to recover the cost of our investment through an anticipated recovery in the fair
value of such securities.
Invested assets are exposed to various risks, such as interest rate and credit risk. Due to the
level of risk associated with certain invested assets and the level of uncertainty related to
changes in the value of these assets, it is possible that changes in these risks in the near term,
including increases in interest rates and further credit spread
widening, could have an adverse material impact on our results of
operations or equity.
Within our overall investment portfolio, $3,810 million of our securities are rated AAA as a result
of insurance from six different mono-line insurers. Insured municipal bonds are $3,602 million of
this total and represent 47% of our total municipal bond holdings. The underlying average credit
quality of the municipal bonds would be A+ without the benefit of the insurance. Should the
insurance be deemed worthless, we do not believe there would be a material impact to our results
of operations or financial condition.
The general account portfolio consists primarily of high quality bonds, 89% and 91% of which were
rated as investment grade (rated BBB- or higher) at December 31, 2007 and 2006. The following
table summarizes the ratings of our general account bond portfolio at carrying value.
General Account Bond Ratings
December 31 | 2007 | % | 2006 | % | ||||||||||||
(In millions) | ||||||||||||||||
U.S. Government and affiliated agency securities |
$ | 816 | 3 | % | $ | 5,285 | 15 | % | ||||||||
Other AAA rated |
16,728 | 50 | 16,311 | 47 | ||||||||||||
AA and A rated |
6,326 | 19 | 5,222 | 15 | ||||||||||||
BBB rated |
5,713 | 17 | 4,933 | 14 | ||||||||||||
Non-investment grade |
3,616 | 11 | 3,188 | 9 | ||||||||||||
Total |
$ | 33,199 | 100 | % | $ | 34,939 | 100 | % | ||||||||
At December 31, 2007 and 2006, approximately 95% and 96% of the general account portfolio was
issued by U.S. Government and affiliated agencies or was rated by Standard & Poors (S&P) or
Moodys Investors Service (Moodys). The remaining bonds were rated by other rating agencies or
internally.
The following table summarizes the bond ratings of the investments supporting separate account
products which guarantee principal and a specified rate of interest.
Separate Account Bond Ratings
December 31 | 2007 | % | 2006 | % | ||||||||||||
(In millions) | ||||||||||||||||
U.S. Government and affiliated agency securities |
$ | | | % | $ | | | % | ||||||||
Other AAA rated |
122 | 29 | 111 | 26 | ||||||||||||
AA and A rated |
224 | 54 | 242 | 56 | ||||||||||||
BBB rated |
73 | 17 | 75 | 17 | ||||||||||||
Non-investment grade |
| | 6 | 1 | ||||||||||||
Total |
$ | 419 | 100 | % | $ | 434 | 100 | % | ||||||||
At December 31, 2007 and 2006, 97% and 100% of the separate account portfolio was issued by U.S.
Government and affiliated agencies or was rated by S&P or Moodys. The remaining bonds were rated
by other rating agencies or internally.
Non-investment grade bonds, as presented in the tables above, are high-yield securities rated below
BBB- by bond rating agencies, as well as other unrated securities that, according to our analysis,
are below investment
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grade. High-yield securities generally involve a greater degree of risk than investment grade
securities. However, expected returns should compensate for the added risk. This risk is also
considered in the interest rate assumptions for the underlying insurance products.
The carrying value of securities that are either subject to trading restrictions or trade in
illiquid private placement markets at December 31, 2007 was $320 million, which represents 0.8% of
our total investment portfolio. These securities were in a net unrealized gain position of
$173 million at December 31, 2007. Of these securities, 94% were priced by independent third party
sources.
Asset-Backed and Sub-prime Mortgage Exposure
Asset-Backed Distribution
Security Type | ||||||||||||||||||||||||||||
Percent | Percent | |||||||||||||||||||||||||||
of Total | of Total | |||||||||||||||||||||||||||
December 31, 2007 | MBS | CMO | ABS | CDO | Total | Security Type | Investments | |||||||||||||||||||||
(In millions) | ||||||||||||||||||||||||||||
U.S. Government Agencies |
$ | 1,212 | $ | 1,460 | $ | | $ | | $ | 2,672 | 23.4 | % | 6.4 | % | ||||||||||||||
AAA |
| 5,297 | 2,063 | 27 | 7,387 | 64.5 | 17.7 | |||||||||||||||||||||
AA |
| 35 | 309 | 80 | 424 | 3.7 | 1.0 | |||||||||||||||||||||
A |
| 56 | 206 | 222 | 484 | 4.2 | 1.2 | |||||||||||||||||||||
BBB |
| 13 | 396 | 20 | 429 | 3.8 | 1.0 | |||||||||||||||||||||
Non-investment grade and equity tranches |
| 1 | 28 | 15 | 44 | 0.4 | 0.1 | |||||||||||||||||||||
Total Fair Value |
$ | 1,212 | $ | 6,862 | $ | 3,002 | $ | 364 | $ | 11,440 | 100.0 | % | 27.4 | % | ||||||||||||||
Total Amortized Cost |
$ | 1,217 | $ | 6,975 | $ | 3,146 | $ | 469 | $ | 11,807 | ||||||||||||||||||
Percent of total fair value by security type |
11 | % | 60 | % | 26 | % | 3 | % | 100 | % | ||||||||||||||||||
Sub-prime (included above) |
||||||||||||||||||||||||||||
Fair Value |
$ | | $ | 13 | $ | 1,064 | $ | 28 | $ | 1,105 | 9.7 | % | 2.6 | % | ||||||||||||||
Amortized Cost |
$ | | $ | 13 | $ | 1,162 | $ | 39 | $ | 1,214 | 10.3 | % | 2.9 | % | ||||||||||||||
Alt-A (included above) |
||||||||||||||||||||||||||||
Fair Value |
$ | | $ | 1,142 | $ | 3 | $ | 51 | $ | 1,196 | 10.5 | % | 2.9 | % | ||||||||||||||
Amortized Cost |
$ | | $ | 1,187 | $ | 3 | $ | 52 | $ | 1,242 | 10.5 | % | 3.0 | % |
Included in our fixed maturity securities at December 31, 2007 were $11,440 million of asset-backed
securities, at fair value, which represents 27% of total invested assets. Structured security
types within this category consist of approximately 11% in mortgage-backed securities (MBS), 60% in
collateralized mortgage obligations (CMO), 26% in corporate asset-backed obligations (ABS), and 3%
in collateralized debt obligations (CDO). Of the total asset-backed securities, 88% were U.S.
Government Agency issued or AAA rated. The majority of our asset-backed securities are actively
traded in liquid markets. We obtain fair values for a majority of these securities from a third
party pricing service. Of the total invested assets, $1,105 million or 2.6% have exposure to
sub-prime residential mortgage (sub-prime) collateral, as measured by the original deal structure,
while 2.9% have exposure to Alternative A (Alt A) collateral. Of the securities with sub-prime
exposure, approximately 98% were rated as investment grade, while 99% of the Alt A securities were
rated investment grade. In addition to sub-prime exposure in fixed maturity securities, there is
exposure of approximately $30 million through other investments, including limited partnerships.
We have mitigated a portion of our sub-prime exposure through an economic hedge position in Credit
Default Swaps (CDS) from which we recognized net gains of $40 million for the year ended December
31, 2007.
All asset-backed securities in an unrealized loss position are reviewed as part of the ongoing OTTI
process and resulted in OTTI losses of $202 million for the year ended December 31, 2007. Included
in this OTTI loss was $163 million related to securities with sub-prime and Alt A exposure. The
Companys review of these securities includes an analysis of cash flow modeling under various
default scenarios, the seniority of the specific tranche within the deal structure, the composition
of the collateral and the actual default experience. Given current market conditions and the
specific facts and circumstances related to our individual sub-prime and Alt A exposures, we
believe that all remaining unrealized losses are temporary in nature. Continued deterioration in
these markets beyond current expectations may cause us to reconsider and record additional OTTI
losses.
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Short Term Investments
The carrying value of the components of the general account short term investment portfolio is
presented in the following table.
Short Term Investments
December 31 | 2007 | 2006 | ||||||
(In millions) | ||||||||
Short term investments available-for-sale: |
||||||||
Commercial paper |
$ | 3,040 | $ | 923 | ||||
U.S. Treasury securities |
577 | 1,093 | ||||||
Money market funds |
72 | 196 | ||||||
Other, including collateral held related to securities lending |
808 | 3,326 | ||||||
Total short term investments available-for-sale |
4,497 | 5,538 | ||||||
Short term investments trading: |
||||||||
Commercial paper |
35 | 43 | ||||||
U.S. Treasury securities |
| 2 | ||||||
Money market funds |
139 | 127 | ||||||
Other |
6 | | ||||||
Total short term investments trading |
180 | 172 | ||||||
Total short term investments |
$ | 4,677 | $ | 5,710 | ||||
The fair value of collateral held related to securities lending, included in other short term
investments, was $53 million and $2,851 million at December 31, 2007 and 2006.
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LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Our principal 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.
For 2007, net cash provided by operating activities was $1,239 million as compared to
$2,250 million in 2006. Cash provided by operating activities was unfavorably impacted by
decreased net sales of trading securities to fund policyholder withdrawals of investment contract
products issued by us. Policyholder fund withdrawals are reflected as financing cash flows. Cash
provided by operating activities was unfavorably impacted by decreased premium collections,
increased tax payments, and increased loss payments.
For 2006, net cash provided by operating activities was $2,250 million as compared to
$2,169 million in 2005. Cash provided by operating activities was favorably impacted by increased
net sales of trading securities to fund policyholder withdrawals of investment contract products
issued by us and increased investment income receipts. Policyholder fund withdrawals are reflected
as financing cash flows. Cash provided by operating activities was unfavorably impacted by
decreased premium collections, increased tax payments, and increased loss payments.
Cash flows from investing activities include the purchase and sale of available-for-sale financial
instruments, as well as the purchase and sale of businesses, land, buildings, equipment and other
assets not generally held for resale.
Net cash used for investing activities was $1,082 million, $1,646 million, and $1,316 million for
2007, 2006, and 2005. Cash flows used by investing activities related principally to purchases of
fixed maturity securities and short term investments. The cash flow from investing activities is
impacted 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. In 2007, net cash flows provided by investing activities-discontinued
operations included $65 million of cash proceeds related to the sale of the United Kingdom
discontinued operations business.
Cash flows from financing activities include proceeds from the issuance of debt and equity
securities, outflows for dividends or repayment of debt, outlays to reacquire equity instruments,
and deposits and withdrawals related to investment contract products issued by us.
For 2007, 2006 and 2005, net cash used for financing activities was $185 million, $605 million, and
$837 million. The decrease in cash used by financing activities is primarily related to decreased
policyholder fund withdrawals in 2007 as compared to 2006, which are reflected as Return of
investment contract account balances on the Consolidated Statements of Cash Flows included under
Item 8.
We believe that our present cash flows from operations, investing activities and financing
activities, including cash dividends from CNAF subsidiaries, are sufficient to fund our working
capital and debt obligation needs.
We have an effective shelf registration statement under which we may issue debt or equity
securities.
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Commitments, Contingencies, and Guarantees
We have various commitments, contingencies and guarantees which we become involved with during the
ordinary course of business. The impact of these commitments, contingencies and guarantees should
be considered when evaluating our liquidity and capital resources.
A summary of our commitments as of December 31, 2007 is presented in the following table.
Contractual Commitments
December 31, 2007 | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | |||||||||||||||
(In millions) | ||||||||||||||||||||
Debt (a) |
$ | 3,175 | $ | 486 | $ | 235 | $ | 680 | $ | 1,774 | ||||||||||
Lease obligations |
247 | 44 | 79 | 63 | 61 | |||||||||||||||
Claim and claim expense reserves (b) |
30,259 | 6,733 | 9,194 | 4,767 | 9,565 | |||||||||||||||
Future policy benefits reserves (c) |
11,388 | 180 | 346 | 332 | 10,530 | |||||||||||||||
Policyholder funds reserves (c) |
882 | 436 | 342 | 3 | 101 | |||||||||||||||
Guaranteed payment contracts (d) |
31 | 14 | 17 | | | |||||||||||||||
Total |
$ | 45,982 | $ | 7,893 | $ | 10,213 | $ | 5,845 | $ | 22,031 | ||||||||||
(a) | Includes estimated future interest payments, but does not include original issue discount. |
|
(b) | Claim and claim adjustment expense reserves are not discounted and represent our estimate of
the amount and timing of the ultimate settlement and administration of claims based on our
assessment of facts and circumstances known as of December 31, 2007. See the Reserves
Estimates and Uncertainties section of this MD&A for further information. Claim and claim
adjustment expense reserves of $16 million related to business which has been 100% ceded to
unaffiliated parties in connection with the individual life sale are not included. |
|
(c) | Future policy benefits and policyholder funds reserves are not discounted and represent our
estimate of the ultimate amount and timing of the settlement of benefits based on our
assessment of facts and circumstances known as of December 31, 2007. Future policy benefit
reserves of $843 million and policyholder fund reserves of $42 million related to business
which has been 100% ceded to unaffiliated parties in connection with the individual life sale
are not included. Additional information on future policy benefits and policyholder funds
reserves is included in Note A of the Consolidated Financial Statements included under Item 8. |
|
(d) | Primarily relating to telecommunications and software services. |
Further information on our commitments, contingencies and guarantees is provided in Notes B, F, G,
I and K of the Consolidated Financial Statements included under Item 8.
Off-Balance Sheet Arrangements
In the course of selling business entities and assets to third parties, we have agreed to indemnify
purchasers for losses arising out of breaches of representation and warranties with respect to the
business entities or assets being sold, including, in certain cases, losses arising from
undisclosed liabilities or certain named litigation. Such indemnification provisions generally
survive for periods ranging from nine months following the applicable closing date to the
expiration of the relevant statutes of limitation. As of December 31, 2007, the aggregate amount
of quantifiable indemnification agreements in effect for sales of business entities, assets and
third party loans was $873 million.
In addition, we have agreed to provide indemnification to third party purchasers for certain losses
associated with sold business entities or assets that are not limited by a contractual monetary
amount. As of December 31, 2007, we had outstanding unlimited indemnifications in connection with
the sales of certain of our business entities or assets that included tax liabilities arising prior
to a purchasers ownership of an entity or asset, defects in title at the time of sale, employee
claims arising prior to closing and in some cases losses arising from certain litigation and
undisclosed liabilities. These indemnification agreements survive until the applicable statutes of
limitation expire, or until the agreed upon contract terms expire. As of December 31, 2007 and
2006, we have recorded approximately $27 million and $28 million of liabilities related to these
indemnification agreements.
Other than the items discussed above, we do not have any other off-balance sheet arrangements.
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Dividends
In 2007, we paid dividends of $0.35 per share of our common stock. On February 6, 2008, our Board
of Directors declared a quarterly dividend of $0.15 per share, payable March 20, 2008 to
shareholders of record on February 25, 2008. 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.
Our ability to pay dividends and other credit obligations is significantly dependent on receipt of
dividends from our subsidiaries. The payment of dividends to us by our insurance subsidiaries
without prior approval of the insurance department of each subsidiarys domiciliary jurisdiction is
limited by formula. Dividends in excess of these amounts are subject to prior approval by the
respective state insurance departments.
Further information on our dividends from subsidiaries is provided in Note L of the Consolidated
Financial Statements included under Item 8.
Share Repurchase Program
Our Board of Directors has approved a Share Repurchase Program to purchase, in the open market or
through privately negotiated transactions, our outstanding common stock, as our management deems
appropriate. No shares of common stock were purchased during 2007 or
2006. On February 12, 2008, we began repurchasing shares pursuant to the Board of Directors resolutions.
As of February 22, 2008, we had repurchased a total of 945,656
shares at an average price of $27.42 (including commission) per share.
Share repurchases may continue.
Regulatory Matters
We previously established a plan to reorganize and streamline our U.S. property and casualty
insurance legal entity structure in order to realize capital, operational, and cost efficiencies.
The remaining phase of this multi-year plan has been completed with the December 31, 2007 merger of
Transcontinental Insurance Company, a New York domiciled insurer, into its parent company, National
Fire Insurance Company of Hartford, which is a CCC subsidiary.
Along with other companies in the industry, we received subpoenas, interrogatories and inquiries
from and have produced documents and/or provided information to: (i) California, Connecticut,
Delaware, Florida, Hawaii, Illinois, Michigan, Minnesota, New Jersey, New York, North Carolina,
Ohio, Pennsylvania, South Carolina, West Virginia and the Canadian Council of Insurance Regulators
concerning investigations into practices including contingent compensation arrangements, fictitious
quotes and tying arrangements; (ii) the Securities and Exchange Commission (SEC), the New York
State Attorney General, the United States Attorney for the Southern District of New York, the
Connecticut Attorney General, the Connecticut Department of Insurance, the Delaware Department of
Insurance, the Georgia Office of Insurance and Safety Fire Commissioner and the California
Department of Insurance concerning reinsurance products and finite insurance products purchased and
sold by us; (iii) the Massachusetts Attorney General and the Connecticut Attorney General
concerning investigations into anti-competitive practices; and (iv) the New York State Attorney
General concerning declinations of attorney malpractice insurance.
The SEC and representatives of the United States Attorneys Office for the Southern District of New
York conducted interviews with several of our current and former executives relating to the
restatement of our financial results for 2004, including our relationship with and accounting for
transactions with an affiliate that were the basis for the restatement. We have also provided the
SEC with information relating to our restatement in 2006 of prior period results. It is possible
that our analyses of, or accounting treatment for, finite reinsurance contracts or discontinued
operations could be questioned or disputed by regulatory authorities.
Ratings
Ratings are an important factor in establishing the competitive position of insurance companies.
Our insurance company subsidiaries are rated by major rating agencies, and these ratings reflect
the rating agencys opinion of the insurance companys financial strength, operating performance,
strategic position and ability to meet our obligations to policyholders. Agency ratings are not a
recommendation to buy, sell or hold any security, and may be revised or withdrawn at any time by
the issuing organization. Each agencys rating should be evaluated independently of any other
agencys rating. One or more of these agencies could take action in the future to change the
ratings of our insurance subsidiaries.
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The table below reflects the various group ratings issued by A.M. Best Company (A.M. Best), Fitch
Ratings (Fitch), Moodys and S&P for the property and casualty and life companies. The table also
includes the ratings for CNAF senior debt and The Continental Corporation (Continental) senior
debt.
Insurance Financial Strength | ||||||||
Ratings | Debt Ratings | |||||||
Property & | ||||||||
Casualty | Life | CNAF | Continental | |||||
CCC | CAC | Senior | Senior | |||||
Group | Debt | Debt | ||||||
A.M. Best
|
A | A- | bbb | Not rated | ||||
Fitch
|
A | Not rated | BBB | BBB | ||||
Moodys
|
A3 | Not rated | Baa3 | Baa3 | ||||
S&P
|
A- | BBB+ | BBB- | BBB- |
The following rating agency actions were taken with respect to CNA from January 1, 2007 through
February 15, 2008:
| On October 5, 2007, Fitch Ratings upgraded the senior debt ratings of CNAF and
Continental to BBB, the financial strength ratings of CNAs property/casualty insurance
subsidiaries to A and withdrew the A- insurance financial strength rating of Continental
Assurance Company (CAC). |
||
| On November 2, 2007, Moodys affirmed CNAs ratings and stable outlook. |
||
| On December 18, 2007, A.M. Best affirmed CNAs ratings and stable outlook. |
If our property and casualty insurance financial strength ratings were downgraded below current
levels, our business and results of operations could be materially adversely affected. The
severity of the impact on our business is dependent on the level of downgrade and, for certain
products, which rating agency takes the rating action. Among the adverse effects in the event of
such downgrades would be the inability to obtain a material volume of business from certain major
insurance brokers, the inability to sell a material volume of our insurance products to certain
markets and the required collateralization of certain future payment obligations or reserves.
In addition, it is possible that a lowering of the debt ratings of Loews by certain of these
agencies could result in an adverse impact on our ratings, independent of any change in our
circumstances. None of the major rating agencies which rates Loews currently maintains a negative
outlook or has Loews on negative Credit Watch.
We have entered into several settlement agreements and assumed reinsurance contracts that require
collateralization of future payment obligations and assumed reserves if our ratings or other
specific criteria fall below certain thresholds. The ratings triggers are generally more than one
level below our current ratings.
Accounting Pronouncements
Statement of Financial Accounting Standard (SFAS) No. 157, Fair Value Measurements (SFAS
157)
In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS 157. SFAS 157
defines fair value, establishes a framework for measuring fair value in accordance with GAAP and
expands disclosures about fair value measurements. SFAS 157 retains the exchange price notion in
the definition of fair value and clarifies that the exchange price is the price in an orderly
transaction between market participants to sell the asset or transfer the liability in the market
in which the reporting entity would transact for the asset or liability. SFAS 157 emphasizes that
fair value is a market-based measurement, not an entity-specific measurement and the fair value
measurement should be determined based on the assumptions that market participants would use in
pricing the asset or liability. SFAS 157 expands disclosures surrounding the use of fair value to
measure assets and liabilities and specifically focuses on the sources used to measure fair value.
In instances of recurring use of fair value measures using unobservable inputs, SFAS 157 requires
separate disclosure of the effect on earnings for the period. SFAS 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and interim periods within
the year of adoption. The adoption of SFAS 157 is not expected to have a material impact on our
results of operations or financial condition.
SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS
159)
In February 2007, the FASB issued SFAS 159, which provides companies with an option to report
selected financial assets and liabilities at fair value, with changes in fair value recorded in
earnings. SFAS 159 helps to mitigate accounting-induced earnings volatility by enabling companies
to report related assets and liabilities at
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fair value, which may reduce the need for companies to comply with detailed rules for hedge
accounting. SFAS 159 also establishes presentation and disclosure requirements designed to
facilitate comparisons between companies that choose different measurement attributes for similar
types of assets and liabilities.
SFAS 159 requires companies to provide additional information that will help investors and other
users of financial statements to more easily understand the effect of the companys choice to use
fair value on its earnings. It also requires entities to display the fair value of those assets
and liabilities for which the company has chosen to use fair value on the face of the balance
sheet. The new Statement does not eliminate disclosure requirements included in other accounting
standards, including requirements for disclosures about fair value measurements included in SFAS
157 and SFAS 107, Disclosures about Fair Value of Financial Instruments. SFAS 159 is
effective for fiscal years beginning after November 15, 2007. We do not intend to select the fair
value option for any assets and liabilities currently held, and therefore SFAS 159 is not expected
to have an impact on our financial condition or results of operations upon adoption.
SFAS No.160, Noncontrolling Interests in Consolidated Financial Statements an amendment of ARB
No. 51 (SFAS 160)
In December 2007, the FASB issued SFAS 160, which provides accounting and reporting standards for
the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It
clarifies that an ownership interest in a subsidiary should be reported as equity in the
consolidated financial statements, requires consolidated net income to be reported at amounts that
include the amounts attributable to both the parent and the noncontrolling interest and provides
for expanded disclosures in the consolidated financial statements. SFAS 160 is effective for
fiscal years, and interim periods within those fiscal years, beginning on or after December 15,
2008. The adoption of this standard in 2009 is not expected to have a material impact on our
financial condition or results of operations.
See Note A of the Consolidated Financial Statements included under Item 8 for additional
information regarding accounting pronouncements.
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
asbestos and environmental pollution 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; expected cost
savings and other results from our expense reduction and restructuring 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. Some examples of these risks and uncertainties are:
| general economic and business conditions, including inflationary pressures on medical care
costs, construction costs and other economic sectors that increase the severity of claims; |
|
| changes in financial markets such as fluctuations in interest rates, long term periods of
low interest rates, credit conditions and currency, commodity and stock prices, including the
short and long term effects of losses produced or threatened in relation to sub-prime
residential mortgage-backed securities (sub-prime); |
|
| the effects of corporate bankruptcies and accounting errors on capital markets, and on the
markets for D&O and E&O coverages; |
|
| changes in foreign or domestic political, social and economic conditions; |
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| regulatory initiatives and compliance with governmental regulations, judicial decisions,
including interpretation of policy provisions, decisions regarding coverage and theories of
liability, trends in litigation and the outcome of any litigation involving us, and rulings
and changes in tax laws and regulations; |
|
| effects upon insurance markets and upon industry business practices and relationships of
current litigation, investigations and regulatory activity by the New York State Attorney
Generals office and other authorities concerning contingent commission arrangements with
brokers and bid solicitation activities; |
|
| legal and regulatory activities with respect to certain non-traditional and finite-risk
insurance products, and possible resulting changes in accounting and financial reporting in
relation to such products, including our restatement of financial results in May of 2005 and
our relationship with an affiliate, Accord Re Ltd., as disclosed in connection with that
restatement; |
|
| regulatory limitations, impositions and restrictions upon us, including the effects of
assessments and other surcharges for guaranty funds and second-injury funds and other
mandatory pooling arrangements; |
|
| 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 under priced accounts, to achieve
premium targets and profitability and to realize growth and retention estimates; |
|
| development of claims and the impact on loss reserves, including changes in claim
settlement policies; |
|
| the effectiveness of current initiatives by claims management to reduce loss and expense
ratios through more efficacious claims handling techniques; |
|
| the performance of reinsurance companies under reinsurance contracts with us; |
|
| results of financing efforts, including the availability of bank credit facilities; |
|
| changes in our composition of operating segments; |
|
| 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 weather patterns, greenhouse
gases, sea, land and air temperatures, sea levels, rain 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 and the effect
of the absence or insufficiency of applicable terrorism legislation on coverages; |
|
| the unpredictability of the nature, targets, severity or frequency of potential terrorist
events, as well as the uncertainty as to our ability to contain our terrorism exposure
effectively, notwithstanding the extension through December 31, 2014 of the Terrorism Risk
Insurance Act of 2002; |
|
| the occurrence of epidemics; |
|
| exposure to liabilities due to claims made by insureds and others relating to asbestos
remediation and health-based asbestos impairments, as well as exposure to liabilities for
environmental pollution, construction defect claims and exposure to liabilities due to claims
made by insureds and others relating to lead-based paint and other mass torts; |
|
| whether a national privately financed trust to replace litigation of asbestos claims with
payments to claimants from the trust will be established or approved through federal
legislation, or, if established |
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and approved, whether it will contain funding requirements in excess of our established
loss reserves or carried loss reserves; |
||
| the sufficiency of our loss reserves and the possibility of future increases in reserves; |
|
| regulatory limitations and restrictions, including limitations upon our ability to receive
dividends from our insurance subsidiaries imposed by state regulatory agencies and minimum
risk-based capital standards established by the National Association of Insurance
Commissioners; |
|
| the risks and uncertainties associated with our loss reserves as outlined in the Critical
Accounting Estimates and the Reserves Estimates and Uncertainties sections of this MD&A; |
|
| the level of success in integrating acquired businesses and operations, and in
consolidating, or selling existing ones; |
|
| 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; and |
|
| the actual closing of contemplated transactions and agreements. |
Our forward-looking statements speak only as of the date on which they are made 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.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is a broad term related to changes in the fair value of a financial instrument.
Discussions herein regarding market risk focus on only one element of market risk, which is price
risk. Price risk relates to changes in the level of prices due to changes in interest rates,
equity prices, foreign exchange rates or other factors that relate to market volatility of the
rate, index or price underlying the financial instrument. Our primary market risk exposures are
due to changes in interest rates, although we have certain exposures to changes in equity prices
and foreign currency exchange rates. The fair value of the financial instruments is adversely
affected when interest rates rise, equity markets decline and the dollar strengthens against
foreign currency.
Active management of market risk is integral to our operations. We may use the following tools to
manage our exposure to market risk within defined tolerance ranges: (1) change the character of
future investments purchased or sold, (2) use derivatives to offset the market behavior of existing
assets and liabilities or assets expected to be purchased and liabilities to be incurred, or (3)
rebalance our existing asset and liability portfolios.
Sensitivity Analysis
We monitor our sensitivity to interest rate risk by evaluating the change in the value of financial
assets and liabilities due to fluctuations in interest rates. The evaluation is performed by
applying an instantaneous change in interest rates of varying magnitudes on a static balance sheet
to determine the effect such a change in rates would have on our fair value at risk and the
resulting effect on stockholders equity. The analysis presents the sensitivity of the fair value
of our financial instruments to selected changes in market rates and prices. The range of change
chosen reflects our view of changes that are reasonably possible over a one-year period. The
selection of the range of values chosen to represent changes in interest rates should not be
construed as our prediction of future market events, but rather an illustration of the impact of
such events.
The sensitivity analysis estimates the decline in the fair value of our interest sensitive assets
and liabilities that were held on December 31, 2007 and 2006 due to instantaneous parallel
increases in the period end yield curve of 100 and 150 basis points.
The sensitivity analysis also assumes an instantaneous 10% and 20% decline in the foreign currency
exchange rates versus the United States dollar from their levels at December 31, 2007 and 2006,
with all other variables held constant.
Equity price risk was measured assuming an instantaneous 10% and 25% decline in the Standard &
Poors 500 Index (S&P 500) from its level at December 31, 2007 and 2006, with all other variables
held constant. Our equity holdings were assumed to be highly and positively correlated with the
S&P 500. At December 31, 2007, a 10% and 25% decrease in the S&P 500 would result in a $217
million and $542 million decrease compared to a $265 million and $662 million decrease at
December 31, 2006, in the market value of our equity investments.
Of these amounts, under the 10% and 25% scenarios, $5 million and $11 million at December 31, 2007
and $4 million and $10 million at December 31, 2006 pertained to decreases in the fair value of the
separate account investments. These decreases would substantially be offset by decreases in
related separate account liabilities to customers. Similarly, increases in the fair value of the
separate account equity investments would also be offset by increases in the same related separate
account liabilities by the same approximate amounts.
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The following tables present the estimated effects on the fair value of our financial instruments
at December 31, 2007 and December 31, 2006, due to an increase in interest rates of 100 basis
points, a 10% decline in foreign currency exchange rates and a 10% decline in the S&P 500.
Market Risk Scenario 1
Increase (Decrease) | ||||||||||||||||
Market | Interest | Currency | Equity | |||||||||||||
December 31, 2007 | Value | Rate Risk | Risk | Risk | ||||||||||||
(In millions) | ||||||||||||||||
General account: |
||||||||||||||||
Fixed maturity securities available-for-sale |
$ | 34,080 | $ | (1,900 | ) | $ | (111 | ) | $ | (42 | ) | |||||
Fixed maturity securities trading |
177 | (2 | ) | (1 | ) | (1 | ) | |||||||||
Equity securities available-for-sale |
568 | | (1 | ) | (57 | ) | ||||||||||
Short term investments available-for-sale |
4,497 | (4 | ) | (42 | ) | | ||||||||||
Short term investments trading |
180 | | | | ||||||||||||
Limited partnerships |
2,214 | 1 | | (43 | ) | |||||||||||
Other invested assets |
7 | | | | ||||||||||||
Interest rate swaps |
36 | 33 | | | ||||||||||||
Equity index futures trading |
| 1 | | (69 | ) | |||||||||||
Other derivative securities |
3 | (3 | ) | 8 | | |||||||||||
Total general account |
41,762 | (1,874 | ) | (147 | ) | (212 | ) | |||||||||
Separate accounts: |
||||||||||||||||
Fixed maturity securities |
419 | (20 | ) | | | |||||||||||
Equity securities |
45 | | | (5 | ) | |||||||||||
Short term investments |
6 | | | | ||||||||||||
Total separate accounts |
470 | (20 | ) | | (5 | ) | ||||||||||
Total securities |
$ | 42,232 | $ | (1,894 | ) | $ | (147 | ) | $ | (217 | ) | |||||
Debt (carrying value) |
$ | 2,157 | $ | (107 | ) | $ | | $ | | |||||||
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Market Risk Scenario 1
Increase (Decrease) | ||||||||||||||||
Market | Interest | Currency | Equity | |||||||||||||
December 31, 2006 | Value | Rate Risk | Risk | Risk | ||||||||||||
(In millions) | ||||||||||||||||
General account: |
||||||||||||||||
Fixed maturity securities available-for-sale |
$ | 35,647 | $ | (1,959 | ) | $ | (98 | ) | $ | (91 | ) | |||||
Fixed maturity securities trading |
204 | (2 | ) | | (2 | ) | ||||||||||
Equity securities available-for-sale |
597 | | (9 | ) | (60 | ) | ||||||||||
Equity securities trading |
60 | | | (6 | ) | |||||||||||
Short term investments available-for-sale |
5,538 | (5 | ) | (32 | ) | | ||||||||||
Short term investments trading |
172 | | | | ||||||||||||
Limited partnerships |
1,852 | 1 | | (37 | ) | |||||||||||
Other invested assets |
23 | | | | ||||||||||||
Interest rate swaps |
1 | 190 | | | ||||||||||||
Equity index futures trading |
| 1 | | (65 | ) | |||||||||||
Other derivative securities |
2 | 1 | (2 | ) | | |||||||||||
Total general account |
44,096 | (1,773 | ) | (141 | ) | (261 | ) | |||||||||
Separate accounts: |
||||||||||||||||
Fixed maturity securities |
434 | (21 | ) | | | |||||||||||
Equity securities |
41 | | | (4 | ) | |||||||||||
Short term investments |
21 | | | | ||||||||||||
Total separate accounts |
496 | (21 | ) | | (4 | ) | ||||||||||
Total securities |
$ | 44,592 | $ | (1,794 | ) | $ | (141 | ) | $ | (265 | ) | |||||
Debt (carrying value) |
$ | 2,156 | $ | (122 | ) | $ | | $ | | |||||||
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The following tables present the estimated effects on the fair value of our financial instruments
at December 31, 2007 and December 31, 2006, due to an increase in interest rates of 150 basis
points, a 20% decline in foreign currency exchange rates and a 25% decline in the S&P 500.
Market Risk Scenario 2
Increase (Decrease) | ||||||||||||||||
Market | Interest | Currency | Equity | |||||||||||||
December 31, 2007 | Value | Rate Risk | Risk | Risk | ||||||||||||
(In millions) | ||||||||||||||||
General account: |
||||||||||||||||
Fixed maturity securities available-for-sale |
$ | 34,080 | $ | (2,789 | ) | $ | (221 | ) | $ | (106 | ) | |||||
Fixed maturity securities trading |
177 | (3 | ) | (1 | ) | (3 | ) | |||||||||
Equity securities available-for-sale |
568 | | (2 | ) | (142 | ) | ||||||||||
Short term investments available-for-sale |
4,497 | (6 | ) | (85 | ) | | ||||||||||
Short term investments trading |
180 | | | | ||||||||||||
Limited partnerships |
2,214 | 1 | | (109 | ) | |||||||||||
Other invested assets |
7 | | | | ||||||||||||
Interest rate swaps |
36 | 48 | | | ||||||||||||
Equity index futures trading |
| 2 | | (171 | ) | |||||||||||
Other derivative securities |
3 | | (8 | ) | | |||||||||||
Total general account |
41,762 | (2,747 | ) | (317 | ) | (531 | ) | |||||||||
Separate accounts: |
||||||||||||||||
Fixed maturity securities |
419 | (30 | ) | | | |||||||||||
Equity securities |
45 | | | (11 | ) | |||||||||||
Short term investments |
6 | | | | ||||||||||||
Total separate accounts |
470 | (30 | ) | | (11 | ) | ||||||||||
Total securities |
$ | 42,232 | $ | (2,777 | ) | $ | (317 | ) | $ | (542 | ) | |||||
Debt (carrying value) |
$ | 2,157 | $ | (156 | ) | $ | | $ | | |||||||
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Market Risk Scenario 2
Increase (Decrease) | ||||||||||||||||
Market | Interest | Currency | Equity | |||||||||||||
December 31, 2006 | Value | Rate Risk | Risk | Risk | ||||||||||||
(In millions) | ||||||||||||||||
General account: |
||||||||||||||||
Fixed maturity securities available-for-sale |
$ | 35,647 | $ | (2,925 | ) | $ | (197 | ) | $ | (227 | ) | |||||
Fixed maturity securities trading |
204 | (3 | ) | | (5 | ) | ||||||||||
Equity securities available-for-sale |
597 | | (18 | ) | (149 | ) | ||||||||||
Equity securities trading |
60 | | | (15 | ) | |||||||||||
Short term investments available-for-sale |
5,538 | (7 | ) | (64 | ) | | ||||||||||
Short term investments trading |
172 | | | | ||||||||||||
Limited partnerships |
1,852 | 1 | | (93 | ) | |||||||||||
Other invested assets |
23 | | | | ||||||||||||
Interest rate swaps |
1 | 279 | | | ||||||||||||
Equity index futures trading |
| 2 | | (162 | ) | |||||||||||
Other derivative securities |
2 | 1 | (4 | ) | (1 | ) | ||||||||||
Total general account |
44,096 | (2,652 | ) | (283 | ) | (652 | ) | |||||||||
Separate accounts: |
||||||||||||||||
Fixed maturity securities |
434 | (31 | ) | | | |||||||||||
Equity securities |
41 | | | (10 | ) | |||||||||||
Short term investments |
21 | | | | ||||||||||||
Total separate accounts |
496 | (31 | ) | | (10 | ) | ||||||||||
Total securities |
$ | 44,592 | $ | (2,683 | ) | $ | (283 | ) | $ | (662 | ) | |||||
Debt (carrying value) |
$ | 2,156 | $ | (180 | ) | $ | | $ | | |||||||
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CNA Financial Corporation
Consolidated Statements of Operations
Consolidated Statements of Operations
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions, except per share data) | ||||||||||||
Revenues |
||||||||||||
Net earned premiums |
$ | 7,484 | $ | 7,603 | $ | 7,569 | ||||||
Net investment income |
2,433 | 2,412 | 1,892 | |||||||||
Realized investment gains (losses), net of participating
policyholders and minority interests |
(311 | ) | 86 | (10 | ) | |||||||
Other revenues |
279 | 275 | 411 | |||||||||
Total revenues |
9,885 | 10,376 | 9,862 | |||||||||
Claims, Benefits and Expenses |
||||||||||||
Insurance claims and policyholders benefits |
6,009 | 6,047 | 6,999 | |||||||||
Amortization of deferred acquisition costs |
1,520 | 1,534 | 1,543 | |||||||||
Other operating expenses |
994 | 1,027 | 1,034 | |||||||||
Restructuring and other related charges |
| (13 | ) | | ||||||||
Interest |
140 | 131 | 124 | |||||||||
Total claims, benefits and expenses |
8,663 | 8,726 | 9,700 | |||||||||
Income before income tax and minority interest |
1,222 | 1,650 | 162 | |||||||||
Income tax (expense) benefit |
(317 | ) | (469 | ) | 105 | |||||||
Minority interest |
(48 | ) | (44 | ) | (24 | ) | ||||||
Income from continuing operations |
857 | 1,137 | 243 | |||||||||
Income (loss) from discontinued operations, net of income
tax (expense) benefit of $0, $7 and $(2) |
(6 | ) | (29 | ) | 21 | |||||||
Net Income |
$ | 851 | $ | 1,108 | $ | 264 | ||||||
Basic Earnings Per Share |
||||||||||||
Income from continuing operations |
$ | 3.15 | $ | 4.17 | $ | 0.68 | ||||||
Income (loss) from discontinued operations |
(0.02 | ) | (0.11 | ) | 0.08 | |||||||
Basic earnings per share available to common stockholders |
$ | 3.13 | $ | 4.06 | $ | 0.76 | ||||||
Diluted Earnings Per Share |
||||||||||||
Income from continuing operations |
$ | 3.15 | $ | 4.16 | $ | 0.68 | ||||||
Income (loss) from discontinued operations |
(0.02 | ) | (0.11 | ) | 0.08 | |||||||
Diluted earnings per share available to common stockholders |
$ | 3.13 | $ | 4.05 | $ | 0.76 | ||||||
Weighted Average Outstanding Common Stock and Common Stock
Equivalents |
||||||||||||
Basic |
271.5 | 262.1 | 256.0 | |||||||||
Diluted |
271.8 | 262.3 | 256.0 | |||||||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
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CNA Financial Corporation
Consolidated Balance Sheets
Consolidated Balance Sheets
December 31 | 2007 | 2006 | ||||||
(In millions, except share data) | ||||||||
Assets |
||||||||
Investments: |
||||||||
Fixed maturity securities at fair value (amortized cost of $34,388 and $35,135) |
$ | 34,257 | $ | 35,851 | ||||
Equity securities at fair value (cost of $366 and $408) |
568 | 657 | ||||||
Limited partnership investments |
2,214 | 1,852 | ||||||
Other invested assets |
46 | 26 | ||||||
Short term investments |
4,677 | 5,710 | ||||||
Total investments |
41,762 | 44,096 | ||||||
Cash |
94 | 84 | ||||||
Reinsurance receivables (less allowance for uncollectible receivables of $461 and $469) |
8,228 | 9,478 | ||||||
Insurance receivables (less allowance for doubtful accounts of $312 and $368) |
1,972 | 2,108 | ||||||
Accrued investment income |
330 | 313 | ||||||
Receivables for securities sold and collateral |
142 | 303 | ||||||
Deferred acquisition costs |
1,161 | 1,190 | ||||||
Prepaid reinsurance premiums |
270 | 342 | ||||||
Deferred income taxes |
1,198 | 855 | ||||||
Property and equipment at cost (less accumulated depreciation of $596 and $571) |
378 | 277 | ||||||
Goodwill and other intangible assets |
142 | 142 | ||||||
Other assets |
579 | 592 | ||||||
Separate account business |
476 | 503 | ||||||
Total assets |
$ | 56,732 | $ | 60,283 | ||||
Liabilities and Stockholders Equity |
||||||||
Liabilities: |
||||||||
Insurance reserves: |
||||||||
Claim and claim adjustment expenses |
$ | 28,588 | $ | 29,636 | ||||
Unearned premiums |
3,598 | 3,784 | ||||||
Future policy benefits |
7,106 | 6,645 | ||||||
Policyholders funds |
930 | 1,015 | ||||||
Collateral on loaned securities and derivatives |
63 | 2,851 | ||||||
Payables for securities purchased |
353 | 221 | ||||||
Participating policyholders funds |
45 | 50 | ||||||
Short term debt |
350 | | ||||||
Long term debt |
1,807 | 2,156 | ||||||
Federal income taxes payable (includes $5 and $38 due to Loews Corporation) |
2 | 40 | ||||||
Reinsurance balances payable |
401 | 539 | ||||||
Other liabilities |
2,478 | 2,740 | ||||||
Separate account business |
476 | 503 | ||||||
Total liabilities |
46,197 | 50,180 | ||||||
Commitments and contingencies (Notes B, F, G, I and K) |
||||||||
Minority interest |
385 | 335 | ||||||
Stockholders equity: |
||||||||
Common stock ($2.50 par value; 500,000,000 shares authorized; 273,040,243 shares
issued; and 271,662,278 and 271,108,480 shares outstanding) |
683 | 683 | ||||||
Additional paid-in capital |
2,169 | 2,166 | ||||||
Retained earnings |
7,285 | 6,486 | ||||||
Accumulated other comprehensive income |
103 | 549 | ||||||
Treasury stock (1,377,965 and 1,931,763 shares), at cost |
(39 | ) | (58 | ) | ||||
10,201 | 9,826 | |||||||
Notes receivable for the issuance of common stock |
(51 | ) | (58 | ) | ||||
Total stockholders equity |
10,150 | 9,768 | ||||||
Total liabilities and stockholders equity |
$ | 56,732 | $ | 60,283 | ||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
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CNA Financial Corporation
Consolidated Statements of Cash Flows
Consolidated Statements of Cash Flows
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions) | ||||||||||||
Cash Flows from Operating Activities: |
||||||||||||
Net income |
$ | 851 | $ | 1,108 | $ | 264 | ||||||
Adjustments to reconcile net income to net cash
flows provided by operating activities: |
||||||||||||
(Income) loss from discontinued operations |
6 | 29 | (21 | ) | ||||||||
Loss (gain) on disposal of property and equipment |
1 | | (1 | ) | ||||||||
Minority interest |
48 | 44 | 24 | |||||||||
Deferred income tax provision |
(99 | ) | 173 | (220 | ) | |||||||
Trading securities activity |
(12 | ) | 374 | 164 | ||||||||
Realized investment (gains) losses, net of
participating policyholders and minority
interests |
311 | (86 | ) | 10 | ||||||||
Undistributed earnings of equity method investees |
(99 | ) | (170 | ) | (45 | ) | ||||||
Net amortization of bond (discount) premium |
(252 | ) | (274 | ) | (153 | ) | ||||||
Depreciation |
64 | 48 | 54 | |||||||||
Changes in: |
||||||||||||
Receivables, net |
1,386 | 2,427 | 3,531 | |||||||||
Accrued investment income |
(17 | ) | (1 | ) | (15 | ) | ||||||
Deferred acquisition costs |
29 | 7 | 71 | |||||||||
Prepaid reinsurance premiums |
72 | (2 | ) | 788 | ||||||||
Federal income taxes recoverable/payable |
(38 | ) | 102 | (62 | ) | |||||||
Insurance reserves |
(830 | ) | (771 | ) | (943 | ) | ||||||
Reinsurance balances payable |
(138 | ) | (1,097 | ) | (1,344 | ) | ||||||
Other assets |
42 | 142 | (16 | ) | ||||||||
Other liabilities |
(80 | ) | 306 | 55 | ||||||||
Other, net |
7 | (98 | ) | 75 | ||||||||
Total adjustments |
401 | 1,153 | 1,952 | |||||||||
Net cash flows provided by operating
activities-continuing operations |
$ | 1,252 | $ | 2,261 | $ | 2,216 | ||||||
Net cash flows used by operating
activities-discontinued operations |
$ | (13 | ) | $ | (11 | ) | $ | (47 | ) | |||
Net cash flows provided by operating activities-total |
$ | 1,239 | $ | 2,250 | $ | 2,169 | ||||||
Cash Flows from Investing Activities: |
||||||||||||
Purchases of fixed maturity securities |
$ | (73,157 | ) | $ | (48,757 | ) | $ | (62,990 | ) | |||
Proceeds from fixed maturity securities: |
||||||||||||
Sales |
69,012 | 42,433 | 55,611 | |||||||||
Maturities, calls and redemptions |
4,744 | 4,310 | 4,579 | |||||||||
Purchases of equity securities |
(236 | ) | (340 | ) | (482 | ) | ||||||
Proceeds from sales of equity securities |
340 | 221 | 316 | |||||||||
Change in short term investments |
1,347 | (1,331 | ) | 1,627 | ||||||||
Change in collateral on loaned securities |
(2,788 | ) | 2,084 | (151 | ) | |||||||
Change in other investments |
(168 | ) | (195 | ) | 86 | |||||||
Purchases of property and equipment |
(160 | ) | (131 | ) | (45 | ) | ||||||
Dispositions |
14 | 8 | 57 | |||||||||
Other, net |
(69 | ) | 16 | 56 | ||||||||
Net cash flows used by investing
activities-continuing operations |
$ | (1,121 | ) | $ | (1,682 | ) | $ | (1,336 | ) | |||
Net cash flows provided by investing
activities-discontinued operations, including
proceeds from disposition |
$ | 39 | $ | 36 | $ | 20 | ||||||
Net cash flows used by investing activities-total |
$ | (1,082 | ) | $ | (1,646 | ) | $ | (1,316 | ) | |||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
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2007 | 2006 | 2005 | ||||||||||
Cash Flows from Financing Activities: |
||||||||||||
Dividends paid to stockholders |
$ | (95 | ) | $ | | $ | | |||||
Proceeds from the issuance of long term debt |
| 759 | | |||||||||
Principal payments on debt |
| (294 | ) | (568 | ) | |||||||
Return of investment contract account balances |
(122 | ) | (589 | ) | (281 | ) | ||||||
Receipts of investment contract account balances |
3 | 4 | 7 | |||||||||
Payment to repurchase Series H Issue preferred stock |
| (993 | ) | | ||||||||
Proceeds from the issuance of common stock |
| 499 | | |||||||||
Stock options exercised |
18 | 10 | 2 | |||||||||
Other, net |
11 | (1 | ) | 3 | ||||||||
Net cash flows used by financing
activities-continuing operations |
$ | (185 | ) | $ | (605 | ) | $ | (837 | ) | |||
Net cash flows provided by financing
activities-discontinued operations |
$ | | $ | | $ | | ||||||
Net cash flows used by financing activities-total |
$ | (185 | ) | $ | (605 | ) | $ | (837 | ) | |||
Effect of foreign exchange rate changes on
cash-continuing operations |
5 | | | |||||||||
Net change in cash |
(23 | ) | (1 | ) | 16 | |||||||
Net cash transactions from continuing operations to
discontinued operations |
59 | 14 | (42 | ) | ||||||||
Net cash transactions from discontinued operations to
continuing operations |
(59 | ) | (14 | ) | 42 | |||||||
Cash, beginning of year |
124 | 125 | 109 | |||||||||
Cash, end of year |
$ | 101 | $ | 124 | $ | 125 | ||||||
Cash-continuing operations |
$ | 94 | $ | 84 | $ | 96 | ||||||
Cash-discontinued operations |
7 | 40 | 29 | |||||||||
Cash-total |
$ | 101 | $ | 124 | $ | 125 | ||||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
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CNA Financial Corporation
Consolidated Statements of Stockholders Equity
Consolidated Statements of Stockholders Equity
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions) | ||||||||||||
Preferred Stock |
||||||||||||
Balance, beginning of period |
$ | | $ | 750 | $ | 750 | ||||||
Repurchase of Series H Issue |
| (750 | ) | | ||||||||
Balance, end of period |
| | 750 | |||||||||
Common Stock |
||||||||||||
Balance, beginning of period |
683 | 645 | 645 | |||||||||
Issuance of common stock |
| 38 | | |||||||||
Balance, end of period |
683 | 683 | 645 | |||||||||
Additional Paid-in Capital |
||||||||||||
Balance, beginning of period |
2,166 | 1,701 | 1,701 | |||||||||
Issuance of common stock and other |
3 | 465 | | |||||||||
Balance, end of period |
2,169 | 2,166 | 1,701 | |||||||||
Retained Earnings |
||||||||||||
Balance, beginning of period |
6,486 | 5,621 | 5,357 | |||||||||
Adjustment
to initially apply FSP 85-4-1, net of tax |
38 | | | |||||||||
Adjustment to initially apply FIN 48 |
5 | | | |||||||||
Adjusted balance, beginning of period |
6,529 | 5,621 | 5,357 | |||||||||
Dividends paid to stockholders |
(95 | ) | | | ||||||||
Liquidation preference in excess of par value on Series H Issue |
| (243 | ) | | ||||||||
Net income |
851 | 1,108 | 264 | |||||||||
Balance, end of period |
7,285 | 6,486 | 5,621 | |||||||||
Accumulated Other Comprehensive Income (Loss) |
||||||||||||
Balance, beginning of period |
549 | 359 | 661 | |||||||||
Other comprehensive income (loss) |
(446 | ) | 236 | (302 | ) | |||||||
Adjustment to initially apply SFAS 158, net of tax |
| (46 | ) | | ||||||||
Balance, end of period |
103 | 549 | 359 | |||||||||
Treasury Stock |
||||||||||||
Balance, beginning of period |
(58 | ) | (67 | ) | (69 | ) | ||||||
Stock options exercised |
19 | 9 | 2 | |||||||||
Balance, end of period |
(39 | ) | (58 | ) | (67 | ) | ||||||
Notes Receivable for the Issuance of Common Stock |
||||||||||||
Balance, beginning of period |
(58 | ) | (59 | ) | (71 | ) | ||||||
Decrease in notes receivable for the issuance of common stock |
7 | 1 | 12 | |||||||||
Balance, end of period |
(51 | ) | (58 | ) | (59 | ) | ||||||
Total Stockholders Equity |
$ | 10,150 | $ | 9,768 | $ | 8,950 | ||||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
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Notes to Consolidated Financial Statements
Note A. Summary of Significant Accounting Policies
Basis of Presentation
The Consolidated Financial Statements include the accounts of CNA Financial Corporation (CNAF) and
its controlled subsidiaries. Collectively, CNAF and its subsidiaries are referred to as CNA or the
Company. CNAs property and casualty and the remaining life & group insurance operations are
primarily conducted by Continental Casualty Company (CCC), The Continental Insurance Company (CIC)
and Continental Assurance Company (CAC). Loews Corporation (Loews) owned approximately 89% of the
outstanding common stock of CNAF as of December 31, 2007.
The accompanying Consolidated Financial Statements have been prepared in conformity with accounting
principles generally accepted in the United States of America (GAAP). All significant intercompany
amounts have been eliminated. The preparation of 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
Consolidated Financial Statements and the reported amounts of revenues and expenses during the
reporting period. Actual results may differ from those estimates.
Business
CNAs core property and casualty insurance operations are reported in two business segments:
Standard Lines and Specialty Lines. CNAs non-core operations are managed in two segments: Life &
Group Non-Core and Corporate & Other Non-Core. In the fourth quarter of 2007, the Company revised
its property and casualty segments. See Note N for further discussion.
CNA serves a wide variety of customers, including small, medium and large businesses; insurance
companies; associations; professionals; and groups and individuals with a broad range of insurance
and risk management products and services.
Core insurance products include commercial property and casualty coverages. Non-core insurance
products, which primarily have been sold or placed in run-off, include life and accident and health
insurance; retirement products and annuities; and property and casualty reinsurance. CNA services
include risk management, information services and claims administration. CNAs products and
services are marketed through independent agents, brokers, managing general agents and direct
sales.
Insurance Operations
Premiums: Insurance premiums on property and casualty insurance contracts are recognized in
proportion to the underlying risk insured which principally are earned ratably over the duration of
the policies. Premiums on accident and health insurance contracts are earned ratably over the
policy year in which they are due. The reserve for unearned premiums on these contracts represents
the portion of premiums written relating to the unexpired terms of coverage.
An estimated allowance for doubtful accounts is recorded on the basis of periodic evaluations of
balances due currently or in the future from insureds, including amounts due from insureds related
to losses under high deductible policies, managements experience and current economic conditions.
Property and casualty contracts that are retrospectively rated contain provisions that result in an
adjustment to the initial policy premium depending on the contract provisions and loss experience
of the insured during the experience period. For such contracts, the Company estimates the amount
of ultimate premiums that the Company may earn upon completion of the experience period and
recognizes either an asset or a liability for the difference between the initial policy premium and
the estimated ultimate premium. The Company adjusts such estimated ultimate premium amounts during
the course of the experience period based on actual results to date. The resulting adjustment is
recorded as either a reduction of or an increase to the earned premiums for the period.
Claim and claim adjustment expense reserves: Claim and claim adjustment expense reserves, except
reserves for structured settlements not associated with asbestos and environmental pollution (A&E),
workers compensation lifetime claims, accident and health claims and certain claims associated
with discontinued
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operations, are not discounted and are based on 1) case basis estimates for losses reported on
direct business, adjusted in the aggregate for ultimate loss expectations; 2) estimates of incurred
but not reported losses; 3) estimates of losses on assumed reinsurance; 4) estimates of future
expenses to be incurred in the settlement of claims; 5) estimates of salvage and subrogation
recoveries and 6) estimates of amounts due from insureds related to losses under high deductible
policies. Management considers current conditions and trends as well as past Company and industry
experience in establishing these estimates. The effects of inflation, which can be significant,
are implicitly considered in the reserving process and are part of the recorded reserve balance.
Ceded claim and claim adjustment expense reserves are reported as a component of Reinsurance
receivables in the Consolidated Balance Sheets. See Note P for further information on claim and
claim adjustment expense reserves for discontinued operations.
Claim and claim adjustment expense reserves are presented net of anticipated amounts due from
insureds related to losses under high deductible policies of $2.2 billion and $2.5 billion as of
December 31, 2007 and 2006. A significant portion of these amounts is supported by collateral.
The Company also has an allowance for uncollectible deductible amounts, which is presented as a
component of the allowance for doubtful accounts included in the Insurance receivables on the
Consolidated Balance Sheets.
Structured settlements have been negotiated for certain property and casualty insurance claims.
Structured settlements are agreements to provide fixed periodic payments to claimants. Certain
structured settlements are funded by annuities purchased from CAC for which the related annuity
obligations are reported in future policy benefits reserves. Obligations for structured
settlements not funded by annuities are included in claim and claim adjustment expense reserves and
carried at present values determined using interest rates ranging from 4.6% to 7.5% at December 31,
2007 and 2006. At December 31, 2007 and 2006, the discounted reserves for unfunded structured
settlements were $786 million and $814 million, net of discount of $1.2 billion and $1.3 billion.
Workers compensation lifetime claim reserves are calculated using mortality assumptions determined
through statutory regulation and economic factors. Accident and health claim reserves are
calculated using mortality and morbidity assumptions based on Company and industry experience.
Workers compensation lifetime claim reserves and accident and health claim reserves are discounted
at interest rates that range from 3.0% to 6.5% at December 31, 2007 and 2006. At December 31, 2007
and 2006, such discounted reserves totaled $1.4 billion and $1.3 billion, net of discount of
$438 million and $416 million.
Future policy benefits reserves: Reserves for long term care products are computed using the net
level premium method, which incorporates actuarial assumptions as to interest rates, mortality,
morbidity, persistency, withdrawals and expenses. Actuarial assumptions generally vary by plan,
age at issue and policy duration, and include a margin for adverse deviation. Interest rates range
from 6.0% to 8.6% at December 31, 2007 and 2006, and mortality, morbidity and withdrawal
assumptions are based on Company and industry experience prevailing at the time of issue. Expense
assumptions include the estimated effects of inflation and expenses to be incurred beyond the
premium paying period.
Policyholders funds reserves: Policyholders funds reserves primarily include reserves for
investment contracts without life contingencies. For these contracts, policyholder liabilities are
equal to the accumulated policy account values, which consist of an accumulation of deposit
payments plus credited interest, less withdrawals and amounts assessed through the end of the
period.
Guaranty fund and other insurance-related assessments: Liabilities for guaranty fund and other
insurance-related assessments are accrued when an assessment is probable, when it can be reasonably
estimated, and when the event obligating the entity to pay an imposed or probable assessment has
occurred. Liabilities for guaranty funds and other insurance-related assessments are not
discounted and are included as part of Other liabilities in the Consolidated Balance Sheets. As of
December 31, 2007 and 2006, the liability balances were $178 million and $189 million. As of
December 31, 2007 and 2006, included in other assets were $6 million and $7 million of related
assets for premium tax offsets. The related asset is limited to the amount that is able to be
assessed on future premium collections from business written or committed to be written.
Reinsurance: Amounts recoverable from reinsurers are estimated in a manner consistent with claim
and claim adjustment expense reserves or future policy benefits reserves and are reported as
receivables in the Consolidated Balance Sheets. The cost of reinsurance is primarily accounted for
over the life of the underlying reinsured policies using assumptions consistent with those used to
account for the underlying policies or over
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the reinsurance contract period. The ceding of insurance does not discharge the primary liability
of the Company. An estimated allowance for doubtful accounts is recorded on the basis of periodic
evaluations of balances due from reinsurers, reinsurer solvency, managements experience and
current economic conditions. The expenses incurred related to uncollectible reinsurance
receivables are presented as a component of Insurance claims and policyholders benefits in the
Consolidated Statements of Operations.
Reinsurance contracts that do not effectively transfer the underlying economic risk of loss on
policies written by the Company are recorded using the deposit method of accounting, which requires
that premium paid or received by the ceding company or assuming company be accounted for as a
deposit asset or liability. At December 31, 2007, the Company had $40 million recorded as deposit
assets and $117 million recorded as deposit liabilities.
Income on reinsurance contracts accounted for under the deposit method is recognized using an
effective yield based on the anticipated timing of payments and the remaining life of the contract.
When the estimate of timing of payments changes, the effective yield is recalculated to reflect
actual payments to date and the estimated timing of future payments. The deposit asset or
liability is adjusted to the amount that would have existed had the new effective yield been
applied since the inception of the contract. This adjustment is reflected in other revenue or
other operating expense as appropriate.
Participating insurance: Policyholder dividends are accrued using an estimate of the amount to be
paid based on underlying contractual obligations under policies and applicable state laws. When
limitations exist on the amount of net income from participating life insurance contracts that may
be distributed to shareholders, the share of net income on those policies that cannot be
distributed to shareholders is excluded from stockholders equity by a charge to operations and the
establishment of a corresponding liability.
Deferred acquisition costs: Acquisition costs include commissions, premium taxes and certain
underwriting and policy issuance costs which vary with and are related primarily to the acquisition
of business. Such costs related to property and casualty business are deferred and amortized
ratably over the period the related premiums are earned.
Deferred acquisition costs related to accident and health insurance are amortized over the
premium-paying period of the related policies using assumptions consistent with those used for
computing future policy benefits reserves for such contracts. Assumptions as to anticipated
premiums are made at the date of policy issuance or acquisition and are consistently applied during
the lives of the contracts. Deviations from estimated experience are included in results of
operations when they occur. For these contracts, the amortization period is typically the
estimated life of the policy.
The Company evaluates deferred acquisition costs for recoverability. Adjustments, if necessary,
are recorded in current results of operations. Anticipated investment income is considered in the
determination of the recoverability of deferred acquisition costs. Deferred acquisition costs are
recorded net of ceding commissions and other ceded acquisition costs. Unamortized deferred
acquisition costs relating to contracts that have been substantially changed by a modification in
benefits, features, rights or coverages are no longer deferred and are included as a charge to
operations in the period during which the contract modification occurred.
Investments in life settlement contracts and related revenue recognition:
Prior to 2002, the Company purchased investments in life settlement contracts. Under a life
settlement contract, the Company obtained the ownership and beneficiary rights of an underlying
life insurance policy. In March 2006, the Financial Accounting Standards Board (FASB) issued FASB
Staff Position Technical Bulletin No. 85-4-1, Accounting for Life Settlement Contracts by
Third-Party Investors (FSP 85-4-1). A life settlement contract for purposes of FSP 85-4-1 is a
contract between the owner of a life insurance policy (the policy owner) and a third-party investor
(investor). The previous accounting guidance, FASB Technical Bulletin No. 85-4, Accounting for
Purchases of Life Insurance (FTB 85-4), required the purchaser of life insurance contracts to
account for the life insurance contract at its cash surrender value. Because life insurance
contracts are purchased in the secondary market at amounts in excess of the policies cash
surrender values, the application of guidance in FTB 85-4 created a loss upon acquisition of
policies. FSP 85-4-1 provides initial and subsequent measurement guidance and financial statement
presentation and disclosure guidance for investments by third-party investors in life settlement
contracts. FSP 85-4-1 allows an investor to elect to account for its investments in life
settlement contracts using either the investment method or the fair value method. The election
must be
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made on an instrument-by-instrument basis and is irrevocable. The Company adopted FSP 85-4-1 on
January 1, 2007.
The Company elected to account for its investments in life settlement contracts using the fair
value method and the initial impact upon adoption of FSP 85-4-1 under the fair value method was an
increase to retained earnings of $38 million, net of tax.
Under the fair value method, each life settlement contract is carried at its fair value at the end
of each reporting period. The change in fair value, life insurance proceeds received and periodic
maintenance costs, such as premiums, necessary to keep the underlying policy in force, are recorded
in Other revenues on the Consolidated Statement of Operations for the year ended December 31,
2007. Amounts presented related to prior years were accounted for under the previous accounting
guidance, FTB 85-4, where the carrying value of life settlement contracts was the cash surrender
value, and revenue was recognized and included in Other revenues on the Consolidated Statement of
Operations when the life insurance policy underlying the life settlement contract matured. Under
the previous accounting guidance, maintenance expenses were expensed as incurred and included in
Other operating expenses on the Consolidated Statement of Operations. The Companys investments in
life settlement contracts of $115 million at December 31, 2007 are included in Other assets on the
Consolidated Balance Sheet. The cash receipts and payments related to life settlement contracts
are included in Cash flows from operating activities on the Consolidated Statements of Cash Flows
for all periods presented.
The fair value of each life insurance policy is determined as the present value of the anticipated
death benefits less anticipated premium payments for that policy. These anticipated values are
determined using mortality rates and policy terms that are distinct for each insured. The discount
rate used reflects current risk-free rates at applicable durations and the risks associated with
assessing the current medical condition of the insured, the potential volatility of mortality
experience for the portfolio and longevity risk. The Company used its own experience to determine
the fair value of its portfolio of life settlement contracts. The mortality experience of this
portfolio of life insurance policies may vary by quarter due to its relatively small size.
The following table details the values for life settlement contracts.
Fair Value of Life Settlement | Face Amount of Life Insurance | |||||||||||
Number of Life Settlement | Contracts | Policies | ||||||||||
December 31, 2007 | Contracts | (In millions) | (In millions) | |||||||||
Estimated maturity during: |
||||||||||||
2008 |
80 | $ | 16 | $ | 53 | |||||||
2009 |
80 | 14 | 52 | |||||||||
2010 |
80 | 13 | 51 | |||||||||
2011 |
80 | 11 | 51 | |||||||||
2012 |
80 | 10 | 51 | |||||||||
Thereafter |
1,008 | 51 | 490 | |||||||||
Total |
1,408 | $ | 115 | $ | 748 | |||||||
The Company uses an actuarial model to estimate the aggregate face amount of life insurance that is
expected to mature in each future year and the corresponding fair value. This model projects the
likelihood of the insureds death for each in force policy based upon the Companys estimated
mortality rates. The number of life settlement contracts presented in the table above is based
upon the average face amount of in force policies estimated to mature in each future year.
The increase in fair value recognized for the year ended December 31, 2007 on contracts still being
held was $12 million. The gain recognized during the year ended December 31, 2007 on contracts
that matured was $38 million.
Separate Account Business
Separate account assets and liabilities represent contract holder funds related to investment and
annuity products, which are segregated into accounts with specific underlying investment
objectives. The assets and liabilities of these contracts are legally segregated and reported as
assets and liabilities of the separate account business. Substantially all assets of the separate
account business are carried at fair value. Separate account liabilities are primarily carried at
contract values. Fee income accruing to the Company related to separate accounts is primarily
included within Other revenue on the Consolidated Statements of Operations.
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Investments
Valuation of investments: CNA classifies its fixed maturity securities (bonds and redeemable
preferred stocks) and its equity securities as either available-for-sale or trading, and as such,
they are carried at fair value. Changes in fair value of trading securities are reported within
net investment income. The amortized cost of fixed maturity securities classified as
available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity,
which are included in net investment income. Changes in fair value related to available-for-sale
securities are reported as a component of other comprehensive income. Investments are written down
to fair value and losses are recognized in Realized investment gains (losses) on the Consolidated
Statements of Operations when a decline in value is determined to be other-than-temporary.
For asset-backed securities included in fixed maturity securities, the Company recognizes income
using an effective yield based on anticipated prepayments and the estimated economic life of the
securities. When estimates of prepayments change, the effective yield is recalculated to reflect
actual payments to date and anticipated future payments. The net investment in the securities is
adjusted to the amount that would have existed had the new effective yield been applied since the
acquisition of the securities. Such adjustments are reflected in net investment income. Interest
income on lower rated beneficial interests in securitized financial assets is determined using the
prospective yield method.
The Companys carrying value of investments in limited partnerships is its share of the net asset
value of each partnership, as determined by the General Partner, and typically reflects a reporting
lag of up to three months. Changes in net asset values are accounted for under the equity method
and recorded within net investment income. In accordance with FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51 (FIN 46R), the Company has consolidated one limited partnership.
The carrying value of limited partnerships as of December 31, 2007 and 2006
was $2.2 billion and $1.9 billion. As of December 31, 2007 and 2006, the Company had 85 and 70 active limited partnership
investments. The number of limited partnerships held and the strategies employed provide diversification to the limited partnership portfolio
and the overall invested asset portfolio. Of the limited partnerships held, 91% or $2.0 billion in carrying value at December 31, 2007
and 91% or $1.7 billion at December 31, 2006 employ strategies that generate returns through investing in a substantial number of
securities that are readily marketable while engaging in various risk management techniques primarily in fixed and public equity markets.
Some of these limited partnership investment strategies may include low levels of leverage and hedging that potentially introduce more
volatility and risk to the partnership returns. Limited partnerships representing 6% or $133 million at December 31, 2007 and 5% or
$98 million at December 31, 2006 were invested in private equity. The remaining 3% or $71 million at December 31, 2007 and
4% or $69 million at December 31, 2006 were invested in various other partnerships including real estate. The ten largest limited
partnership positions held totaled $1.2 billion and $1.1 billion as of December 31, 2007 and 2006. Based on the most recent
information available regarding the Companys percentage ownership of the individual limited partnerships, the carrying value and related
income reflected in the Companys 2007 and 2006 Consolidated Financial Statements represents approximately 4% and 4% of the aggregate
partnership equity and 2% and 5% of the changes in partnership equity for all limited partnership investments.
Other invested assets include certain derivative securities and real estate investments.
Investments in derivative securities are carried at fair value with changes in fair value reported
as a component of realized gains or losses or other comprehensive income, depending on their hedge
designation. Changes in the fair value of derivative securities which are not designated as hedges
are reported as a component of realized gains or losses. Real estate investments are carried at
the lower of cost or market value.
Short term investments are generally carried at amortized cost, which approximates fair value.
Realized investment gains and losses: All securities sold resulting in investment gains and losses
are recorded on the trade date, except for bank loan participations which are recorded on the date
that the legal agreements are finalized. Realized investment gains and losses are determined on
the basis of the cost or amortized cost of the specific securities sold.
Securities lending activities: CNA lends securities to unrelated parties, primarily major
brokerage firms. Borrowers of these securities must deposit collateral with CNA of at least 102%
of the fair value of the securities loaned if the collateral is cash or securities. CNA maintains
effective control over all loaned securities and, therefore, continues to report such securities as
Fixed maturity securities in the Consolidated Balance Sheets.
Cash collateral received on these transactions is invested in short term investments with an
offsetting liability recognized for the obligation to return the collateral. Non-cash collateral,
such as securities received by the Company, is not reflected as assets of the Company as there
exists no right to sell or repledge the collateral. The fair value of collateral held and included
in short term investments was $53 million and $2.9 billion at December 31, 2007 and 2006. The fair
value of non-cash collateral was $273 million and $385 million at December 31, 2007 and 2006.
Derivative Financial Instruments
All investments in derivatives are recorded at fair value. A derivative is typically defined as an
instrument whose value is derived from an underlying instrument, index or rate, has a notional
amount, requires little or
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no initial investment and can be net settled. Derivatives include, but are not limited to, the
following types of financial instruments: interest rate swaps, interest rate caps and floors, put
and call options, warrants, futures, forwards, commitments to purchase securities, credit default
swaps and combinations of the foregoing. Derivatives embedded within non-derivative instruments
(such as call options embedded in convertible bonds) must be separated from the host instrument
when the embedded derivative is not clearly and closely related to the host instrument.
The Companys derivatives are reported as other invested assets or other liabilities. Embedded
derivative instruments subject to bifurcation are reported together with the host contract, at fair
value. If certain criteria are met, a derivative may be specifically designated as a hedge of
exposures to changes in fair value, cash flows or foreign currency exchange rates. The accounting
for changes in the fair value of a derivative depends on the intended use of the derivative, the
nature of any hedge designation thereon and whether the derivative was transacted in a designated
trading portfolio.
The Companys accounting for changes in the fair value of general account derivatives is as
follows:
Nature of Hedge Designation | Derivatives Change in Fair Value Reflected In: | |
No hedge designation
|
Realized investment gains or losses | |
Fair value designation
|
Realized investment gains or losses, along with the change in fair value of the hedged asset or liability that is attributable to the hedged risk | |
Cash flow designation
|
Other comprehensive income, with subsequent reclassification to earnings when the hedged transaction, asset or liability impacts earnings | |
Foreign currency designation
|
Consistent with fair value or cash flow above, depending on the nature of the hedging relationship |
The Company formally documents all relationships between hedging instruments and hedged items, as
well as its risk-management objective and strategy for undertaking various hedging transactions.
The Company also formally assesses (both at the hedges inception and on an ongoing basis) whether
the derivatives that are used in hedging transactions have been highly effective in offsetting
changes in fair value or cash flows of hedged items and whether those derivatives may be expected
to remain highly effective in future periods. When it is determined that a derivative for which
hedge accounting has been designated is not (or ceases to be) highly effective, the Company
discontinues hedge accounting prospectively.
Derivatives held in designated trading portfolios are carried at fair value with changes therein
reflected in investment income. These derivatives are generally not designated as hedges.
The Company uses derivatives in the normal course of business, primarily in an attempt to reduce
its exposure to market risk (principally interest rate risk, equity stock price risk and foreign
currency risk) stemming from various assets and liabilities and credit risk (the ability of an
obligor to make timely payment of principal and/or interest). The Companys principal objective
under such risk strategies is to achieve the desired reduction in economic risk, even if the
position will not receive hedge accounting treatment.
The Companys use of derivatives is limited by statutes and regulations promulgated by the various
regulatory bodies to which it is subject, and by its own derivative policy. The derivative policy
limits the authorization to initiate derivative transactions to certain personnel. Derivatives
entered into for hedging, regardless of the choice to designate hedge accounting, shall have a
maturity that effectively correlates to the underlying hedged asset or liability. The policy
prohibits the use of derivatives containing greater than one-to-one leverage with respect to
changes in the underlying price, rate or index. The policy also prohibits the use of borrowed
funds, including funds obtained through securities lending, to engage in derivative transactions.
Credit exposure associated with non-performance by the counterparties to derivative instruments is
generally limited to the uncollateralized fair value of the asset related to the instruments
recognized in the Consolidated Balance Sheets. The Company attempts to mitigate the risk of
non-performance by monitoring the creditworthiness of counterparties and diversifying derivatives
to multiple counterparties. The Company
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generally requires that all over-the-counter derivative contracts be governed by an International
Swaps and Derivatives Association (ISDA) Master Agreement, and exchanges collateral under the terms
of these agreements with its derivative investment counterparties depending on the amount of the
exposure and the credit rating of the counterparty.
The Company has exposure to economic losses due to interest rate risk arising from changes in the
level of, or volatility of, interest rates. The Company attempts to mitigate its exposure to
interest rate risk through portfolio management, which includes rebalancing its existing portfolios
of assets and liabilities, as well as changing the characteristics of investments to be purchased
or sold in the future. In addition, various derivative financial instruments are used to modify
the interest rate risk exposures of certain assets and liabilities. These strategies include the
use of interest rate swaps, interest rate caps and floors, options, futures, forwards and
commitments to purchase securities. These instruments are generally used to lock interest rates or
market values, to shorten or lengthen durations of fixed maturity securities or investment
contracts, or to hedge (on an economic basis) interest rate risks associated with investments and
variable rate debt. The Company has used these types of instruments as designated hedges against
specific assets or liabilities on an infrequent basis.
The Company is exposed to equity price risk as a result of its investment in equity securities and
equity derivatives. Equity price risk results from changes in the level or volatility of equity
prices, which affect the value of equity securities, or instruments that derive their value from
such securities. CNA attempts to mitigate its exposure to such risks by limiting its investment in
any one security or index. The Company may also manage this risk by utilizing instruments such as
options, swaps, futures and collars to protect appreciation in securities held. CNA uses
derivatives to mitigate equity price risk associated with its indexed group annuity contracts by
purchasing Standard & Poors 500 Index (S&P 500) futures contracts in a notional amount equal to
the contract holder liability.
The Company has exposure to credit risk arising from the uncertainty associated with a financial
instrument obligors ability to make timely principal and/or interest payments. The Company
attempts to mitigate this risk by limiting credit concentrations, practicing diversification, and
frequently monitoring the credit quality of issuers and counterparties. In addition, the Company
may utilize credit derivatives such as credit default swaps to modify the credit risk inherent in
certain investments. Credit default swaps involve a transfer of credit risk from one party to
another in exchange for periodic payments. The Company infrequently designates these types of
instruments as hedges against specific assets.
Foreign exchange rate risk arises from the possibility that changes in foreign currency exchange
rates will impact the fair value of financial instruments denominated in a foreign currency. The
Companys foreign transactions are primarily denominated in British pounds, Euros and Canadian
dollars. The Company typically manages this risk via asset/liability currency matching and through
the use of foreign currency forwards. The Company has infrequently designated these types of
instruments as hedges against specific assets or liabilities.
The contractual or notional amounts for derivatives are used to calculate the exchange of
contractual payments under the agreements and are not representative of the potential for gain or
loss on these instruments. Interest rates, equity prices and foreign currency exchange rates
affect the fair value of derivatives. The fair values generally represent the estimated amounts
that CNA would expect to receive or pay upon termination of the contracts at the reporting date.
Dealer quotes are available for substantially all of CNAs derivatives. For derivative instruments
not actively traded, fair values are estimated using values obtained from independent pricing
services, costs to settle or quoted market prices of comparable instruments.
The Company is required to provide collateral for all exchange-traded futures and options
contracts. These margin requirements are determined by the individual exchanges based on the fair
value of the open positions and are in the custody of the exchange. Collateral may also be
required for over-the-counter contracts such as interest rate swaps, credit default swaps and
currency forwards per the ISDA agreements in place. The Company does not offset its net derivative
positions against the fair value of the collateral provided. The fair value of collateral
provided, consisting primarily of cash, was $64 million at December 31, 2007 and $58 million at
December 31, 2006.
Income Taxes
The Company and its eligible subsidiaries (CNA Tax Group) are included in the consolidated federal
income tax return of Loews and its eligible subsidiaries. The Company accounts for income taxes
under the asset and liability method. Under the asset and liability method, deferred income taxes
are recognized for temporary
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differences between the financial statement and tax return bases of assets and liabilities. Future
tax benefits are recognized to the extent that realization of such benefits is more likely than
not.
Pension and Postretirement Benefits
Pursuant
to Statement of Financial Accounting Standards (SFAS) No. 158,
Employers Accounting for Defined Benefit Pension and Other
Postretirement Plans (an amendment of FASB Statements No. 87,
88, 106 and 132(R)), which the Company adopted on December 31,
2006, the Company recognizes the overfunded or underfunded status of its defined benefit plans as an
asset or liability in the Consolidated Balance Sheets and recognizes changes in that funded status
in the year in which the changes occur through Other comprehensive income. The Company measures
its benefit plan assets and obligations at December 31 in the Consolidated Balance Sheets.
Stock-Based Compensation
Pursuant to Statement of Financial Accounting Standards No. 123 (revised 2004),
Share-Based Payment (SFAS 123R), the Company records compensation expense for all awards it
grants, modifies, repurchases or cancels. On January 1, 2006, the Company adopted SFAS 123R using
the modified prospective method. Under this method, the Company is required to record compensation
expense for the unvested portion of previously granted awards that remained outstanding as of
January 1, 2006 over the remaining portion of the service period. For stock-based awards granted
on or after January 1, 2006, the Company records stock-based compensation expense primarily on a
straight-line basis over the requisite service period, generally four years. Prior to 2006, the
Company applied the intrinsic value method under Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25), in accounting for its stock-based
compensation plan. Under the recognition and measurement principles of APB 25, no stock-based
compensation cost was recognized, as the exercise price of the granted options equaled the market
price of the underlying stock at the grant date.
Foreign Currency
Foreign currency translation gains and losses are reflected in Stockholders equity as a component
of Accumulated other comprehensive income. The Companys foreign subsidiaries balance sheet
accounts are translated at the exchange rates in effect at each year end and income statement
accounts are translated at the average exchange rates. Foreign currency transaction losses of $10
million, $7 million and $26 million were included in determining net income for the years ended
December 31, 2007, 2006 and 2005.
Property and Equipment
Property and equipment are carried at cost less accumulated depreciation. Depreciation is based on
the estimated useful lives of the various classes of property and equipment and is determined
principally on the straight-line method. Furniture and fixtures are depreciated over seven years.
Office equipment is depreciated over five years. The estimated lives for data processing equipment
and software range from three to five years. Leasehold improvements are depreciated over the
corresponding lease terms.
Goodwill and Other Intangible Assets
Goodwill and other indefinite-lived intangible assets of $142 million as of December 31, 2007 and
2006 primarily represent the excess of purchase price over the fair value of the net assets of
acquired entities and businesses. The balance at December 31, 2007 and 2006 related to Specialty
Lines. During 2006, the Company determined that goodwill and other intangible assets of
approximately $4 million was impaired related to the Standard Lines segment. Goodwill and
indefinite-lived intangible assets are tested for impairment annually or when certain triggering
events require such tests.
Earnings per Share Data
Earnings per share available to common stockholders is based on weighted average outstanding
shares. Basic earnings per share excludes dilution and is computed by dividing net income
attributable to common stockholders by the weighted average number of common shares outstanding
for the period. Diluted earnings 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 years ended December 31, 2007, 2006 and 2005, less than one million shares attributable to
exercises under stock-based employee compensation plans were excluded from the calculation of
diluted earnings per share because they were antidilutive.
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The Series H Cumulative Preferred Stock Issue (Series H Issue) was held by Loews and accrued
cumulative dividends at an initial rate of 8% per year, compounded annually. In August 2006, the
Company repurchased the Series H Issue from Loews for approximately $993 million, a price equal to
the liquidation preference. The Series H Issue dividend amounts through the repurchase date for
the years ended December 31, 2006 and 2005 have been subtracted from Income from Continuing
Operations to determine income from continuing operations available to common stockholders.
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The computation of earnings per share is as follows:
Earnings Per Share
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions, except per share amounts) | ||||||||||||
Income from continuing operations |
$ | 857 | $ | 1,137 | $ | 243 | ||||||
Less: undeclared preferred stock dividend through repurchase date |
| (46 | ) | (70 | ) | |||||||
Income from continuing operations available to common stockholders |
$ | 857 | $ | 1,091 | $ | 173 | ||||||
Weighted average outstanding common stock and common stock equivalents |
271.5 | 262.1 | 256.0 | |||||||||
Effect of dilutive securities, employee stock options and appreciation rights |
0.3 | 0.2 | | |||||||||
Adjusted weighted average outstanding common stock and common stock
equivalents assuming conversions |
271.8 | 262.3 | 256.0 | |||||||||
Basic earnings per share from continuing operations available
to common stockholders |
$ | 3.15 | $ | 4.17 | $ | 0.68 | ||||||
Diluted earnings per share from continuing operations available
to common stockholders |
$ | 3.15 | $ | 4.16 | $ | 0.68 | ||||||
The following table illustrates the effect on net income and earnings per share data if the Company
had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based
Compensation (SFAS 123) to stock-based employee compensation under the Companys stock-based
compensation plans for the year ended December 31, 2005.
Pro Forma Effect of SFAS 123 on Results
Year ended December 31 | 2005 | |||
(In millions, except per share amounts) | ||||
Income from continuing operations |
$ | 243 | ||
Less: undeclared preferred stock dividend |
(70 | ) | ||
Income from continuing operations available to common stockholders |
173 | |||
Income from discontinued operations, net of tax |
21 | |||
Net income available to common stockholders |
194 | |||
Less: Total stock-based compensation cost determined under the fair value method, net of tax |
(2 | ) | ||
Pro forma net income available to common stockholders |
$ | 192 | ||
Basic and diluted earnings per share, as reported |
$ | 0.76 | ||
Basic and diluted earnings per share, pro forma |
$ | 0.75 | ||
Supplementary Cash Flow Information
Cash payments made for interest were $142 million, $109 million and $139 million for the years
ended December 31, 2007, 2006 and 2005. Cash payments made for federal income taxes were $420
million, $173 million and $164 million for the years ended December 31, 2007, 2006 and 2005.
Accounting Pronouncements
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes an interpretation of
FASB Statement No. 109 (FIN 48)
In June 2006, the FASB issued FIN 48. FIN 48 prescribes a comprehensive model for how a company
should recognize, measure, present and disclose in its financial statements uncertain tax positions
that the company has taken or expects to take on a tax return. FIN 48 states that a tax benefit
from an uncertain position may be recognized only if it is more likely than not that the position
is sustainable, based on its technical merits. The tax benefit of a qualifying position is the
largest amount of tax benefit that is greater than 50 percent likely of
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being realized upon ultimate settlement with a taxing authority having full knowledge of all
relevant information. The adoption of FIN 48 as of January 1, 2007 increased retained earnings by
$5 million.
SFAS No. 155, Accounting for Certain Hybrid Financial Instruments an amendment of FASB
Statements No. 133 and 140 (SFAS 155)
In February 2006, the FASB issued SFAS 155. SFAS 155 amends SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities (SFAS 133), and SFAS No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS 155 also
resolves issues addressed in SFAS 133 Implementation Issue No. D1, Application of Statement 133
to Beneficial Interests in Securitized Financial Assets. SFAS 155 eliminates the exemption
from applying SFAS 133 to interests in certain securitized financial assets so that similar
instruments are accounted for in the same manner regardless of the form of the instruments. SFAS
155 also allows a preparer to elect fair value measurement at acquisition, at issuance, or when a
previously recognized financial instrument is subject to a remeasurement (new basis) event, on an
instrument-by-instrument basis. The fair value election provided for in paragraph 4(c) of SFAS 155
may also be applied upon adoption of SFAS 155 for hybrid financial instruments that had been
bifurcated under paragraph 12 of SFAS 133 prior to the adoption of this Statement. SFAS 155 was
effective for all financial instruments acquired or issued after the beginning of an entitys first
fiscal year that begins after September 15, 2006. The adoption of SFAS 155 as of January 1, 2007
had no impact on the results of operations or financial condition of the Company.
SFAS 133 Implementation Issue No. B40, Embedded Derivatives: Application of Paragraph 13(b) to
Securitized Interests in Prepayable Financial Assets (Issue B40)
In January 2007, the FASB released Issue B40 which was applied upon adoption of SFAS 155. Issue
B40 provides a narrow scope exception from paragraph 13(b) of SFAS 133 for securitized interests
that meet certain criteria and contain only an embedded derivative that is tied to the prepayment
risk of the underlying prepayable financial assets. There were no securities impacted by the
adoption of Issue B40 in conjunction with SFAS 155.
Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs
in Connection with Modifications or Exchanges of Insurance Contracts (SOP 05-1)
In September 2005, the Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants issued SOP 05-1. SOP 05-1 provides guidance on accounting by
insurance enterprises for deferred acquisition costs on internal replacements of insurance and
investment contracts other than those specifically described in SFAS No. 97, Accounting and
Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and
Losses from the Sale of Investments. SOP 05-1 defines an internal replacement as a
modification in product benefits, features, rights, or coverages that occurs by the exchange of a
contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the
election of a feature or coverage within a contract. SOP 05-1 was adopted by the Company as of
January 1, 2007 and had no impact on the results of operations or financial condition of the
Company.
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Note B. Investments
The significant components of net investment income are presented in the following table.
Net Investment Income
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions) | ||||||||||||
Fixed maturity securities |
$ | 2,047 | $ | 1,842 | $ | 1,608 | ||||||
Short term investments |
186 | 248 | 147 | |||||||||
Limited partnerships |
183 | 288 | 254 | |||||||||
Equity securities |
25 | 23 | 25 | |||||||||
Income from trading portfolio (a) |
10 | 103 | 47 | |||||||||
Interest on funds withheld and other deposits |
(1 | ) | (68 | ) | (166 | ) | ||||||
Other |
36 | 18 | 20 | |||||||||
Gross investment income |
2,486 | 2,454 | 1,935 | |||||||||
Investment expenses |
(53 | ) | (42 | ) | (43 | ) | ||||||
Net investment income |
$ | 2,433 | $ | 2,412 | $ | 1,892 | ||||||
(a) | The change in net unrealized losses on trading securities included in net investment income
was $15 million and $7 million for the years ended December 31, 2007 and 2005. There was no
change in net unrealized gains (losses) on trading securities included in net investment
income for the year ended December 31, 2006. |
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Net realized investment gains (losses) are presented in the following table.
Net Realized Investment Gains (Losses)
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions) | ||||||||||||
Net realized investment gains (losses): |
||||||||||||
Fixed maturity securities: |
||||||||||||
Gross realized gains |
$ | 486 | $ | 382 | $ | 361 | ||||||
Gross realized losses |
(964 | ) | (377 | ) | (451 | ) | ||||||
Net realized investment gains (losses) on fixed maturity securities |
(478 | ) | 5 | (90 | ) | |||||||
Equity securities: |
||||||||||||
Gross realized gains |
146 | 24 | 73 | |||||||||
Gross realized losses |
(29 | ) | (8 | ) | (35 | ) | ||||||
Net realized investment gains on equity securities |
117 | 16 | 38 | |||||||||
Other |
48 | 66 | 39 | |||||||||
Net realized investment gains (losses) before allocation to
participating policyholders and minority interests |
(313 | ) | 87 | (13 | ) | |||||||
Allocated to participating policyholders and minority interests |
2 | (1 | ) | 3 | ||||||||
Net realized investment gains (losses) |
$ | (311 | ) | $ | 86 | $ | (10 | ) | ||||
Net change in unrealized appreciation (depreciation) in investments is presented in the following
table.
Net Change in Unrealized Appreciation (Depreciation)
Years ended December 31 | 2007 | 2006 | 2005 | |||||||||
(In millions) | ||||||||||||
Net change in unrealized appreciation (depreciation) in general account investments: |
||||||||||||
Fixed maturity securities |
$ | (847 | ) | $ | 98 | $ | (443 | ) | ||||
Equity securities |
(47 | ) | 78 | 34 | ||||||||
Other |
2 | 2 | (1 | ) | ||||||||
Total net change in unrealized appreciation (depreciation) in general account
investments |
(892 | ) | 178 | (410 | ) | |||||||
Net change in unrealized appreciation on other |
1 | (10 | ) | (12 | ) | |||||||
Allocated to participating policyholders and minority interests |
3 | 4 | 18 | |||||||||
Deferred income tax (expense) benefit |
315 | (58 | ) | 158 | ||||||||
Net change in unrealized appreciation (depreciation) in investments |
$ | (573 | ) | $ | 114 | $ | (246 | ) | ||||
Realized investment losses included $741 million, $173 million and $107 million of
other-than-temporary impairment (OTTI) losses for the years ended December 31, 2007, 2006 and 2005.
The 2007 OTTI losses were recorded primarily in the asset-backed bonds and corporate and other
taxable bonds sectors. The 2006 and 2005 OTTI losses were recorded across various sectors. The
increase in OTTI losses for 2007 was primarily driven by credit issue related OTTI losses on
securities for which the Company did not assert an intent to hold until an anticipated recovery in
value. These OTTI losses were driven mainly by credit market conditions and the continued
disruption caused by issues surrounding the sub-prime residential mortgage (sub-prime) crisis. The
increase in OTTI losses for 2006 was primarily driven by an increase in interest rate related OTTI
losses on securities for which the Company did not assert an intent to hold until an anticipated
recovery in value. The 2005 OTTI losses included $34 million related to loans made under a credit
facility to a national contractor, that were classified as fixed maturity securities. See Note R
for additional information on loans to the national contractor.
The Companys investment policies emphasize high credit quality and diversification by industry,
issuer and issue. Assets supporting interest rate sensitive liabilities are segmented within the
general account to facilitate asset/liability duration management.
83
Table of Contents
The following tables provide a summary of fixed maturity and equity securities investments.
Summary of Fixed Maturity and Equity Securities
Cost or | Gross | Gross Unrealized Losses | Estimated | |||||||||||||||||
Amortized | Unrealized | Less than | Greater than | Fair | ||||||||||||||||
December 31, 2007 | Cost | Gains | 12 Months | 12 Months | Value | |||||||||||||||
(In millions) | ||||||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||||||
U.S. Treasury securities and obligations of
government agencies |
$ | 594 | $ | 93 | $ | | $ | | $ | 687 | ||||||||||
Asset-backed securities |
11,776 | 39 | 223 | 183 | 11,409 | |||||||||||||||
States, municipalities and political
subdivisions tax-exempt securities |
7,615 | 144 | 82 | 2 | 7,675 | |||||||||||||||
Corporate bonds |
8,867 | 246 | 149 | 12 | 8,952 | |||||||||||||||
Other debt securities |
4,143 | 208 | 48 | 4 | 4,299 | |||||||||||||||
Redeemable preferred stock |
1,216 | 2 | 160 | | 1,058 | |||||||||||||||
Total fixed maturity securities available-for-sale |
34,211 | 732 | 662 | 201 | 34,080 | |||||||||||||||
Total fixed maturity securities trading |
177 | | | | 177 | |||||||||||||||
Equity securities available-for-sale: |
||||||||||||||||||||
Common stock |
246 | 207 | 1 | | 452 | |||||||||||||||
Preferred stock |
120 | 7 | 11 | | 116 | |||||||||||||||