CNA FINANCIAL CORP - Annual Report: 2008 (Form 10-K)
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, 2008
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 | ||
Chicago, Illinois | 60604 | |
(Address of principal executive offices) | (Zip Code) |
(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 o No þ
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. o
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 20, 2009, 269,024,408 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, 2008 was
approximately $692 million based on the closing price of $25.15 per share of the common stock on
the New York Stock Exchange on June 30, 2008.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the CNA Financial Corporation Proxy Statement prepared for the 2009 annual meeting of
shareholders, pursuant to Regulation 14A, are incorporated by reference into Part III of this
Report.
2
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 90% of
our outstanding common stock as of December 31, 2008.
Our ongoing core businesses serve a wide variety of customers, including small, medium and large
businesses, associations, professionals, and groups 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 and managing general agents.
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. Based on 2007 statutory net written premiums, we are the seventh largest commercial
insurance writer and the thirteenth largest property and casualty insurance organization in the
United States of America.
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
3
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.
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; various tax proposals affecting insurance companies; and possible regulatory
limitations, impositions and restrictions, as well as potential impacts on the fair value
determinations of our invested assets, arising from the Emergency Economic Stabilization Act of
2008.
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, 2008 and 2007, 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, 2008, we had approximately 9,000 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.
4
Supplementary Insurance Data
The following table sets forth supplementary insurance data.
Supplementary Insurance Data
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
Trade Ratios GAAP basis (a) |
||||||||||||
Loss and loss adjustment expense ratio |
78.7 | % | 77.7 | % | 75.7 | % | ||||||
Expense ratio |
30.1 | 30.0 | 30.0 | |||||||||
Dividend ratio |
0.2 | 0.2 | 0.3 | |||||||||
Combined ratio |
109.0 | % | 107.9 | % | 106.0 | % | ||||||
Trade Ratios Statutory basis (preliminary) (a) |
||||||||||||
Loss and loss adjustment expense ratio |
83.8 | % | 79.8 | % | 78.7 | % | ||||||
Expense ratio |
30.1 | 30.0 | 30.2 | |||||||||
Dividend ratio |
0.3 | 0.3 | 0.2 | |||||||||
Combined ratio |
114.2 | % | 110.1 | % | 109.1 | % | ||||||
(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
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 future policy benefits 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. |
The following table displays the distribution of direct written premiums for our operations by
geographic concentration.
Direct Written Premiums
Percent of Total | ||||||||||||
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
California |
9.2 | % | 9.5 | % | 9.7 | % | ||||||
New York |
6.9 | 7.0 | 7.5 | |||||||||
Florida |
6.5 | 7.5 | 8.0 | |||||||||
Texas |
6.2 | 6.1 | 5.8 | |||||||||
Illinois |
3.8 | 3.8 | 4.2 | |||||||||
New Jersey |
3.8 | 3.7 | 4.0 | |||||||||
Pennsylvania |
3.3 | 3.4 | 3.4 | |||||||||
Missouri |
3.1 | 2.9 | 3.1 | |||||||||
All other states, countries or political subdivisions (a) |
57.2 | 56.1 | 54.3 | |||||||||
Total |
100.0 | % | 100.0 | % | 100.0 | % | ||||||
(a) | No other individual state, country or political subdivision accounts for more than 3.0% of
direct written premiums. |
Approximately 7.4%, 6.9% and 5.9% of our direct written premiums were derived from outside of the
United States for the years ended December 31, 2008, 2007 and 2006. Premiums from any individual
foreign country were not significant.
5
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 companies. 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 include the impact of commutations, but exclude the impact of the provision for
uncollectible reinsurance.
6
Schedule of Loss Reserve Development
Calendar Year Ended | ||||||||||||||||||||||||||||||||||||||||||||
(In millions) | 1998 | 1999 (a) | 2000 | 2001 (b) | 2002 (c) | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | |||||||||||||||||||||||||||||||||
Originally reported gross
reserves for unpaid claim
and claim adjustment
expenses |
$ | 28,506 | $ | 26,850 | $ | 26,510 | $ | 29,649 | $ | 25,719 | $ | 31,284 | $ | 31,204 | $ | 30,694 | $ | 29,459 | $ | 28,415 | $ | 27,475 | ||||||||||||||||||||||
Originally reported ceded
recoverable |
5,182 | 6,091 | 7,333 | 11,703 | 10,490 | 13,847 | 13,682 | 10,438 | 8,078 | 6,945 | 6,213 | |||||||||||||||||||||||||||||||||
Originally reported net
reserves for unpaid claim
and claim adjustment
expenses |
$ | 23,324 | $ | 20,759 | $ | 19,177 | $ | 17,946 | $ | 15,229 | $ | 17,437 | $ | 17,522 | $ | 20,256 | $ | 21,381 | $ | 21,470 | $ | 21,262 | ||||||||||||||||||||||
Cumulative net paid as of: |
||||||||||||||||||||||||||||||||||||||||||||
One year later |
$ | 7,321 | $ | 6,547 | $ | 7,686 | $ | 5,981 | $ | 5,373 | $ | 4,382 | $ | 2,651 | $ | 3,442 | $ | 4,436 | $ | 4,308 | $ | | ||||||||||||||||||||||
Two years later |
12,241 | 11,937 | 11,992 | 10,355 | 8,768 | 6,104 | 4,963 | 7,022 | 7,676 | | | |||||||||||||||||||||||||||||||||
Three years later |
16,020 | 15,256 | 15,291 | 12,954 | 9,747 | 7,780 | 7,825 | 9,620 | | | | |||||||||||||||||||||||||||||||||
Four years later |
18,271 | 18,151 | 17,333 | 13,244 | 10,870 | 10,085 | 9,914 | | | | | |||||||||||||||||||||||||||||||||
Five years later |
20,779 | 19,686 | 17,775 | 13,922 | 12,814 | 11,834 | | | | | | |||||||||||||||||||||||||||||||||
Six years later |
21,970 | 20,206 | 18,970 | 15,493 | 14,320 | | | | | | | |||||||||||||||||||||||||||||||||
Seven years later |
22,564 | 21,231 | 20,297 | 16,769 | | | | | | | | |||||||||||||||||||||||||||||||||
Eight years later |
23,453 | 22,373 | 21,382 | | | | | | | | | |||||||||||||||||||||||||||||||||
Nine years later |
24,426 | 23,276 | | | | | | | | | | |||||||||||||||||||||||||||||||||
Ten years later |
25,178 | | | | | | | | | | | |||||||||||||||||||||||||||||||||
Net reserves re-estimated
as of: |
||||||||||||||||||||||||||||||||||||||||||||
End of initial year |
$ | 23,324 | $ | 20,759 | $ | 19,177 | $ | 17,946 | $ | 15,229 | $ | 17,437 | $ | 17,522 | $ | 20,256 | $ | 21,381 | $ | 21,470 | $ | 21,262 | ||||||||||||||||||||||
One year later |
24,306 | 21,163 | 21,502 | 17,980 | 17,650 | 17,671 | 18,513 | 20,588 | 21,601 | 21,463 | | |||||||||||||||||||||||||||||||||
Two years later |
24,134 | 23,217 | 21,555 | 20,533 | 18,248 | 19,120 | 19,044 | 20,975 | 21,706 | | | |||||||||||||||||||||||||||||||||
Three years later |
26,038 | 23,081 | 24,058 | 21,109 | 19,814 | 19,760 | 19,631 | 21,408 | | | | |||||||||||||||||||||||||||||||||
Four years later |
25,711 | 25,590 | 24,587 | 22,547 | 20,384 | 20,425 | 20,212 | | | | | |||||||||||||||||||||||||||||||||
Five years later |
27,754 | 26,000 | 25,594 | 22,983 | 21,076 | 21,060 | | | | | | |||||||||||||||||||||||||||||||||
Six years later |
28,078 | 26,625 | 26,023 | 23,603 | 21,769 | | | | | | | |||||||||||||||||||||||||||||||||
Seven years later |
28,437 | 27,009 | 26,585 | 24,267 | | | | | | | | |||||||||||||||||||||||||||||||||
Eight years later |
28,705 | 27,541 | 27,207 | | | | | | | | | |||||||||||||||||||||||||||||||||
Nine years later |
29,211 | 28,035 | | | | | | | | | | |||||||||||||||||||||||||||||||||
Ten years later |
29,674 | | | | | | | | | | | |||||||||||||||||||||||||||||||||
Total net (deficiency)
redundancy |
$ | (6,350 | ) | $ | (7,276 | ) | $ | (8,030 | ) | $ | (6,321 | ) | $ | (6,540 | ) | $ | (3,623 | ) | $ | (2,690 | ) | $ | (1,152 | ) | $ | (325 | ) | $ | 7 | $ | | |||||||||||||
Reconciliation to gross
re-estimated reserves: |
||||||||||||||||||||||||||||||||||||||||||||
Net reserves re-estimated |
$ | 29,674 | $ | 28,035 | $ | 27,207 | $ | 24,267 | $ | 21,769 | $ | 21,060 | $ | 20,212 | $ | 21,408 | $ | 21,706 | $ | 21,463 | $ | | ||||||||||||||||||||||
Re-estimated ceded
recoverable |
8,178 | 10,673 | 11,458 | 16,965 | 16,313 | 14,709 | 13,576 | 10,935 | 8,622 | 7,277 | | |||||||||||||||||||||||||||||||||
Total gross re-estimated
reserves |
$ | 37,852 | $ | 38,708 | $ | 38,665 | $ | 41,232 | $ | 38,082 | $ | 35,769 | $ | 33,788 | $ | 32,343 | $ | 30,328 | $ | 28,740 | $ | | ||||||||||||||||||||||
Net (deficiency)
redundancy related to: |
||||||||||||||||||||||||||||||||||||||||||||
Asbestos claims |
$ | (2,152 | ) | $ | (1,576 | ) | $ | (1,511 | ) | $ | (739 | ) | $ | (748 | ) | $ | (98 | ) | $ | (43 | ) | $ | (34 | ) | $ | (32 | ) | $ | (27 | ) | $ | | ||||||||||||
Environmental claims |
(616 | ) | (616 | ) | (559 | ) | (212 | ) | (207 | ) | (134 | ) | (134 | ) | (83 | ) | (84 | ) | (83 | ) | | |||||||||||||||||||||||
Total asbestos and
environmental |
(2,768 | ) | (2,192 | ) | (2,070 | ) | (951 | ) | (955 | ) | (232 | ) | (177 | ) | (117 | ) | (116 | ) | (110 | ) | | |||||||||||||||||||||||
Other claims |
(3,582 | ) | (5,084 | ) | (5,960 | ) | (5,370 | ) | (5,585 | ) | (3,391 | ) | (2,513 | ) | (1,035 | ) | (209 | ) | 117 | | ||||||||||||||||||||||||
Total net (deficiency)
redundancy |
$ | (6,350 | ) | $ | (7,276 | ) | $ | (8,030 | ) | $ | (6,321 | ) | $ | (6,540 | ) | $ | (3,623 | ) | $ | (2,690 | ) | $ | (1,152 | ) | $ | (325 | ) | $ | 7 | $ | | |||||||||||||
7
(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.
8
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.
We may continue to incur significant realized and unrealized investment losses and volatility in
net investment income arising from the severe disruption in the capital and credit markets.
We maintain a large portfolio of fixed income and equity securities, including large amounts of
corporate and government issued debt securities, collateralized mortgage obligations (CMOs),
asset-backed and other structured securities, equity and equity-based securities and investments in
limited partnerships which pursue a variety of long and short investment strategies across a broad
array of asset classes. Our investment portfolio supports our obligation to pay future insurance
claims and provides investment returns which are an important part of our overall profitability.
For more than a year, capital and credit markets have experienced severe levels of volatility,
illiquidity, uncertainty and overall disruption. Despite government intervention, market
conditions have led to the merger or failure of a number of prominent financial institutions and
government sponsored entities, sharply increased unemployment and reduced economic activity. In
addition, significant declines in the value of assets and securities that began with the
residential sub-prime mortgage crisis have spread to nearly all classes of investments, including
most of those held in our investment portfolio. As a result, during 2008 we incurred significant
realized and unrealized losses in our investment portfolio and experienced substantial declines in
our net investment income which have materially adversely impacted our results of operations and
equity.
In addition, certain categories of our investments are particularly subject to significant
exposures in the current market environment. Although we normally expect limited partnership
investments to provide higher returns over time, since 2008, they have presented greater risk,
greater volatility and higher illiquidity than our fixed income investments. Commercial
mortgage-backed securities (CMBS) also present greater risks due to the credit deterioration in the
commercial real estate market. Notably, even senior tranches of CMBS have experienced significant
price erosion due to market concerns involving the valuation and credit performance of commercial
real estate. If these economic and market conditions persist, we may continue to experience
reduced investment income and to incur substantial additional realized and unrealized losses on our
investments. As a result, our results of operations, equity, business and insurer financial
strength and debt ratings could be materially adversely impacted. Additional information on our
investment portfolio is included in the MD&A under Item 7 and Note B to the Consolidated Financial
Statements included under Item 8.
We may continue to incur underwriting losses as a result of the global economic crisis.
Overall global economic conditions may continue to be recessionary and highly unfavorable.
Although many lines of our business have both direct and indirect exposure to this economic crisis,
the exposure is especially high for the lines of business that provide management and professional
liability insurance, as well as surety bonds, to businesses engaged in real estate, financial
services and professional services. As a result, we have experienced and may continue to experience
unanticipated underwriting losses with respect to these lines of business. Additionally, we could
experience declines in our premium volume and related insurance losses. Consequently, our results
of operations, equity, business and insurer financial strength and debt ratings could be adversely
impacted.
Our valuation of investments and impairment of securities requires significant judgment.
Our investment portfolio is exposed to various risks such as interest rate, market and credit
risks, many of which are unpredictable. We exercise significant judgment in analyzing these risks
and in validating fair values provided by third parties for securities in our investment portfolio
that are not regularly traded. We also exercise significant judgment in determining whether the
impairment of particular investments is temporary or other-than-temporary. Securities with
exposure to sub-prime residential mortgage collateral or Alternative A (Alt-A) collateral are
particularly sensitive to fairly small changes in actual collateral performance and assumptions as
to future collateral performance.
9
During 2008, we incurred significant unrealized losses in our investment portfolio. In addition,
we recorded significant other-than-temporary impairment (OTTI) losses primarily in the corporate
and other taxable bonds, asset-backed bonds and non-redeemable preferred equity securities sectors.
Due to the inherent uncertainties involved with these types of judgments, we may incur further
unrealized losses and conclude that further other-than-temporary write downs of our investments are
required. As a result, our results of operations, equity, business and insurer financial strength
and debt ratings could be materially adversely impacted. Additional information on our investment
portfolio is included in the MD&A under Item 7 and Note B to the Consolidated Financial Statements
included under Item 8.
We are unable to predict the impact on us of governmental efforts taken and proposed to be taken in
response to the economic and credit crisis.
The Federal government has implemented various measures, including the establishment of the
Troubled Assets Relief Program pursuant to the Emergency Economic Stabilization Act of 2008, in an
effort to deal with the ongoing economic and credit crisis. In addition, there are numerous
proposals for further legislative and regulatory actions at both the Federal and state levels,
particularly with respect to the financial services industry. Since these new laws and regulations
could involve critical matters affecting our operations, they may have an impact on our business
and our overall financial condition. Due to this significant uncertainty, we are unable to
determine whether our actions in response to these governmental efforts will be effective or to
predict with any certainty the overall impact these governmental efforts will have on us. As a
result, our results of operations, equity, business and insurer financial strength and debt ratings
could be materially adversely impacted.
We may continue to incur significant losses from our investments in financial institutions.
Our investment portfolio includes preferred stock and hybrid debt securities issued by banks and
other financial institutions. To date, government sponsored efforts to recapitalize the financial
system both in the United States, as well as overseas, have been inconsistent and unpredictable.
The uncertainty surrounding these efforts and their potential impact on existing financial
institution securities has caused these securities to experience adverse price movement and rating
agency downgrades. If this uncertainty continues or if regulatory decisions negatively affect our
investments in financial institutions, we may continue to incur significant losses in our
investment portfolio. As a result, our results of operations, equity, business and insurer
financial strength and debt ratings could be materially adversely impacted. Additional information
on our investment portfolio is included in the MD&A under Item 7 and Note B to the Consolidated
Financial Statements included under Item 8.
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 (A.M. Best), Moodys Investors Service, Inc. (Moodys) 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 severe disruption in the
capital and credit markets, 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. Recently, Moodys and A.M. Best have revised their outlook on us from stable to
negative.
In addition, it is possible that a lowering of the debt ratings of Loews 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
10
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 and ratings triggers 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.
Any of these regulations could materially adversely affect our results of operations, equity,
business and insurer financial strength and debt ratings.
We are subject to capital adequacy requirements and, if we are unable to maintain or raise
sufficient capital to 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.
During the fourth quarter of 2008, we took several actions to replenish our capital position and
bolster the statutory surplus of our operating insurance subsidiaries. One of these actions was
the November 7, 2008 purchase by Loews of 12,500 shares of our non-voting cumulative preferred
stock (2008 Senior Preferred) for $1.25 billion. Loews, which owned approximately 90% of our
outstanding common stock as of December 31, 2008, has also provided us with substantial amounts of
capital in prior years. Given the ongoing turmoil in the capital and credit markets, we may be
limited in our ability to raise significant amounts of capital on favorable terms or at all. In
addition, Loews may be restricted in its ability or willingness to provide additional capital
support to us. As a result, if we are in need of additional capital, we may be required to
attempt to secure this funding from sources other than Loews on terms that are not favorable.
11
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.
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 the 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
12
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 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 the MD&A
under Item 7 and Note F to the Consolidated Financial Statements included under Item 8.
Asbestos claims. The estimation of reserves for asbestos claims is particularly difficult in
light of the factors noted above. In addition, our ability to estimate the ultimate cost of
asbestos claims is further complicated by the following:
| inconsistency of court decisions and jury attitudes, as well as future court decisions; |
|
| interpretation of 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; |
13
| 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.
Environmental pollution claims. The estimation of reserves for environmental pollution claims is
complicated by liability and coverage issues arising from these claims. We and others in the
insurance industry are disputing coverage for many such claims. In addition to the coverage issues
noted in the asbestos claims section above, key coverage issues in environmental pollution 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.
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 Notes F and G to the Consolidated Financial
Statements included under Item 8.
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
14
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. 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.
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 by terrorist act losses.
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. A
continuation or worsening of the current highly unfavorable global economic conditions, along with
the severe disruptions in the capital and credit markets, could similarly impact all of our
reinsurers. 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
15
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.
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 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.
16
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
|
845,567 | Principal executive offices of CNAF | ||
401 Penn Street, Reading, Pennsylvania
|
170,143 | Property and casualty insurance offices | ||
2405 Lucien Way, Maitland, Florida
|
124,946 | Property and casualty insurance offices | ||
40 Wall Street, New York, New York
|
107,607 | Property and casualty insurance offices | ||
1100 Ward Avenue, Honolulu, Hawaii
|
104,478 | Property and casualty insurance offices | ||
101 S. Phillips Avenue, Sioux Falls, South Dakota
|
81,101 | Property and casualty insurance offices | ||
600 N. Pearl Street, Dallas, Texas
|
72,240 | Property and casualty insurance offices | ||
4267 Meridian Parkway, Aurora, Illinois
|
70,004 | Data Center | ||
675 Placentia Avenue, Brea, California
|
64,939 | Property and casualty insurance offices | ||
1249 South River Road, Cranbury, New Jersey
|
57,671 | 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.
17
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 Nasdaq, under the symbol CNA.
As of
February 20, 2009, we had 269,024,408 shares of common stock outstanding. Approximately 90%
of our outstanding common stock is owned by Loews. We had 1,902 stockholders of record as of
February 20, 2009 according to the records maintained by our transfer agent.
In November 2008, we issued and Loews purchased $1.25 billion of CNAF non-voting cumulative senior
preferred stock, designated the 2008 Senior Preferred Stock (2008 Senior Preferred). The terms of
the 2008 Senior Preferred were approved by a special review committee of independent members of
CNAFs Board of Directors. No dividends may be declared on our common stock or any future preferred
stock while the 2008 Senior Preferred is outstanding. As such, we have suspended our quarterly
common stock dividend payment. We paid $19 million on December 31, 2008, representing the first
quarterly dividend payment on the 2008 Senior Preferred. See Note L of the Consolidated Financial
Statements included under Item 8 for further details on the 2008 Senior Preferred.
Our Board of Directors has approved an authorization to purchase, in the open market or through
privately negotiated transactions, our outstanding common stock, as our management deems
appropriate. In the first quarter of 2008, we repurchased a total of 2,649,621 shares at an
average price of $26.53 (including commission) per share. Under the terms of the 2008 Senior
Preferred discussed above, common stock repurchases are prohibited while the 2008 Senior Preferred
is outstanding. No shares of common stock were purchased during 2007.
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
2008 | 2007 | |||||||||||||||||||||||
Dividends | Dividends | |||||||||||||||||||||||
High | Low | Declared | High | Low | Declared | |||||||||||||||||||
Quarter: |
||||||||||||||||||||||||
First |
$ | 35.04 | $ | 23.01 | $ | 0.15 | $ | 44.29 | $ | 39.09 | $ | | ||||||||||||
Second |
32.15 | 24.34 | 0.15 | 51.96 | 42.96 | 0.10 | ||||||||||||||||||
Third |
30.61 | 21.88 | 0.15 | 49.18 | 37.12 | 0.10 | ||||||||||||||||||
Fourth |
26.70 | 8.50 | | 41.84 | 32.26 | 0.15 |
18
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, 2003 through December 31, 2008. The graph assumes that the value of the investment in our
common stock and for each index was $100 on December 31, 2003 and that dividends were reinvested.
Stock Price Performance Graph
Company / Index | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | ||||||||||||||||||
CNA Financial Corporation |
100.00 | 111.00 | 135.81 | 167.30 | 141.12 | 69.90 | ||||||||||||||||||
S&P 500 Index |
100.00 | 110.88 | 116.33 | 134.70 | 142.10 | 89.53 | ||||||||||||||||||
S&P 500 Property & Casualty Insurance Index |
100.00 | 110.42 | 127.11 | 143.47 | 123.44 | 87.13 |
19
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) | 2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||||
Results of Operations: |
||||||||||||||||||||
Revenues |
$ | 7,799 | $ | 9,885 | $ | 10,376 | $ | 9,862 | $ | 9,924 | ||||||||||
Income (loss) from continuing
operations |
$ | (308 | ) | $ | 857 | $ | 1,137 | $ | 243 | $ | 446 | |||||||||
Income (loss) from discontinued
operations, net of tax |
9 | (6 | ) | (29 | ) | 21 | (21 | ) | ||||||||||||
Net income (loss) |
$ | (299 | ) | $ | 851 | $ | 1,108 | $ | 264 | $ | 425 | |||||||||
Basic Earnings (Loss) Per Share: |
||||||||||||||||||||
Income (loss) from continuing
operations |
$ | (1.21 | ) | $ | 3.15 | $ | 4.17 | $ | 0.68 | $ | 1.49 | |||||||||
Income (loss) from discontinued
operations |
0.03 | (0.02 | ) | (0.11 | ) | 0.08 | (0.09 | ) | ||||||||||||
Basic earnings (loss) per share
available to common stockholders |
$ | (1.18 | ) | $ | 3.13 | $ | 4.06 | $ | 0.76 | $ | 1.40 | |||||||||
Diluted Earnings (Loss) Per Share: |
||||||||||||||||||||
Income (loss) from continuing
operations |
$ | (1.21 | ) | $ | 3.15 | $ | 4.16 | $ | 0.68 | $ | 1.49 | |||||||||
Income (loss) from discontinued
operations |
0.03 | (0.02 | ) | (0.11 | ) | 0.08 | (0.09 | ) | ||||||||||||
Diluted earnings (loss) per share
available to common stockholders |
$ | (1.18 | ) | $ | 3.13 | $ | 4.05 | $ | 0.76 | $ | 1.40 | |||||||||
Dividends declared per common share |
$ | 0.45 | $ | 0.35 | $ | | $ | | $ | | ||||||||||
Financial Condition: |
||||||||||||||||||||
Total investments |
$ | 35,003 | $ | 41,789 | $ | 44,096 | $ | 39,695 | $ | 39,231 | ||||||||||
Total assets |
51,688 | 56,759 | 60,283 | 59,016 | 62,496 | |||||||||||||||
Insurance reserves |
38,771 | 40,222 | 41,080 | 42,436 | 43,653 | |||||||||||||||
Long and short term debt |
2,058 | 2,157 | 2,156 | 1,690 | 2,257 | |||||||||||||||
Stockholders equity |
6,877 | 10,150 | 9,768 | 8,950 | 8,974 | |||||||||||||||
Book value per common share |
$ | 20.92 | $ | 37.36 | $ | 36.03 | $ | 31.26 | $ | 31.63 | ||||||||||
Statutory Surplus (preliminary): |
||||||||||||||||||||
Property and casualty companies (a) |
$ | 8,002 | $ | 8,511 | $ | 8,137 | $ | 6,940 | $ | 6,998 | ||||||||||
Life company |
487 | 471 | 687 | 627 | 1,177 |
(a) | Surplus includes the property and casualty companies equity ownership of the life companys
capital and surplus. |
20
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 |
22 | ||
Critical Accounting Estimates |
25 | ||
Reserves Estimates and Uncertainties |
27 | ||
Segment Results |
33 | ||
Standard Lines |
34 | ||
Specialty Lines |
37 | ||
Life & Group Non-Core |
40 | ||
Corporate & Other Non-Core |
41 | ||
Asbestos and Environmental Pollution (A&E) Reserves |
42 | ||
Investments |
48 | ||
Net Investment Income |
48 | ||
Net Realized Investment Gains (Losses) |
49 | ||
Gross Unrealized Losses |
51 | ||
Duration |
54 | ||
Asset-Backed and Sub-prime Mortgage Exposure |
55 | ||
Short Term Investments |
56 | ||
Separate Accounts |
56 | ||
Liquidity and Capital Resources |
57 | ||
Cash Flows |
57 | ||
Common Stock Dividends |
58 | ||
Share Repurchases |
58 | ||
Liquidity |
58 | ||
Commitments, Contingencies, and Guarantees |
59 | ||
Ratings |
59 | ||
Accounting Pronouncements |
60 | ||
Forward-Looking Statements |
61 |
21
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) | 2008 | 2007 | 2006 | |||||||||
Revenues |
||||||||||||
Net earned premiums |
$ | 7,151 | $ | 7,484 | $ | 7,603 | ||||||
Net investment income |
1,619 | 2,433 | 2,412 | |||||||||
Other revenues |
326 | 279 | 275 | |||||||||
Total operating revenues |
9,096 | 10,196 | 10,290 | |||||||||
Claims, Benefits and Expenses |
||||||||||||
Net incurred claims and benefits |
5,703 | 5,995 | 6,025 | |||||||||
Policyholders dividends |
20 | 14 | 22 | |||||||||
Amortization of deferred acquisition costs |
1,467 | 1,520 | 1,534 | |||||||||
Other insurance related expenses |
694 | 733 | 757 | |||||||||
Restructuring and other related charges |
| | (13 | ) | ||||||||
Other expenses |
477 | 401 | 401 | |||||||||
Total claims, benefits and expenses |
8,361 | 8,663 | 8,726 | |||||||||
Operating income from continuing operations before income tax and
minority interest |
735 | 1,533 | 1,564 | |||||||||
Income tax expense on operating income |
(145 | ) | (425 | ) | (450 | ) | ||||||
Minority interest |
(57 | ) | (48 | ) | (44 | ) | ||||||
Net operating income from continuing operations |
533 | 1,060 | 1,070 | |||||||||
Realized investment gains (losses), net of participating
policyholders and minority interests |
(1,297 | ) | (311 | ) | 86 | |||||||
Income tax (expense) benefit on realized investment gains (losses) |
456 | 108 | (19 | ) | ||||||||
Income (loss) from continuing operations |
(308 | ) | 857 | 1,137 | ||||||||
Income (loss) from discontinued operations, net of income tax (expense)
benefit of $9, $0 and $7 |
9 | (6 | ) | (29 | ) | |||||||
Net income (loss) |
$ | (299 | ) | $ | 851 | $ | 1,108 | |||||
Basic Earnings (Loss) Per Share |
||||||||||||
Income (loss) from continuing operations |
$ | (1.21 | ) | $ | 3.15 | $ | 4.17 | |||||
Income (loss) from discontinued operations |
0.03 | (0.02 | ) | (0.11 | ) | |||||||
Basic earnings (loss) per share available to common stockholders |
$ | (1.18 | ) | $ | 3.13 | $ | 4.06 | |||||
Diluted Earnings (Loss) Per Share |
||||||||||||
Income (loss) from continuing operations |
$ | (1.21 | ) | $ | 3.15 | $ | 4.16 | |||||
Income (loss) from discontinued operations |
0.03 | (0.02 | ) | (0.11 | ) | |||||||
Diluted earnings (loss) per share available to common stockholders |
$ | (1.18 | ) | $ | 3.13 | $ | 4.05 | |||||
Weighted Average Outstanding Common Stock and Common Stock Equivalents |
||||||||||||
Basic |
269.4 | 271.5 | 262.1 | |||||||||
Diluted |
269.4 | 271.8 | 262.3 | |||||||||
22
2008 Compared with 2007
Net results decreased $1,150 million in 2008 as compared with 2007. This decrease was due to
higher net realized investment losses and decreased net operating income.
Net realized investment losses increased $638 million in 2008 as compared to 2007. The increase
was primarily driven by higher impairment losses. See the Investment section of this MD&A for
further discussion of net realized investment results.
Net operating income from continuing operations in 2008 decreased $527 million as compared with
2007. The decrease was primarily due to lower net investment income, driven by limited partnership
results, and higher catastrophe impacts. Net investment income included a decline in trading
portfolio results of $159 million, which was substantially offset by a corresponding decrease in
the policyholders funds reserves supported by the trading portfolio. See the Investments section
of this MD&A for further discussion of net investment income. The catastrophe impacts were $239
million after-tax in 2008, as compared to catastrophe losses of $51 million after-tax in 2007. Net
operating income from continuing operations in 2007 included an after-tax loss of $108 million in
connection with the settlement of an arbitration proceeding (IGI Contingency), as discussed below.
Favorable net prior year development of $80 million was recorded in 2008 related to our Standard
Lines, Specialty Lines and Corporate & Other Non-core segments. This amount consisted of $75
million of favorable claim and allocated claim adjustment expense reserve development and $5
million of favorable premium development. 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. Further information
on Net Prior Year Development for 2008 and 2007 is included in Note F of the Consolidated Financial
Statements included under Item 8.
Net earned premiums decreased $333 million in 2008 as compared with 2007, including a $314 million
decrease related to Standard Lines and a $7 million decrease related to Specialty Lines. See the
Segment Results section of this MD&A for further discussion.
Results from discontinued operations improved $15 million in 2008 as compared to 2007. The 2008
results are primarily driven by the recognition in 2008 of a change in estimate of the tax benefit
related to the 2007 sale of our United Kingdom discontinued operations subsidiary. The loss in
2007 was primarily driven by unfavorable net prior year development.
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.
23
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 Statements
included under Item 8.
24
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 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.
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 fair 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. A significant judgment in the valuation of investments is the determination
of when an other-than-temporary impairment has occurred. We have an Impairment Committee, which
reviews the investment portfolio on at least 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.
25
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 results of operations or equity 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.
To determine the discount rate assumption as of the year-end measurement date for our CNA
Retirement Plan and CNA Retiree Health and Group Benefits Plan, we considered the estimated timing
of plan benefit payments and available yields on high quality fixed income debt securities. For
this purpose, high quality is considered a rating of Aa or better by Moodys Investors Service,
Inc. (Moodys) or a rating of AA or better from Standard & Poors (S&P). We reviewed several yield
curves constructed using the cash flow characteristics of the plans as well as bond indices as of
the measurement date. The year-over-year change of those data points was also considered. Based
on this review, management determined that 6.30% and 6.30% were the appropriate discount rates as
of December 31, 2008 to calculate our accrued pension and postretirement liabilities. Accordingly,
the 6.30% and 6.30% rates will also be used to determine our 2009 pension and postretirement
expense. At December 31, 2007, the discount rates used to calculate our accrued pension and
postretirement liabilities were 6.00% and 5.875%.
We recorded a benefit of $14 million in 2008 related to the CNA Retirement Plan and CNA Retiree
Health and Group Benefits Plan. Based on our current assumptions and investment performance in
2008, our expense for the CNA Retirement Plan and the CNA Retiree Health and Group Benefits Plan
will be approximately $49 million for 2009.
Further information on our pension and postretirement benefit obligations is included in Note J of
the Consolidated Financial Statements included under Item 8.
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.
Income Taxes
We account for taxes under the asset and liability method. Under this method, deferred income
taxes are recognized for temporary differences between the financial statement and tax return bases
of assets and liabilities. Any resulting future tax benefits are recognized to the extent that
realization of such benefits is more likely than not, and a valuation allowance is established for
any portion of a deferred tax asset that management believes will not be realized. The assessment
of the need for a valuation allowance requires management to make estimates and assumptions about
future earnings, reversal of existing temporary differences and available tax planning strategies.
If actual experience differs from these estimates and assumptions, the recorded deferred tax asset
may not be fully realized resulting in an increase to income tax expense in our results of
operations. In addition, the ability to record deferred tax assets in the future could be limited
resulting in a higher effective tax rate in that future period.
26
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; |
|
| 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. |
27
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. Our actuaries 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 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).
28
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 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
29
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.
30
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 Lines, the difference between our reserves and
the actuarial point estimate is primarily due to the three most recent accident years because the
claim data from these accident years is very immature. For Specialty Lines, the difference between
our reserves and the actuarial point estimate is spread more broadly across accident years
reflecting the volatility of claim outcomes. 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 100 basis points for the entire period over
which claim payments will be made, we estimate that our net reserves would increase by
approximately $500 million. If estimated workers compensation claim cost inflation decreases by
100 basis points for the entire period over which claim payments will be made, we estimate that our
net reserves would decrease by approximately $450 million. Our net reserves for Standard Lines
workers compensation were approximately $4.8 billion at December 31, 2008.
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 12%, we estimate that our net reserves would
increase by approximately $250 million. If the estimated incurred development factor for general
liability decreases by 10%, we estimate that our net reserves would decrease
31
by approximately $200 million. Our net reserves for Standard Lines general liability were
approximately $3.3 billion at December 31, 2008.
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 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 9%, we estimate that the net reserves would increase by approximately $400
million. If the estimated claim severity decreases by 3%, we estimate that net reserves would
decrease by approximately $150 million. Our net reserves for this business were approximately $4.8
billion at December 31, 2008.
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 24%, we estimate that our net
reserves for CNA Re would increase by approximately $125 million. If the estimated incurred
development factor for CNA Re decreases by 18%, we estimate that our net reserves would decrease by
approximately $100 million. Our net reserves for CNA Re were approximately $0.7 billion at
December 31, 2008.
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 400 basis points, we estimate that our A&E net reserves would increase by
approximately $250 million. If the estimated overall account size trend for A&E decreases by 400
basis points, we estimate that our A&E net reserves would decrease by approximately $150 million.
Our net reserves for A&E were approximately $1.5 billion at December 31, 2008.
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.
32
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. 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).
Our property and casualty field structure consists of 32 branch locations across the country
organized into 2 territories. 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.
Changes in estimates of claim and allocated claim adjustment expense reserves and premium accruals,
net of reinsurance, for prior years are defined as net prior year development within this MD&A.
These changes can be favorable or unfavorable. Net prior year development does not include the
impact of related acquisition expenses. Further information on our reserves is provided in Note F
of the Consolidated Financial Statements included under Item 8.
33
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 domestically,
primarily to small, middle-market and large businesses and organizations. 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 also 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 | 2008 | 2007 | 2006 | |||||||||
(In millions) | ||||||||||||
Net written premiums |
$ | 3,054 | $ | 3,267 | $ | 3,598 | ||||||
Net earned premiums |
3,065 | 3,379 | 3,557 | |||||||||
Net investment income |
506 | 878 | 840 | |||||||||
Net operating income |
221 | 602 | 446 | |||||||||
Net realized investment gains (losses), after-tax |
(317 | ) | (97 | ) | 48 | |||||||
Net income (loss) |
(96 | ) | 505 | 494 | ||||||||
Ratios |
||||||||||||
Loss and loss adjustment expense |
75.4 | % | 67.4 | % | 72.5 | % | ||||||
Expense |
31.6 | 32.5 | 31.6 | |||||||||
Dividend |
| 0.2 | 0.5 | |||||||||
Combined |
107.0 | % | 100.1 | % | 104.6 | % | ||||||
2008 Compared with 2007
Net written premiums for Standard Lines decreased $213 million in 2008 as compared with 2007.
Premiums written in 2008 were unfavorably impacted by competitive market conditions resulting in
decreased production, as compared with 2007, across both our Business and Commercial Insurance
groups. The competitive market conditions may put ongoing pressure on premium and income levels,
and the expense ratio. This unfavorable impact was partially offset by decreased ceded premiums.
Net earned premiums decreased $314 million in 2008 as compared with 2007, consistent with the
decreased net written premiums.
Standard Lines averaged rate decreases of 5% for 2008, as compared to decreases of 4% for 2007 for
the contracts that renewed during those periods. Retention rates of 82% and 78% were achieved for
those contracts that were available for renewal in each period.
Net results decreased $601 million in 2008 as compared with 2007. This decrease was attributable
to decreased net operating income and higher net realized investment losses. See the Investments
section of this MD&A for further discussion of the net realized investment results and net
investment income.
Net operating income decreased $381 million in 2008 as compared with 2007. This decrease was
primarily driven by significantly lower net investment income and higher catastrophe impacts. The
catastrophe impacts were $227 million after-tax in 2008, which included a $7 million after-tax
catastrophe-related insurance assessment, as compared to catastrophe losses of $48 million
after-tax in 2007.
34
In 2008, the amount due from policyholders related to losses under deductible policies within
Standard Lines was reduced by $90 million for insolvent insureds. The reduction of this amount,
which is reflected as unfavorable net prior year reserve development, had no effect on 2008 results
of operations as the Company had previously recognized provisions in prior years. These impacts
were reported in Insurance claims and policyholders benefits in the 2008 Consolidated Statement of
Operations.
The combined ratio increased 6.9 points in 2008 as compared with 2007. The loss ratio increased
8.0 points primarily due to increased catastrophe losses. Catastrophes losses related to 2008
events had an adverse impact of 11.1 points on the loss ratio in 2008 compared with an adverse
impact of 2.2 points in 2007.
The expense ratio decreased 0.9 points in 2008 as compared with 2007 primarily related to changes
in the assessment rates imposed by certain states for insurance-related assessments. The dividend
ratio decreased 0.2 points in 2008 as compared with 2007 due to increased favorable dividend
development in the workers compensation line of business.
Favorable net prior year development of $18 million was recorded in 2008, including $34 million of
favorable claim and allocated claim adjustment expense reserve development and $16 million of
unfavorable premium development. Excluding the impact of the $90 million of unfavorable net prior
year reserve development discussed above, which had no net impact on the 2008 results of
operations, favorable net prior year development was $108 million. Favorable net prior year
development of $123 million, including $104 million of favorable claim and allocated claim
adjustment expense reserve development and $19 million of favorable premium development, was
recorded in 2007. Further information on Standard Lines net prior year development for 2008 and
2007 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, 2008 and 2007
for Standard Lines.
Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
Claim and Claim Adjustment Expense Reserves
December 31 | 2008 | 2007 | ||||||
(In millions) | ||||||||
Gross Case Reserves |
$ | 6,158 | $ | 5,988 | ||||
Gross IBNR Reserves |
5,890 | 6,060 | ||||||
Total Gross Carried Claim and Claim Adjustment Expense Reserves |
$ | 12,048 | $ | 12,048 | ||||
Net Case Reserves |
$ | 4,995 | $ | 4,750 | ||||
Net IBNR Reserves |
4,875 | 5,170 | ||||||
Total Net Carried Claim and Claim Adjustment Expense Reserves |
$ | 9,870 | $ | 9,920 | ||||
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 reflected our disciplined
participation in the competitive market. 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 78% 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
35
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.
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.
36
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 and related products that protect individuals
from the financial burden associated with mechanical breakdown. Products are distributed through
independent agents.
CNA Global consists of subsidiaries operating in Europe, Latin America, Canada and Hawaii. These
affiliates offer property and casualty insurance, through brokers, managing general underwriters
and independent agencies, to small and medium size businesses and capitalize on strategic
indigenous opportunities.
37
The following table details results of operations for Specialty Lines.
Results of Operations
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
(In millions) | ||||||||||||
Net written premiums |
$ | 3,435 | $ | 3,506 | $ | 3,431 | ||||||
Net earned premiums |
3,477 | 3,484 | 3,411 | |||||||||
Net investment income |
451 | 621 | 554 | |||||||||
Net operating income |
482 | 619 | 635 | |||||||||
Net realized investment gains (losses), after-tax |
(185 | ) | (53 | ) | 25 | |||||||
Net income |
297 | 566 | 660 | |||||||||
Ratios |
||||||||||||
Loss and loss adjustment expense |
61.9 | % | 62.8 | % | 60.4 | % | ||||||
Expense |
27.8 | 26.7 | 27.4 | |||||||||
Dividend |
0.4 | 0.2 | 0.1 | |||||||||
Combined |
90.1 | % | 89.7 | % | 87.9 | % | ||||||
2008 Compared with 2007
Net written premiums for Specialty Lines decreased $71 million in 2008 as compared with 2007.
Premiums written in 2008 were unfavorably impacted by competitive market conditions resulting in
decreased production, as compared with 2007, primarily in U.S. Specialty Lines. These competitive
market conditions may put ongoing pressure on premium and income levels, and the expense ratio.
The unfavorable impact in premiums written was partially offset by decreased ceded premiums
primarily due to decreased use of reinsurance. Net earned premiums decreased $7 million as
compared with the same period in 2007, consistent with the decrease in net written premiums.
Specialty Lines averaged rate decreases of 3% for 2008 and 2007 for the contracts that renewed
during those periods. Retention rates of 84% and 83% were achieved for those contracts that were
up for renewal in each period.
Net income decreased $269 million in 2008 as compared with 2007. This decrease was primarily
attributable to lower net operating income and higher net realized investment losses. See the
Investments section of this MD&A for further discussion of net investment income and net realized
investment results.
Net operating income decreased $137 million in 2008 as compared with 2007. This decrease was
primarily driven by significantly lower net investment income, decreased current accident year
underwriting results and increased foreign currency transaction losses. These unfavorable results
were partially offset by increased favorable net prior year development.
The combined ratio increased 0.4 points in 2008 as compared with 2007. The loss ratio improved 0.9
points, primarily due to increased favorable net prior year development in 2008 as compared to
2007. This was partially offset by higher current accident year loss ratios recorded primarily in
our E&O and D&O coverages for financial institutions due to the current financial markets credit
crisis.
The expense ratio increased 1.1 points in 2008 as compared with 2007. The increase primarily
related to increased underwriting expenses and reduced ceding commissions.
Favorable net prior year development of $184 million was recorded in 2008, including $164 million
of favorable claim and allocated claim adjustment expense reserve development and $20 million of
favorable premium development. 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. Further information on Specialty
Lines Net Prior Year Development for 2008 and 2007 is included in Note F of the Consolidated
Financial Statements included under Item 8.
38
The following table summarizes the gross and net carried reserves as of December 31, 2008 and 2007
for Specialty Lines.
Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
Claim and Claim Adjustment Expense Reserves
December 31 | 2008 | 2007 | ||||||
(In millions) | ||||||||
Gross Case Reserves |
$ | 2,719 | $ | 2,585 | ||||
Gross IBNR Reserves |
5,563 | 5,818 | ||||||
Total Gross Carried Claim and Claim Adjustment Expense Reserves |
$ | 8,282 | $ | 8,403 | ||||
Net Case Reserves |
$ | 2,149 | $ | 2,090 | ||||
Net IBNR Reserves |
4,694 | 4,527 | ||||||
Total Net Carried Claim and Claim Adjustment Expense Reserves |
$ | 6,843 | $ | 6,617 | ||||
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 reflected our disciplined participation in a competitive market.
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 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 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.
39
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 business, while
considered non-core, continues to be actively marketed. During 2008, we exited the indexed group
annuity portion of our pension deposit business.
The following table summarizes the results of operations for Life & Group Non-Core.
Results of Operations
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
(In millions) | ||||||||||||
Net earned premiums |
$ | 612 | $ | 618 | $ | 641 | ||||||
Net investment income |
484 | 622 | 698 | |||||||||
Net operating loss |
(108 | ) | (159 | ) | (14 | ) | ||||||
Net realized investment losses, after-tax |
(236 | ) | (36 | ) | (33 | ) | ||||||
Net loss |
(344 | ) | (195 | ) | (47 | ) |
2008 Compared with 2007
Net earned premiums for Life & Group Non-Core decreased $6 million in 2008 as compared with 2007.
Net earned premiums relate primarily to the group and individual long term care businesses.
Net loss increased $149 million in 2008 as compared with 2007. The increase in net loss was
primarily due to increased net realized investment losses and adverse investment performance on a
portion of our pension deposit business. Certain of the separate account investment contracts
related to the Companys pension deposit business guarantee principal and a minimum rate of
interest, for which the Company recorded a pretax liability of $68 million in Policyholders funds
during 2008 due to the performance of the related assets supporting the business. The net loss in
2007 included an after-tax loss of $108 million related to the settlement of the IGI Contingency,
as discussed below. The decreased net investment income included a decline of trading portfolio
results of $157 million, which was substantially offset by a corresponding decrease in the
policyholders fund reserves supported by the trading portfolio. The trading portfolio supported
the indexed group annuity portion of our pension deposit business. See the Investments section of
this MD&A for further discussion of net investment income and net realized investment results.
The indexed group annuity portion of our pension deposit business had a net loss of $22 million and
$14 million for 2008 and 2007. The related assets were $720 million and related liabilities were
$688 million at December 31, 2007. During 2008, we settled these liabilities with policyholders
with no material impact to results of operations.
2007 Compared with 2006
Net earned premiums for Life & Group Non-Core decreased $23 million in 2007 as compared with 2006.
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.
40
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 A&E and intrasegment eliminations.
Results of Operations
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
(In millions) | ||||||||||||
Net investment income |
$ | 178 | $ | 312 | $ | 320 | ||||||
Revenues |
30 | 298 | 355 | |||||||||
Net operating income (loss) |
(62 | ) | (2 | ) | 3 | |||||||
Net realized investment gains (losses), after-tax |
(103 | ) | (17 | ) | 27 | |||||||
Net income (loss) |
(165 | ) | (19 | ) | 30 |
2008 Compared with 2007
Revenues decreased $268 million in 2008 as compared with 2007. Revenues were unfavorably impacted
by lower net investment income and higher net realized investment losses. See the Investments
section of this MD&A for further discussion of net investment income and net realized investment
results.
Net results decreased $146 million in 2008 as compared with 2007. The decrease was primarily due
to decreased revenues as discussed above and expenses associated with a legal contingency. These
unfavorable impacts were partially offset by a $27 million release from the allowance for
uncollectible reinsurance receivables arising from a change in estimate. In addition, the 2007
results included current accident year losses related to certain mass torts.
Unfavorable net prior year development of $122 million was recorded during 2008, including $123
million of unfavorable claim and allocated claim adjustment expense reserve development and $1
million of favorable premium development. Unfavorable net prior year development of $86 million
was recorded in 2007, including $91 million of unfavorable claim and allocated claim adjustment
expense reserve development and $5 million of favorable premium development. Further information
on Corporate & Other Non-Cores net prior year development for 2008 and 2007 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, 2008 and 2007
for Corporate & Other Non-Core.
Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
Claim and Claim Adjustment Expense Reserves
December 31 | 2008 | 2007 | ||||||
(In millions) | ||||||||
Gross Case Reserves |
$ | 1,823 | $ | 2,159 | ||||
Gross IBNR Reserves |
2,578 | 2,951 | ||||||
Total Gross Carried Claim and Claim Adjustment Expense Reserves |
$ | 4,401 | $ | 5,110 | ||||
Net Case Reserves |
$ | 1,126 | $ | 1,328 | ||||
Net IBNR Reserves |
1,561 | 1,787 | ||||||
Total Net Carried Claim and Claim Adjustment Expense Reserves |
$ | 2,687 | $ | 3,115 | ||||
41
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.
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 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
42
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, 2008 | December 31, 2007 | |||||||||||||||
Environmental | Environmental | |||||||||||||||
Asbestos | Pollution | Asbestos | Pollution | |||||||||||||
(In millions) | ||||||||||||||||
Gross reserves |
$ | 2,112 | $ | 392 | $ | 2,352 | $ | 367 | ||||||||
Ceded reserves |
(910 | ) | (130 | ) | (1,030 | ) | (125 | ) | ||||||||
Net reserves |
$ | 1,202 | $ | 262 | $ | 1,322 | $ | 242 | ||||||||
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.
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
43
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 with our policyholders identifying the policies and the
terms for payment of asbestos related liabilities. Claim payments are contingent on presentation
of 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% of our total active
asbestos accounts are classified as small accounts at December 31, 2008 and 2007.
We also evaluate our asbestos liabilities arising from our assumed reinsurance business and our
participation in various pools, including Excess & Casualty Reinsurance Association (ECRA).
We carry unassigned IBNR reserves for asbestos. These reserves relate to potential development on
accounts that have not settled and potential future claims from unidentified policyholders.
The tables below depict our overall pending asbestos accounts and associated reserves at December
31, 2008 and 2007.
Pending Asbestos Accounts and Associated Reserves
Net Paid Losses | Net Asbestos | Percent of | ||||||||||||||
Number of | in 2008 | Reserves | Asbestos | |||||||||||||
Policyholders | (In millions) | (In millions) | Net Reserves | |||||||||||||
December 31, 2008 | ||||||||||||||||
Policyholders with settlement agreements |
||||||||||||||||
Structured settlements |
18 | $ | 17 | $ | 133 | 11 | % | |||||||||
Wellington |
3 | 1 | 11 | 1 | ||||||||||||
Coverage in place |
36 | 16 | 94 | 8 | ||||||||||||
Total with settlement agreements |
57 | 34 | 238 | 20 | ||||||||||||
Other policyholders with active accounts |
||||||||||||||||
Large asbestos accounts |
236 | 62 | 234 | 19 | ||||||||||||
Small asbestos accounts |
1,009 | 32 | 91 | 8 | ||||||||||||
Total other policyholders |
1,245 | 94 | 325 | 27 | ||||||||||||
Assumed reinsurance and pools |
| 19 | 114 | 9 | ||||||||||||
Unassigned IBNR |
| | 525 | 44 | ||||||||||||
Total |
1,302 | $ | 147 | $ | 1,202 | 100 | % | |||||||||
44
Pending Asbestos Accounts and Associated Reserves
Net Paid Losses | Net Asbestos | Percent of | ||||||||||||||
Number of | in 2007 | Reserves | Asbestos | |||||||||||||
December 31, 2007 | Policyholders | (In millions) | (In millions) | Net Reserves | ||||||||||||
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 | % | |||||||||
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 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.
45
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.
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 with 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 of cumulative paid losses. Approximately 73% of our total
active pollution accounts are classified as small accounts as of December 31, 2008 and 2007.
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.
46
The tables below depict our overall pending environmental pollution accounts and associated
reserves at December 31, 2008 and 2007.
Pending Environmental Pollution Accounts and Associated Reserves
Net | ||||||||||||||||
Environmental | Percent of | |||||||||||||||
Net Paid Losses | Pollution | Environmental | ||||||||||||||
Number of | in 2008 | Reserves | Pollution Net | |||||||||||||
December 31, 2008 | Policyholders | (In millions) | (In millions) | Reserve | ||||||||||||
Policyholders with settlement agreements |
||||||||||||||||
Structured settlements |
16 | $ | 5 | $ | 9 | 4 | % | |||||||||
Coverage in place |
16 | 3 | 13 | 5 | ||||||||||||
Total with settlement agreements |
32 | 8 | 22 | 9 | ||||||||||||
Other policyholders with active accounts |
||||||||||||||||
Large pollution accounts |
116 | 40 | 48 | 18 | ||||||||||||
Small pollution accounts |
320 | 11 | 41 | 16 | ||||||||||||
Total other policyholders |
436 | 51 | 89 | 34 | ||||||||||||
Assumed reinsurance and pools |
| 4 | 27 | 10 | ||||||||||||
Unassigned IBNR |
| | 124 | 47 | ||||||||||||
Total |
468 | $ | 63 | $ | 262 | 100 | % | |||||||||
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 | % | |||||||||
47
INVESTMENTS
We maintain a large portfolio of fixed income and equity securities, including large amounts of
corporate and government issued debt securities, collateralized mortgage obligations (CMOs),
asset-backed and other structured securities, equity and equity-based securities and investments in
limited partnerships which pursue a variety of long and short investment strategies across a broad
array of asset classes. Our investment portfolio supports our obligation to pay future insurance
claims and provides investment returns which are an important part of our overall profitability.
For more than a year, capital and credit markets have experienced severe levels of volatility,
illiquidity, uncertainty and overall disruption. Despite government intervention, market
conditions have led to the merger or failure of a number of prominent financial institutions and
government sponsored entities, sharply increased unemployment and reduced economic activity. In
addition, significant declines in the value of assets and securities that began with the
residential sub-prime mortgage crisis have spread to nearly all classes of investments, including
most of those held in our investment portfolio. As a result, during 2008 we incurred significant
realized and unrealized losses in our investment portfolio and experienced substantial declines in
our net investment income which have materially adversely impacted our results of operations and
equity.
Net Investment Income
The significant components of net investment income are presented in the following table.
Net Investment Income
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
(In millions) | ||||||||||||
Fixed maturity securities |
$ | 1,984 | $ | 2,047 | $ | 1,842 | ||||||
Short term investments |
115 | 186 | 248 | |||||||||
Limited partnerships |
(379 | ) | 183 | 288 | ||||||||
Equity securities |
80 | 25 | 23 | |||||||||
Income (loss) from trading portfolio (a) |
(149 | ) | 10 | 103 | ||||||||
Interest on funds withheld and other deposits |
(2 | ) | (1 | ) | (68 | ) | ||||||
Other |
21 | 36 | 18 | |||||||||
Gross investment income |
1,670 | 2,486 | 2,454 | |||||||||
Investment expense |
(51 | ) | (53 | ) | (42 | ) | ||||||
Net investment income |
$ | 1,619 | $ | 2,433 | $ | 2,412 | ||||||
(a) | The change in net unrealized gains (losses) on trading securities included in Net investment
income was $3 million and $(15) million for the years ended December 31, 2008 and 2007. 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 decreased by $814 million in 2008 compared with 2007. The decrease was
primarily driven by significant losses from limited partnerships and the trading portfolio in 2008
and a decline in short term interest rates. Limited partnerships may present greater risk, greater
volatility and higher illiquidity than fixed income investments. The decreased results from the
trading portfolio were substantially 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 $21 million in 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.
During 2006, we commuted several significant reinsurance contracts which contained interest
crediting provisions that were reflected as a component of Net investment income in our
Consolidated Statement of Operations. As of December 31, 2006, no further interest expense was due
on the commuted contracts.
The bond segment of the fixed maturity investment portfolio provided an income yield of 5.7%, 5.8%
and 5.6% for the years ended December 31, 2008, 2007 and 2006.
48
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 | 2008 | 2007 | 2006 | |||||||||
(In millions) | ||||||||||||
Fixed maturity securities: |
||||||||||||
U.S. Government bonds |
$ | 235 | $ | 86 | $ | 62 | ||||||
Corporate and other taxable bonds |
(643 | ) | (183 | ) | (98 | ) | ||||||
Tax-exempt bonds |
53 | 3 | 53 | |||||||||
Asset-backed bonds |
(476 | ) | (343 | ) | (9 | ) | ||||||
Redeemable preferred stock |
| (41 | ) | (3 | ) | |||||||
Total fixed maturity securities |
(831 | ) | (478 | ) | 5 | |||||||
Equity securities |
(490 | ) | 117 | 16 | ||||||||
Derivative securities |
(19 | ) | 32 | 18 | ||||||||
Short term investments |
34 | 7 | (5 | ) | ||||||||
Other |
9 | 11 | 52 | |||||||||
Realized investment gains
(losses), net of participating
policyholders and minority
interests |
(1,297 | ) | (311 | ) | 86 | |||||||
Income tax (expense) benefit |
456 | 108 | (19 | ) | ||||||||
Net realized investment gains
(losses), net of participating
policyholders and minority
interests |
$ | (841 | ) | $ | (203 | ) | $ | 67 | ||||
Net realized investment results decreased by $638 million for 2008 compared with 2007. Net
realized investment results decreased by $270 million for 2007 compared with 2006. The decrease in
Net realized investment results in both periods was primarily driven by an increase in
other-than-temporary impairment (OTTI) losses. Further information on our OTTI losses and
impairment decision process is set forth in Note B of the Consolidated Financial Statements
included under Item 8.
49
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, 2008
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. |
$ | 10,663 | $ | 106 | 0-6 | |||||||
Non-redeemable preferred stock of Federal National Mortgage
Association. The company is now in conservatorship. |
6 | 51 | 0-12 | + | ||||||||
Fixed income securities of an investment banking firm that filed
bankruptcy causing the fair value of the securities to decline
rapidly. |
37 | 41 | 0-12 | |||||||||
Non-redeemable preferred stock of Federal Home Loan Mortgage
Corporation. The company is now in conservatorship. |
3 | 27 | 0-12 | |||||||||
Mortgage backed pass-through securities were sold based on
deteriorating performance of the underlying loans and the
resulting rapid market price decline. |
36 | 18 | 0-6 | |||||||||
Fixed income securities of a provider of wireless and wire line
communication services. Securities were sold to reduce exposure
because the company announced a significant shortfall in
operating results, causing significant credit deterioration
which resulted in a rating downgrade. |
41 | 17 | 0-12 | |||||||||
$ | 10,786 | $ | 260 | |||||||||
(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. |
50
Gross Unrealized Losses
The following tables summarize the fair value and gross unrealized loss of fixed income investment
and non-investment grade securities categorized first by the length of time, as measured by the
first date, those securities have been in a continuous unrealized loss position, and then further
categorized by the severity of the unrealized loss position as of December 31, 2008 and 2007.
Unrealized Loss Aging for Fixed Income Securities
Fair Value as a Percentage of Amortized Cost | ||||||||||||||||||||||||||||||||||||||
Estimated | Gross Unrealized |
|||||||||||||||||||||||||||||||||||||
December 31, 2008 | Fair Value | 90-99% | 80-89% | 70-79% | 60-69% | 50-59% | 40-49% | <40% | Loss | |||||||||||||||||||||||||||||
(In millions) | ||||||||||||||||||||||||||||||||||||||
Investment grade: |
||||||||||||||||||||||||||||||||||||||
0-6 months |
$ | 6,749 | $ | 169 | $ | 264 | $ | 167 | $ | 58 | $ | 7 | $ | 11 | $ | 5 | $ | 681 | ||||||||||||||||||||
7-11 months |
6,159 | 126 | 376 | 315 | 364 | 262 | 118 | 30 | 1,591 | |||||||||||||||||||||||||||||
12-24 months |
3,549 | 55 | 143 | 128 | 355 | 449 | 230 | 443 | 1,803 | |||||||||||||||||||||||||||||
Greater than 24 months |
1,778 | 27 | 67 | 151 | 68 | 52 | 8 | 136 | 509 | |||||||||||||||||||||||||||||
Total
investment grade |
$ | 18,235 | $ | 377 | $ | 850 | $ | 761 | $ | 845 | $ | 770 | $ | 367 | $ | 614 | $ | 4,584 | ||||||||||||||||||||
Non-investment grade: |
||||||||||||||||||||||||||||||||||||||
0-6
months |
$ | 853 | $ | 10 | $ | 47 | $ | 93 | $ | 50 | $ | 44 | $ | 16 | $ | 30 | $ | 290 | ||||||||||||||||||||
7-11 months |
374 | 1 | 20 | 43 | 40 | 33 | 19 | 17 | 173 | |||||||||||||||||||||||||||||
12-24 months |
1,078 | 3 | 30 | 83 | 193 | 94 | 203 | 41 | 647 | |||||||||||||||||||||||||||||
Greater than 24 months |
12 | | | | 5 | | 2 | | 7 | |||||||||||||||||||||||||||||
Total
non-investment grade |
$ | 2,317 | $ | 14 | $ | 97 | $ | 219 | $ | 288 | $ | 171 | $ | 240 | $ | 88 | $ | 1,117 | ||||||||||||||||||||
Total |
$ | 20,552 | $ | 391 | $ | 947 | $ | 980 | $ | 1,133 | $ | 941 | $ | 607 | $ | 702 | $ | 5,701 | ||||||||||||||||||||
51
Unrealized Loss Aging for Fixed Income Securities
Fair Value as a Percentage of Amortized Cost | ||||||||||||||||||||||||||||||||||||||
Estimated | Gross Unrealized |
|||||||||||||||||||||||||||||||||||||
December 31, 2007 | Fair Value | 90-99% | 80-89% | 70-79% | 60-69% | 50-59% | 40-49% | <40% | Loss | |||||||||||||||||||||||||||||
(In millions) | ||||||||||||||||||||||||||||||||||||||
Investment grade: |
||||||||||||||||||||||||||||||||||||||
0-6 months |
$ | 4,771 | $ | 100 | $ | 42 | $ | 29 | $ | 26 | $ | 25 | $ | 6 | $ | | $ | 228 | ||||||||||||||||||||
7-11 months |
1,584 | 35 | 81 | 17 | 25 | 13 | 7 | 15 | 193 | |||||||||||||||||||||||||||||
12-24 months |
690 | 21 | 2 | 10 | 7 | 8 | 9 | | 57 | |||||||||||||||||||||||||||||
Greater than 24 months |
3,869 | 88 | 42 | 8 | | | | | 138 | |||||||||||||||||||||||||||||
Total
investment grade |
$ | 10,914 | $ | 244 | $ | 167 | $ | 64 | $ | 58 | $ | 46 | $ | 22 | $ | 15 | $ | 616 | ||||||||||||||||||||
Non-investment grade: |
||||||||||||||||||||||||||||||||||||||
0-6 months |
$ | 1,527 | $ | 56 | $ | 14 | $ | 3 | $ | | $ | | $ | | $ | | $ | 73 | ||||||||||||||||||||
7-11 months |
125 | 6 | 2 | | | | | | 8 | |||||||||||||||||||||||||||||
12-24 months |
26 | 1 | 1 | 1 | 1 | | | | 4 | |||||||||||||||||||||||||||||
Greater than 24 months |
9 | 1 | 1 | | | | | | 2 | |||||||||||||||||||||||||||||
Total
non-investment grade |
$ | 1,687 | $ | 64 | $ | 18 | $ | 4 | $ | 1 | $ | | $ | | $ | | $ | 87 | ||||||||||||||||||||
Total |
$ | 12,601 | $ | 308 | $ | 185 | $ | 68 | $ | 59 | $ | 46 | $ | 22 | $ | 15 | $ | 703 | ||||||||||||||||||||
52
The classification between investment grade and non-investment grade is based on a ratings
methodology that takes into account ratings from the three major providers, S&P, Moodys and Fitch
in that order of preference. If a security is not rated by any of the three, the Company
formulates an internal rating.
As part of the ongoing OTTI monitoring process, we evaluated the facts and circumstances based on
available information for each of these securities and determined that the securities presented in
the above tables were temporarily impaired when evaluated at December 31, 2008 or 2007. 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 until maturity. We believe we have sufficient
levels of liquidity so as to not impact the asset/liability management process. Further
information on our unrealized losses by asset class and our considerations in determining that the
securities were temporarily impaired at December 31, 2008 is included in Note B to the Consolidated
Financial Statements included under Item 8.
Non-investment grade bonds, as presented in the tables above, are primarily high-yield securities
rated below BBB- by bond rating agencies, as well as other unrated securities that, according to
our analysis, are below investment grade. Non-investment grade securities generally involve a
greater degree of risk than investment grade securities.
The following table provides the composition of fixed maturity securities available-for-sale in a
gross unrealized loss position at December 31, 2008 by maturity profile. Securities not due at a
single date are allocated based on weighted average life.
Maturity Profile
Percent of Fair |
Percent of Unrealized |
|||||||
Value | Loss | |||||||
Due in one year or less |
11 | % | 8 | % | ||||
Due after one year through five years |
31 | 21 | ||||||
Due after five years through ten years |
14 | 21 | ||||||
Due after ten years |
44 | 50 | ||||||
Total |
100 | % | 100 | % | ||||
Our fixed income portfolio consists primarily of high quality bonds, 91% and 89% of which were
rated as investment grade (rated BBB- or higher) at December 31, 2008 and 2007. The following
table summarizes the ratings of our fixed income bond portfolio at carrying value.
Fixed Income Bond Ratings
December 31 | 2008 | % | 2007 | % | ||||||||||||
(In millions) | ||||||||||||||||
U.S. Government and affiliated agency securities |
$ | 2,993 | 11 | % | $ | 816 | 3 | % | ||||||||
Other AAA rated |
10,112 | 35 | 16,728 | 50 | ||||||||||||
AA and A rated |
8,166 | 28 | 6,326 | 19 | ||||||||||||
BBB rated |
5,000 | 17 | 5,713 | 17 | ||||||||||||
Non-investment grade |
2,569 | 9 | 3,616 | 11 | ||||||||||||
Total |
$ | 28,840 | 100 | % | $ | 33,199 | 100 | % | ||||||||
At December 31, 2008 and 2007, approximately 97% and 95% of the 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.
53
The carrying value of securities that are either subject to trading restrictions or trade in
illiquid private placement markets at December 31, 2008 was $368 million, which represents 1.1% of
our total investment portfolio. These securities were in a net unrealized gain position of
$170 million at December 31, 2008.
Duration
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 typically 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 income securities, short term investments, preferred stocks 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.
Effective Durations
December 31, 2008 | December 31, 2007 | |||||||||||||||
Effective Duration | Effective Duration | |||||||||||||||
Fair Value | (In years) | Fair Value | (In years) | |||||||||||||
(In millions) | ||||||||||||||||
Segregated investments |
$ | 8,168 | 9.9 | $ | 9,211 | 10.7 | ||||||||||
Other interest sensitive investments |
25,194 | 4.5 | 29,406 | 3.3 | ||||||||||||
Total |
$ | 33,362 | 5.8 | $ | 38,617 | 5.1 | ||||||||||
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.
54
Asset-Backed Mortgage Exposure
Asset-Backed Distribution
Security Type | ||||||||||||||||||||||||||||
Percent | Percent | |||||||||||||||||||||||||||
of Total | of Total | |||||||||||||||||||||||||||
December 31, 2008 | MBS(a) | CMO(b) | ABS(c) | CDO(d) | Total | Security Type | Investments | |||||||||||||||||||||
(In millions) | ||||||||||||||||||||||||||||
U.S. Government Agencies |
$ | 408 | $ | 1,273 | $ | | $ | | $ | 1,681 | 22 | % | 4 | % | ||||||||||||||
AAA |
| 3,249 | 1,672 | 3 | 4,924 | 63 | 14 | |||||||||||||||||||||
AA |
| 187 | 190 | 6 | 383 | 5 | 1 | |||||||||||||||||||||
A |
| 80 | 96 | 28 | 204 | 3 | 1 | |||||||||||||||||||||
BBB |
| 92 | 230 | 2 | 324 | 4 | 1 | |||||||||||||||||||||
Non-investment grade and equity tranches |
| 213 | 27 | 8 | 248 | 3 | 1 | |||||||||||||||||||||
Total Fair Value |
$ | 408 | $ | 5,094 | $ | 2,215 | $ | 47 | $ | 7,764 | 100 | % | 22 | % | ||||||||||||||
Total Amortized Cost |
$ | 405 | $ | 6,181 | $ | 2,887 | $ | 197 | $ | 9,670 | ||||||||||||||||||
Percent of total fair value by security type |
5 | % | 65 | % | 29 | % | 1 | % | 100 | % | ||||||||||||||||||
Sub-prime (included above) |
||||||||||||||||||||||||||||
Fair Value |
$ | | $ | | $ | 1,163 | $ | 1 | $ | 1,164 | 15 | % | 3 | % | ||||||||||||||
Amortized Cost |
$ | | $ | | $ | 1,477 | $ | 31 | $ | 1,508 | 16 | % | 4 | % | ||||||||||||||
Alt-A (included above) |
||||||||||||||||||||||||||||
Fair Value |
$ | | $ | 898 | $ | | $ | 3 | $ | 901 | 12 | % | 3 | % | ||||||||||||||
Amortized Cost |
$ | | $ | 1,229 | $ | | $ | 8 | $ | 1,237 | 13 | % | 3 | % |
(a) | Mortgage-backed securities (MBS) |
|
(b) | Collateralized mortgage obligations (CMO) |
|
(c) | Asset-backed securities (ABS) |
|
(d) | Collateralized debt obligations (CDO) |
Included in our fixed maturity securities at December 31, 2008 were $7,764 million of asset-backed
securities, at fair value, which represents 22% of total invested assets. Of the total
asset-backed securities, 85% were U.S. Government Agency issued or AAA rated. Of the total
invested assets, $1,164 million or 3% have exposure to sub-prime residential mortgage (sub-prime)
collateral, as measured by the original deal structure, while 3% have exposure to Alternative A
residential mortgages that have lower than normal standards of loan documentation (Alt-A)
collateral. Of the securities with sub-prime exposure, approximately 98% were rated investment
grade, while 97% of the Alt-A securities were rated investment grade. We believe that each of
these securities would be rated investment grade even without the benefit of any applicable
third-party guarantees. In addition to sub-prime exposure in fixed maturity securities, there is
exposure of approximately $36 million through limited partnerships and sold credit default swaps
which provide the buyer protection against declines in sub-prime indices.
Included
in the table above are commercial mortgage-backed securities (CMBS), which had an aggregate fair
value of $661 million and an aggregate amortized cost of $1,068 million at December 31, 2008. Most
of our CMBS holdings are in the form of senior tranches of securitization, which benefit from
significant credit support from subordinated tranches.
All asset-backed securities in an unrealized loss position are reviewed as part of the ongoing OTTI
process, which resulted in OTTI losses of $302 million after-tax for the year ended December 31,
2008. Included in this OTTI loss was $128 million after-tax related to securities with sub-prime
and Alt-A exposure. Our 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, Alt-A and CMBS exposures, we believe that all remaining unrealized losses are temporary
in nature. Continued deterioration in these markets beyond our current expectations may cause us
to reconsider and record additional OTTI losses. See Note B of the Consolidated Financial
Statements included under Item 8 for additional information related to unrealized losses on
asset-backed securities.
55
Short Term Investments
The carrying value of the components of the short term investment portfolio is presented in the
following table.
Short Term Investments
December 31 | 2008 | 2007 | ||||||
(In millions) | ||||||||
Short term investments available-for-sale: |
||||||||
Commercial paper |
$ | 563 | $ | 3,040 | ||||
U.S. Treasury securities |
2,258 | 577 | ||||||
Money market funds |
329 | 72 | ||||||
Other, including collateral held related to securities lending |
384 | 808 | ||||||
Total short term investments available-for-sale |
3,534 | 4,497 | ||||||
Short term investments trading: |
||||||||
Commercial paper |
| 35 | ||||||
Money market funds |
| 139 | ||||||
Other |
| 6 | ||||||
Total short term investments trading |
| 180 | ||||||
Total short term investments |
$ | 3,534 | $ | 4,677 | ||||
Separate Accounts
The following table summarizes the bond ratings of the investments supporting separate account
products which guarantee principal and a minimum rate of interest, for which additional amounts may
be recorded in Policyholders funds should the aggregate contract value exceed the fair value of
the related assets supporting the business at any point in time.
Separate Account Bond Ratings
December 31 | 2008 | % | 2007 | % | ||||||||||||
(In millions) | ||||||||||||||||
AAA rated |
$ | 120 | 35 | % | $ | 122 | 29 | % | ||||||||
AA and A rated |
148 | 43 | 224 | 54 | ||||||||||||
BBB rated |
74 | 22 | 73 | 17 | ||||||||||||
Non-investment grade |
1 | | | | ||||||||||||
Total |
$ | 343 | 100 | % | $ | 419 | 100 | % | ||||||||
At December 31, 2008 and 2007, approximately 97% of the separate account portfolio was rated by S&P
or Moodys. The remaining bonds were rated by other rating agencies or internally.
56
LIQUIDITY AND CAPITAL RESOURCES
As a result of the significant realized and unrealized losses in our investment portfolio and
declines in our net investment income during 2008 as discussed in the Investments section of this
MD&A, we took several actions during the fourth quarter to strengthen our capital position and to
ensure our operating insurance subsidiaries had sufficient statutory surplus, including the
following:
| In October 2008, we suspended our quarterly dividend payment to common stockholders. |
||
| In November 2008, we issued, and Loews Corporation (Loews) purchased, 12,500 shares of
our non-voting cumulative preferred stock (2008 Senior Preferred) for $1.25 billion. |
||
| We used the majority of the proceeds from the 2008 Senior Preferred to increase the
statutory surplus of our principal insurance subsidiary, Continental Casualty Company
(CCC), through the purchase of a $1.0 billion surplus note of CCC. |
||
| In November 2008, we borrowed $250 million on an existing credit facility and used $200
million of the proceeds to retire senior notes that matured in December 2008. |
||
| In December 2008, we contributed $500 million of cash and short term investments from
our holding company to CCC. |
||
| We requested and received approval for a statutory permitted practice related to the
recognition of deferred tax assets which increased statutory surplus of CCC by
approximately $700 million as of December 31, 2008. The permitted practice will remain in
effect for the first, second and third quarter 2009 reporting periods. |
Further information on the 2008 Senior Preferred, CCC surplus note and the statutory permitted
practice is included in Note L of the Consolidated Financial Statements included under Item 8.
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 2008, net cash provided by operating activities was $1,558 million as compared to
$1,239 million in 2007. Cash provided by operating activities was favorably impacted by increased
net sales of trading securities to fund policyholders withdrawals of investment contract products
issued by us, decreased tax payments and decreased loss payments. Policyholders fund withdrawals
are reflected as financing cash flows. Cash provided by operating activities was unfavorably
impacted by decreased premium collections and decreased investment income receipts.
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. Cash provided by operating activities was also 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 $1,908 million, $1,082 million and $1,646 million for
2008, 2007 and 2006. 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.
57
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.
Net cash provided by financing activities was $347 million in 2008. In 2007 and 2006, net cash
used for financing activities was $185 million and $605 million. Net cash flow provided by
financing activities in 2008 was primarily related to the issuance of the 2008 Senior Preferred
stock to Loews, as discussed above, partially offset by policyholders fund withdrawals and
dividend payments. Additionally, in January 2008, we repaid our $150 million 6.45% senior note at
maturity. In November 2008, we drew down $250 million on a credit facility established in 2007 and
used $200 million of the proceeds to retire our 6.60% Senior Notes that were due December 15, 2008.
Common Stock Dividends
Dividends of $0.45 and $0.35 per share of our common stock were declared and paid in 2008 and 2007.
No dividends were paid in 2006. In October 2008, we suspended our quarterly dividend payment.
Share Repurchases
Our Board of Directors has approved an authorization to purchase, in the open market or through
privately negotiated transactions, our outstanding common stock, as our management deems
appropriate. In the first quarter of 2008, we repurchased a total of 2,649,621 shares at an
average price of $26.53 (including commission) per share. In accordance with the terms of the 2008
Senior Preferred, common stock repurchases are prohibited. No shares of common stock were
purchased during the years ended December 31, 2007 or 2006.
Liquidity
We believe that our present cash flows from operations, investing activities and financing
activities are sufficient to fund our working capital and debt obligation needs and we do not
expect this to change in the near term due to the following factors:
| We do not anticipate changes in our core property and casualty commercial insurance
operations which would significantly impact liquidity and we continue to maintain
reinsurance contracts which limit the impact of potential catastrophic events. |
||
| 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. A downgrade below our
current ratings levels would also result in additional collateral requirements for
derivative contracts for which we are in a liability position at any given point in time.
As of December 31, 2008, the total potential collateralization requirements amounted to
approximately $85 million. |
||
| As of December 31, 2008, our holding company held short term investments of $539
million. Our holding companys ability to meet its debt service and other obligations is
significantly dependent on receipt of dividends from our subsidiaries. As discussed
further in Note L of the Consolidated Financial Statements included under Item 8, 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.
Notwithstanding this limitation, we believe that our holding company has sufficient
liquidity to fund our preferred stock dividend and debt service payments in 2009. |
We have an effective shelf registration statement under which we may issue $2.0 billion of debt or
equity securities.
58
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, 2008 is presented in the following table.
Contractual Commitments
December 31, 2008 | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | |||||||||||||||
(In millions) | ||||||||||||||||||||
Debt (a) |
$ | 2,980 | $ | 123 | $ | 644 | $ | 503 | $ | 1,710 | ||||||||||
Lease obligations |
204 | 41 | 70 | 54 | 39 | |||||||||||||||
Claim and claim expense reserves (b) |
29,104 | 6,425 | 8,087 | 4,210 | 10,382 | |||||||||||||||
Future policy benefits reserves (c) |
11,956 | 176 | 342 | 327 | 11,111 | |||||||||||||||
Policyholder funds reserves (c) |
207 | 24 | 10 | 4 | 169 | |||||||||||||||
Guaranteed payment contracts (d) |
17 | 16 | 1 | | | |||||||||||||||
Preferred stock dividends (e) |
625 | 125 | 250 | 250 | | |||||||||||||||
Total (f) |
$ | 45,093 | $ | 6,930 | $ | 9,404 | $ | 5,348 | $ | 23,411 | ||||||||||
(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 gross claims based on
our assessment of facts and circumstances known as of December 31, 2008. See the Reserves -
Estimates and Uncertainties section of this MD&A for further information. Claim and claim
adjustment expense reserves of $12 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, 2008. Future policy benefit
reserves of $810 million and policyholder fund reserves of $38 million related to business
which has been 100% ceded to unaffiliated parties in connection with the sale of our
individual life business in 2004 are not included. Additional information on future policy
benefits and policyholder funds reserves is included in Note A of the Consolidated Financial
Statements under Item 8. |
|
(d) | Primarily relating to telecommunications and software services. |
|
(e) | Our preferred stock has a dividend rate of 10% due quarterly. We have reflected the dividend
payment in the table above for a period of 5 years, which may be more or less than the actual
period the preferred stock remains outstanding. As long as the preferred stock is outstanding,
the minimum dividend payment, if declared, is $125 million a year. |
|
(f) | Does not include expected estimated contribution of $70 million to the Companys pension and
postretirement plans in 2009. |
Further information on our commitments, contingencies and guarantees is provided in Notes B, C, F,
G, I, K and L of the Consolidated Financial Statements included under Item 8.
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.
59
The table below reflects the various group ratings issued by A.M. Best Company (A.M. Best), 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 | ||||
Moodys |
A3 | Not rated | Baa3 | Baa3 | ||||
S&P |
A- | Not rated | BBB- | BBB- |
The following rating agency actions were taken by these rating agencies with respect to CNA from
January 1, 2008 through February 23, 2009:
| On January 27, 2009, S&P withdrew CACs insurance financial strength rating of BBB+ at
our request. |
||
| On February 9, 2009, Moodys affirmed CNAs ratings and revised the outlook from stable
to negative. |
||
| On February 13, 2009, A.M. Best affirmed CNAs ratings and revised the outlook from
stable to negative. |
In January 2009, we exercised our early termination right under our contract with Fitch Ratings.
As a result, we no longer retain Fitch Ratings to issue insurance financial strength ratings for
the CCC Group or debt ratings for CNAF and Continental.
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.
As discussed in the Liquidity section above, additional collateralization may be required for
certain settlement agreements and assumed reinsurance contracts, as well as derivative contracts,
if our ratings or other specific criteria fall below certain thresholds.
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.
Accounting Pronouncements
For a discussion of accounting pronouncements that have been adopted or will be adopted in the
future, see Note A of the Consolidated Financial Statements included under Item 8.
60
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 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:
| conditions in the capital and credit markets including severe levels of volatility,
illiquidity, uncertainty and overall disruption, as well as sharply reduced economic activity,
that may impact the returns, types, liquidity and valuation of our investments; |
|
| general economic and business conditions, including recessionary conditions that may
decrease the size and number of our insurance customers and create higher exposures to our
lines of business, especially those that provide management and professional liability
insurance, as well as surety bonds, to businesses engaged in real estate, financial services
and professional services, and inflationary pressures on medical care costs, construction
costs and other economic sectors that increase the severity of claims; |
|
| the effects of the mergers and failures of a number of prominent financial institutions and
government sponsored entities, as well as the effects of accounting and financial reporting
scandals and other major failures in internal controls and governance, on capital and credit
markets, as well as on the markets for directors and officers and errors and omissions
coverages; |
|
| changes in foreign or domestic political, social and economic conditions; |
|
| 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; |
|
| regulatory limitations, impositions and restrictions upon us, including the effects of
assessments and other surcharges for guaranty funds and second-injury funds, other mandatory
pooling arrangements and future assessments levied on insurance companies and other financial
industry participants under the Emergency Economic Stabilization Act of 2008 recoupment
provisions; |
|
| 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; |
|
| conditions in the capital and credit markets that may limit our ability to raise
significant amounts of capital on favorable terms, as well as restrictions on the ability or
willingness of Loews Corporation to provide additional capital support to us; |
61
| 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; |
| 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 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.
62
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our financial instruments are exposed to various risks, such as interest rate, credit and currency
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 and/or equity.
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, 2008 and 2007 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, 2008 and 2007,
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, 2008 and 2007, with all other variables
held constant. Our equity holdings were assumed to be highly and positively correlated with the
S&P 500.
Our sensitivity analysis has also been applied to the assets supporting our separate account
business because certain of our separate account products guarantee principal and a minimum rate of
interest. All or a portion of these decreases related to the separate account assets may be
offset by decreases in related separate account liabilities to customers, but that is dependent on
the position of the separate account in relation to the specific guarantees at the time of the
interest rate or price decline. Similarly, increases in the fair value of the separate account
investments would also be offset by increases in the same related separate account liabilities by
the same approximate amounts.
63
The following tables present the estimated effects on the fair value of our financial instruments
at December 31, 2008 and December 31, 2007, 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, 2008 | Value | Rate Risk | Risk | Risk | ||||||||||||
(In millions) | ||||||||||||||||
General account: |
||||||||||||||||
Fixed maturity securities available-for-sale |
$ | 28,886 | $ | (1,919 | ) | $ | (99 | ) | $ | (2 | ) | |||||
Fixed maturity securities trading |
1 | | | | ||||||||||||
Equity securities available-for-sale |
871 | | (1 | ) | (87 | ) | ||||||||||
Short term investments available-for-sale |
3,534 | (17 | ) | (13 | ) | | ||||||||||
Limited partnerships |
1,683 | 1 | | (38 | ) | |||||||||||
Other invested assets |
28 | | | | ||||||||||||
Total general account |
35,003 | (1,935 | ) | (113 | ) | (127 | ) | |||||||||
Separate accounts: |
||||||||||||||||
Fixed maturity securities |
343 | (17 | ) | | | |||||||||||
Equity securities |
27 | | | (2 | ) | |||||||||||
Short term investments |
7 | | | | ||||||||||||
Total separate accounts |
377 | (17 | ) | | (2 | ) | ||||||||||
Derivative financial instruments, included
in Other liabilities |
(111 | ) | 90 | | | |||||||||||
Total securities |
$ | 35,269 | $ | (1,862 | ) | $ | (113 | ) | $ | (129 | ) | |||||
Debt (carrying value) |
$ | 2,058 | $ | (102 | ) | $ | | $ | | |||||||
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 |
73 | (2 | ) | 8 | (69 | ) | ||||||||||
Total general account |
41,789 | (1,907 | ) | (147 | ) | (212 | ) | |||||||||
Separate accounts: |
||||||||||||||||
Fixed maturity securities |
419 | (20 | ) | | | |||||||||||
Equity securities |
45 | | | (5 | ) | |||||||||||
Short term investments |
6 | | | | ||||||||||||
Total separate accounts |
470 | (20 | ) | | (5 | ) | ||||||||||
Derivative financial instruments, included
in Other liabilities |
(62 | ) | 33 | | | |||||||||||
Total securities |
$ | 42,197 | $ | (1,894 | ) | $ | (147 | ) | $ | (217 | ) | |||||
Debt (carrying value) |
$ | 2,157 | $ | (107 | ) | $ | | $ | | |||||||
64
The following tables present the estimated effects on the fair value of our financial instruments
at December 31, 2008 and December 31, 2007, 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, 2008 | Value | Rate Risk | Risk | Risk | ||||||||||||
(In millions) | ||||||||||||||||
General account: |
||||||||||||||||
Fixed maturity securities available-for-sale |
$ | 28,886 | $ | (2,834 | ) | $ | (197 | ) | $ | (5 | ) | |||||
Fixed maturity securities trading |
1 | | | | ||||||||||||
Equity securities available-for-sale |
871 | | (2 | ) | (218 | ) | ||||||||||
Short term investments available-for-sale |
3,534 | (29 | ) | (26 | ) | | ||||||||||
Limited partnerships |
1,683 | 1 | | (94 | ) | |||||||||||
Other invested assets |
28 | | | | ||||||||||||
Total general account |
35,003 | (2,862 | ) | (225 | ) | (317 | ) | |||||||||
Separate accounts: |
||||||||||||||||
Fixed maturity securities |
343 | (25 | ) | | | |||||||||||
Equity securities |
27 | | | (7 | ) | |||||||||||
Short term investments |
7 | | | | ||||||||||||
Total separate accounts |
377 | (25 | ) | | (7 | ) | ||||||||||
Derivative financial instruments, included
in Other liabilities |
(111 | ) | 131 | | | |||||||||||
Total securities |
$ | 35,269 | $ | (2,756 | ) | $ | (225 | ) | $ | (324 | ) | |||||
Debt (carrying value) |
$ | 2,058 | $ | (149 | ) | $ | | $ | | |||||||
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 |
73 | 2 | (8 | ) | (171 | ) | ||||||||||
Total general account |
41,789 | (2,795 | ) | (317 | ) | (531 | ) | |||||||||
Separate accounts: |
||||||||||||||||
Fixed maturity securities |
419 | (30 | ) | | | |||||||||||
Equity securities |
45 | | | (11 | ) | |||||||||||
Short term investments |
6 | | | | ||||||||||||
Total separate accounts |
470 | (30 | ) | | (11 | ) | ||||||||||
Derivative financial instruments, included
in Other liabilities |
(62 | ) | 48 | | | |||||||||||
Total securities |
$ | 42,197 | $ | (2,777 | ) | $ | (317 | ) | $ | (542 | ) | |||||
Debt (carrying value) |
$ | 2,157 | $ | (156 | ) | $ | | $ | | |||||||
65
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CNA Financial Corporation
Consolidated Statements of Operations
Consolidated Statements of Operations
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
(In millions, except per share data) | ||||||||||||
Revenues |
||||||||||||
Net earned premiums |
$ | 7,151 | $ | 7,484 | $ | 7,603 | ||||||
Net investment income |
1,619 | 2,433 | 2,412 | |||||||||
Realized investment gains (losses), net of participating
policyholders and minority interests |
(1,297 | ) | (311 | ) | 86 | |||||||
Other revenues |
326 | 279 | 275 | |||||||||
Total revenues |
7,799 | 9,885 | 10,376 | |||||||||
Claims, Benefits and Expenses |
||||||||||||
Insurance claims and policyholders benefits |
5,723 | 6,009 | 6,047 | |||||||||
Amortization of deferred acquisition costs |
1,467 | 1,520 | 1,534 | |||||||||
Other operating expenses |
1,037 | 994 | 1,027 | |||||||||
Restructuring and other related charges |
| | (13 | ) | ||||||||
Interest |
134 | 140 | 131 | |||||||||
Total claims, benefits and expenses |
8,361 | 8,663 | 8,726 | |||||||||
Income (loss) before income tax and minority interest |
(562 | ) | 1,222 | 1,650 | ||||||||
Income tax (expense) benefit |
311 | (317 | ) | (469 | ) | |||||||
Minority interest |
(57 | ) | (48 | ) | (44 | ) | ||||||
Income (loss) from continuing operations |
(308 | ) | 857 | 1,137 | ||||||||
Income (loss) from discontinued operations, net of income tax
(expense) benefit of $9, $0 and $7 |
9 | (6 | ) | (29 | ) | |||||||
Net income (loss) |
$ | (299 | ) | $ | 851 | $ | 1,108 | |||||
Basic Earnings (Loss) Per Share |
||||||||||||
Income (loss) from continuing operations |
$ | (1.21 | ) | $ | 3.15 | $ | 4.17 | |||||
Income (loss) from discontinued operations |
0.03 | (0.02 | ) | (0.11 | ) | |||||||
Basic earnings (losses) per share available to common stockholders |
$ | (1.18 | ) | $ | 3.13 | $ | 4.06 | |||||
Diluted Earnings (Loss) Per Share |
||||||||||||
Income (loss) from continuing operations |
$ | (1.21 | ) | $ | 3.15 | $ | 4.16 | |||||
Income (loss) from discontinued operations |
0.03 | (0.02 | ) | (0.11 | ) | |||||||
Diluted earnings (losses) per share available to common stockholders |
$ | (1.18 | ) | $ | 3.13 | $ | 4.05 | |||||
Weighted Average Outstanding Common Stock and Common Stock
Equivalents |
||||||||||||
Basic |
269.4 | 271.5 | 262.1 | |||||||||
Diluted |
269.4 | 271.8 | 262.3 | |||||||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
66
CNA Financial Corporation
Consolidated Balance Sheets
Consolidated Balance Sheets
December 31 | 2008 | 2007 | ||||||
(In millions, except share data) | ||||||||
Assets |
||||||||
Investments: |
||||||||
Fixed maturity securities at fair value (amortized cost of $34,155 and $34,388) |
$ | 28,887 | $ | 34,257 | ||||
Equity securities at fair value (cost of $1,016 and $366) |
871 | 568 | ||||||
Limited partnership investments |
1,683 | 2,214 | ||||||
Other invested assets |
28 | 73 | ||||||
Short term investments |
3,534 | 4,677 | ||||||
Total investments |
35,003 | 41,789 | ||||||
Cash |
85 | 94 | ||||||
Reinsurance receivables (less allowance for uncollectible receivables of $366 and $461) |
7,395 | 8,228 | ||||||
Insurance receivables (less allowance for doubtful accounts of $221 and $312) |
1,818 | 1,972 | ||||||
Accrued investment income |
356 | 330 | ||||||
Receivables for securities sold and collateral |
402 | 142 | ||||||
Deferred acquisition costs |
1,125 | 1,161 | ||||||
Prepaid reinsurance premiums |
237 | 270 | ||||||
Federal income tax recoverable (includes $299 and $0 due from Loews Corporation) |
294 | | ||||||
Deferred income taxes |
3,493 | 1,198 | ||||||
Property and equipment at cost (less accumulated depreciation of $641 and $596) |
393 | 378 | ||||||
Goodwill and other intangible assets |
141 | 142 | ||||||
Other assets |
562 | 579 | ||||||
Separate account business |
384 | 476 | ||||||
Total assets |
$ | 51,688 | $ | 56,759 | ||||
Liabilities and Stockholders Equity |
||||||||
Liabilities: |
||||||||
Insurance reserves: |
||||||||
Claim and claim adjustment expenses |
$ | 27,593 | $ | 28,588 | ||||
Unearned premiums |
3,406 | 3,598 | ||||||
Future policy benefits |
7,529 | 7,106 | ||||||
Policyholders funds |
243 | 930 | ||||||
Collateral on loaned securities and derivatives |
6 | 63 | ||||||
Payables for securities purchased |
12 | 353 | ||||||
Participating policyholders funds |
20 | 45 | ||||||
Short term debt |
| 350 | ||||||
Long term debt |
2,058 | 1,807 | ||||||
Federal income taxes payable (includes $0 and $5 due to Loews Corporation) |
| 2 | ||||||
Reinsurance balances payable |
316 | 401 | ||||||
Other liabilities |
2,824 | 2,505 | ||||||
Separate account business |
384 | 476 | ||||||
Total liabilities |
44,391 | 46,224 | ||||||
Commitments and contingencies (Notes B, C, F, G, I , K and L) |
||||||||
Minority interest |
420 | 385 | ||||||
Stockholders equity: |
||||||||
Preferred stock (12,500,000 shares authorized) 2008 Senior Preferred (no par value; $100,000 stated value; 12,500 shares and no shares issued; held by Loews Corporation) |
1,250 | | ||||||
Common stock ($2.50 par value; 500,000,000 shares authorized; 273,040,243
shares issued; and 269,024,408 and 271,662,278 shares outstanding) |
683 | 683 | ||||||
Additional paid-in capital |
2,174 | 2,169 | ||||||
Retained earnings |
6,845 | 7,285 | ||||||
Accumulated other comprehensive income (loss) |
(3,924 | ) | 103 | |||||
Treasury stock (4,015,835 and 1,377,965 shares), at cost |
(109 | ) | (39 | ) | ||||
6,919 | 10,201 | |||||||
Notes receivable for the issuance of common stock |
(42 | ) | (51 | ) | ||||
Total stockholders equity |
6,877 | 10,150 | ||||||
Total liabilities and stockholders equity |
$ | 51,688 | $ | 56,759 | ||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
67
CNA Financial Corporation
Consolidated Statements of Cash Flows
Consolidated Statements of Cash Flows
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
(In millions) | ||||||||||||
Cash Flows from Operating Activities: |
||||||||||||
Net income (loss) |
$ | (299 | ) | $ | 851 | $ | 1,108 | |||||
Adjustments to reconcile net income (loss) to net cash flows
provided by operating activities: |
||||||||||||
(Income) loss from discontinued operations |
(9 | ) | 6 | 29 | ||||||||
Loss on disposal of property and equipment |
1 | 1 | | |||||||||
Minority interest |
57 | 48 | 44 | |||||||||
Deferred income tax (benefit) provision |
(174 | ) | (99 | ) | 173 | |||||||
Trading portfolio activity |
644 | (12 | ) | 374 | ||||||||
Realized investment (gains) losses, net of participating
policyholders and minority interests |
1,297 | 311 | (86 | ) | ||||||||
Undistributed losses (earnings) of equity method investees |
446 | (99 | ) | (170 | ) | |||||||
Net amortization of bond discount |
(278 | ) | (252 | ) | (274 | ) | ||||||
Depreciation |
78 | 64 | 48 | |||||||||
Changes in: |
||||||||||||
Receivables, net |
987 | 1,386 | 2,427 | |||||||||
Accrued investment income |
(26 | ) | (17 | ) | (1 | ) | ||||||
Deferred acquisition costs |
36 | 29 | 7 | |||||||||
Prepaid reinsurance premiums |
33 | 72 | (2 | ) | ||||||||
Federal income taxes recoverable/payable |
(287 | ) | (38 | ) | 102 | |||||||
Insurance reserves |
(590 | ) | (830 | ) | (771 | ) | ||||||
Reinsurance balances payable |
(85 | ) | (138 | ) | (1,097 | ) | ||||||
Other assets |
13 | 42 | 142 | |||||||||
Other liabilities |
(287 | ) | (80 | ) | 306 | |||||||
Other, net |
9 | 7 | (98 | ) | ||||||||
Total adjustments |
1,865 | 401 | 1,153 | |||||||||
Net cash flows provided by operating activities-continuing
operations |
$ | 1,566 | $ | 1,252 | $ | 2,261 | ||||||
Net cash flows used by operating activities-discontinued
operations |
$ | (8 | ) | $ | (13 | ) | $ | (11 | ) | |||
Net cash flows provided by operating activities-total |
$ | 1,558 | $ | 1,239 | $ | 2,250 | ||||||
Cash Flows from Investing Activities: |
||||||||||||
Purchases of fixed maturity securities |
$ | (48,404 | ) | $ | (73,157 | ) | $ | (48,757 | ) | |||
Proceeds from fixed maturity securities: |
||||||||||||
Sales |
41,749 | 69,012 | 42,433 | |||||||||
Maturities, calls and redemptions |
4,092 | 4,744 | 4,310 | |||||||||
Purchases of equity securities |
(205 | ) | (236 | ) | (340 | ) | ||||||
Proceeds from sales of equity securities |
220 | 340 | 221 | |||||||||
Change in short term investments |
1,032 | 1,347 | (1,331 | ) | ||||||||
Change in collateral on loaned securities and derivatives |
(57 | ) | (2,788 | ) | 2,084 | |||||||
Change in other investments |
(295 | ) | (168 | ) | (195 | ) | ||||||
Purchases of property and equipment |
(104 | ) | (160 | ) | (131 | ) | ||||||
Dispositions |
| 14 | 8 | |||||||||
Other, net |
46 | (69 | ) | 16 | ||||||||
Net cash flows used by investing activities-continuing
operations |
$ | (1,926 | ) | $ | (1,121 | ) | $ | (1,682 | ) | |||
Net cash flows provided by investing activities-discontinued
operations |
$ | 18 | $ | 39 | $ | 36 | ||||||
Net cash flows used by investing activities-total |
$ | (1,908 | ) | $ | (1,082 | ) | $ | (1,646 | ) | |||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
68
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
(In millions) | ||||||||||||
Cash Flows from Financing Activities: |
||||||||||||
Dividends paid to common stockholders |
$ | (122 | ) | $ | (95 | ) | $ | | ||||
Dividends paid to Loews for 2008 Senior Preferred |
(19 | ) | | | ||||||||
Proceeds from the issuance of long term debt |
250 | | 759 | |||||||||
Principal payments on debt |
(350 | ) | | (294 | ) | |||||||
Return of investment contract account balances |
(607 | ) | (122 | ) | (589 | ) | ||||||
Receipts on investment contract account balances |
3 | 3 | 4 | |||||||||
Payment to repurchase Series H Issue preferred stock |
| | (993 | ) | ||||||||
Proceeds from the issuance of common stock |
| | 499 | |||||||||
Proceeds from the issuance of 2008 Senior Preferred |
1,250 | | | |||||||||
Stock options exercised |
1 | 18 | 10 | |||||||||
Purchase of treasury stock |
(70 | ) | | | ||||||||
Other, net |
11 | 11 | (1 | ) | ||||||||
Net cash flows provided (used) by financing
activities-continuing operations |
$ | 347 | $ | (185 | ) | $ | (605 | ) | ||||
Net cash flows provided by financing
activities-discontinued operations |
$ | | $ | | $ | | ||||||
Net cash flows provided (used) by financing activities-total |
$ | 347 | $ | (185 | ) | $ | (605 | ) | ||||
Effect of foreign exchange rate changes on cash-continuing
operations |
(13 | ) | 5 | | ||||||||
Net change in cash |
(16 | ) | (23 | ) | (1 | ) | ||||||
Net cash transactions from continuing operations to
discontinued operations |
17 | 59 | 14 | |||||||||
Net cash transactions from discontinued operations to
continuing operations |
(17 | ) | (59 | ) | (14 | ) | ||||||
Cash, beginning of year |
101 | 124 | 125 | |||||||||
Cash, end of year |
$ | 85 | $ | 101 | $ | 124 | ||||||
Cash-continuing operations |
$ | 85 | $ | 94 | $ | 84 | ||||||
Cash-discontinued operations |
| 7 | 40 | |||||||||
Cash-total |
$ | 85 | $ | 101 | $ | 124 | ||||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
69
CNA Financial Corporation
Consolidated Statements of Stockholders Equity
Consolidated Statements of Stockholders Equity
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
(In millions) | ||||||||||||
Preferred Stock |
||||||||||||
Balance, beginning of period |
$ | | $ | | $ | 750 | ||||||
Repurchase of Series H Issue |
| | (750 | ) | ||||||||
Issuance of 2008 Senior Preferred |
1,250 | | | |||||||||
Balance, end of period |
1,250 | | | |||||||||
Common Stock |
||||||||||||
Balance, beginning of period |
683 | 683 | 645 | |||||||||
Issuance of common stock |
| | 38 | |||||||||
Balance, end of period |
683 | 683 | 683 | |||||||||
Additional Paid-in Capital |
||||||||||||
Balance, beginning of period |
2,169 | 2,166 | 1,701 | |||||||||
Issuance of common stock and other |
5 | 3 | 465 | |||||||||
Balance, end of period |
2,174 | 2,169 | 2,166 | |||||||||
Retained Earnings |
||||||||||||
Balance, beginning of period |
7,285 | 6,486 | 5,621 | |||||||||
Adjustment
to initially apply FSP 85-4-1, net of tax |
| 38 | | |||||||||
Adjustment to initially apply FIN 48 |
| 5 | | |||||||||
Adjusted balance, beginning of period |
7,285 | 6,529 | 5,621 | |||||||||
Dividends paid to common stockholders |
(122 | ) | (95 | ) | | |||||||
Dividends paid to Loews for 2008 Senior Preferred |
(19 | ) | | | ||||||||
Liquidation preference in excess of par value on
Series H Issue |
| | (243 | ) | ||||||||
Net income (loss) |
(299 | ) | 851 | 1,108 | ||||||||
Balance, end of period |
6,845 | 7,285 | 6,486 | |||||||||
Accumulated Other Comprehensive Income (Loss) |
||||||||||||
Balance, beginning of period |
103 | 549 | 359 | |||||||||
Other comprehensive income (loss) |
(4,027 | ) | (446 | ) | 236 | |||||||
Adjustment to initially apply SFAS 158, net of tax |
| | (46 | ) | ||||||||
Balance, end of period |
(3,924 | ) | 103 | 549 | ||||||||
Treasury Stock |
||||||||||||
Balance, beginning of period |
(39 | ) | (58 | ) | (67 | ) | ||||||
Purchase of treasury stock |
(70 | ) | | | ||||||||
Stock options exercised |
| 19 | 9 | |||||||||
Balance, end of period |
(109 | ) | (39 | ) | (58 | ) | ||||||
Notes Receivable for the Issuance of Common Stock |
||||||||||||
Balance, beginning of period |
(51 | ) | (58 | ) | (59 | ) | ||||||
Decrease in notes receivable for the issuance of
common stock |
9 | 7 | 1 | |||||||||
Balance, end of period |
(42 | ) | (51 | ) | (58 | ) | ||||||
Total Stockholders Equity |
$ | 6,877 | $ | 10,150 | $ | 9,768 | ||||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
70
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),
Continental Assurance Company (CAC) and CNA Surety Corporation (CNA Surety). The Company owned
approximately 62% of the outstanding common stock of CNA Surety as of December 31, 2008. Loews
Corporation (Loews) owned approximately 90% of the outstanding common stock of CNAF as of
December 31, 2008.
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.
CNA serves 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.
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, and managing general agents.
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
71
compensation lifetime claims, accident and health claims and certain claims associated with
discontinued 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 on 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 deductible policies of $2.0 billion and $2.2 billion as of
December 31, 2008 and 2007. 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 Insurance receivables on the
Consolidated Balance Sheets. In 2008, the amount due from policyholders related to losses under
deductible policies within Standard Lines was reduced by $90 million for insolvent insureds. The
reduction of this amount, which is reflected as unfavorable net prior year reserve development, had
no effect on 2008 results of operations as the Company had previously recognized provisions in
prior years. These impacts were reported in Insurance claims and policyholders benefits in the
2008 Consolidated Statement of Operations.
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,
2008 and 2007. At December 31, 2008 and 2007, the discounted reserves for unfunded structured
settlements were $756 million and $786 million, net of discount of $1.1 billion and $1.2 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% for the years ended December 31, 2008 and 2007. At
December 31, 2008 and 2007, such discounted reserves totaled $1.6 billion and $1.4 billion, net of
discount of $482 million and $438 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, 2008 and 2007, 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, including reserves related to the indexed group
annuity portion of the Companys pension deposit business. 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. During 2008, the Company exited the indexed group annuity portion of its pension
deposit business and settled the related liabilities with policyholders with no material impact to
results of operations. Cash flows related to the settlement of the liabilities with policyholders
are presented on the Consolidated Statements of Cash Flows in Cash flows from financing activities,
as Return of investment contract account balances. Cash flows related to proceeds from the
liquidation of the related assets supporting the policyholder liabilities are presented on the
Consolidated Statements of Cash Flows in Cash flows from operating activities, as Trading portfolio
activity.
72
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 on the Consolidated Balance Sheets. As of
December 31, 2008 and 2007, the liability balances were $170 million and $178 million. As of
December 31, 2008 and 2007, included in Other assets on the Consolidated Balance Sheets were $6
million and $6 million of related assets for premium tax offsets. This asset is limited to the
amount that is able to be offset against premium tax 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 on 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 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 on 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, 2008 and 2007, the Company had $25 million and $40
million recorded as deposit assets and $110 million 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 revenues or
Other operating expenses on the Consolidated Statements of Operations 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 benefit 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
Prior to 2002, the Company purchased investments in life settlement contracts. Under a life settlement contract, the Company obtained the
73
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 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 years ended December 31,
2008 and 2007. Amounts presented related to 2006 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 were $129 million and $115 million at December 31, 2008 and 2007, and are
included in Other assets on the Consolidated Balance Sheets. 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, 2008 | Contracts | (In millions) | (In millions) | |||||||||
Estimated maturity during: |
||||||||||||
2009 |
100 | $ | 19 | $ | 55 | |||||||
2010 |
100 | 17 | 55 | |||||||||
2011 |
100 | 15 | 53 | |||||||||
2012 |
100 | 13 | 53 | |||||||||
2013 |
100 | 11 | 51 | |||||||||
Thereafter |
814 | 54 | 436 | |||||||||
Total |
1,314 | $ | 129 | $ | 703 | |||||||
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.
74
The increase in fair value recognized for the years ended December 31, 2008 and 2007 on contracts
still being held was $17 million and $12 million. The gain recognized during the years ended
December 31, 2008 and 2007 on contracts that matured was $30 million and $38 million.
Separate Account Business:
Separate account assets and liabilities represent contract holder funds related to investment and annuity products for which the policyholder assumes substantially all the risk and reward. The assets are segregated into accounts with specific underlying investment objectives and are legally segregated from the Company. All assets of the separate account business are carried at fair value with an equal amount recorded for separate account liabilities. Certain of the separate account investment contracts related to the Companys pension deposit business guarantee principal and a minimum rate of interest, for which additional amounts may be recorded in Policyholders funds should the aggregate contract value exceed fair value of the related assets supporting the business at any point in time. Most of these contracts are subject to a fair value adjustment if terminated by the policyholder. During 2008, the Company recorded $68 million of additional amounts in Policyholders funds due to declines in the value of the related assets. To the extent the related assets supporting the business recover in value in the future, the amount of any such recovery will accrue to the Companys benefit and will reduce the related liability in Policyholders funds. Fee income accruing to the Company related to separate accounts is primarily included within Other revenue on the Consolidated Statements of Operations.
Separate account assets and liabilities represent contract holder funds related to investment and annuity products for which the policyholder assumes substantially all the risk and reward. The assets are segregated into accounts with specific underlying investment objectives and are legally segregated from the Company. All assets of the separate account business are carried at fair value with an equal amount recorded for separate account liabilities. Certain of the separate account investment contracts related to the Companys pension deposit business guarantee principal and a minimum rate of interest, for which additional amounts may be recorded in Policyholders funds should the aggregate contract value exceed fair value of the related assets supporting the business at any point in time. Most of these contracts are subject to a fair value adjustment if terminated by the policyholder. During 2008, the Company recorded $68 million of additional amounts in Policyholders funds due to declines in the value of the related assets. To the extent the related assets supporting the business recover in value in the future, the amount of any such recovery will accrue to the Companys benefit and will reduce the related liability in Policyholders funds. Fee income accruing to the Company related to separate accounts is primarily included within Other revenue on the Consolidated Statements of Operations.
Investments
Valuation of investments: CNA classifies its fixed maturity securities 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 on the Consolidated
Statements of Operations. 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 on the Consolidated Statements of Operations. 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 on the
Consolidated Statements of Operations. 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. Certain partnerships for which
results are not available on a timely basis are reported on a lag, primarily one month. Changes in
net asset values are accounted for under the equity method and recorded within Net investment
income on the Consolidated Statements of Operations.
Other invested assets include certain derivative securities and real estate investments. The
Companys accounting for derivative securities is discussed in further detail below. Real estate
investments are carried at the lower of cost or fair value.
Short term investments are generally carried at amortized cost, which approximates fair value.
Realized investment gains (losses): All securities sold resulting in investment gains (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 (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, through two programs: an internally managed program and an external program
managed by the Companys lead custodial bank as agent. The securities lending program is for the
purpose of enhancing income. The Company does not lend securities for operating or financing
purposes. Borrowers of these securities must initially deposit collateral with the Company of at
least 102% and maintain collateral of no less than 100% of
75
the fair value of the securities loaned, regardless of whether the collateral is cash or
securities. Only cash collateral is accepted for the Companys internally managed program and is
typically invested in the highest quality commercial paper with maturities of less than 7 days.
U.S. Government, agencies or Government National Mortgage Association securities are accepted as
non-cash collateral for the external program. The Company maintains effective control over all
loaned securities and, therefore, continues to report such securities as Fixed maturity securities
on the Consolidated Balance Sheets.
The lending programs are matched-book programs where the collateral is invested to substantially
match the term of the loan which limits risk. In accordance with the Companys lending agreements,
securities on loan are returned immediately to the Company upon notice. 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 an asset of the Company as there exists no right to sell or
repledge the collateral. The fair value of collateral held related to securities lending, included
in Short term investments on the Consolidated Balance Sheets, was $53 million at December 31, 2007.
There was no cash collateral held at December 31, 2008. The fair value of non-cash collateral was
$348 million and $273 million at December 31, 2008 and 2007.
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 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 on the
Consolidated Balance Sheets. 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 derivatives not held in a trading
portfolio is as follows:
Nature of Hedge Designation | Derivatives Change in Fair Value Reflected In: | |
No hedge designation
|
Realized investment gains (losses) | |
Fair value designation
|
Realized investment gains (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
76
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 Net investment income on the Consolidated Statements of Operations. These derivatives
are generally not designated as hedges.
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 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, and a valuation allowance is established for any portion of a
deferred tax asset that management believes will not be realized.
Pension and Postretirement Benefits
Pension and Postretirement Benefits
The Company recognizes the overfunded or underfunded status of its defined benefit plans in Other
assets or Other liabilities on 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 funded status at December 31.
Stock-Based Compensation
The Company records compensation expense using the fair value method for all awards it grants,
modifies, repurchases or cancels primarily on a straight-line basis over the requisite service
period, generally four years.
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 $35
million, $10 million and $7 million were included in determining net income (loss) for the years
ended December 31, 2008, 2007 and 2006.
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. The Companys owned buildings are depreciated over a period not to
exceed fifty years. Capitalized improvements are depreciated over the remaining useful lives of
the buildings.
Goodwill and Other Intangible Assets
Goodwill and other indefinite-lived intangible assets of $141 million and $142 million as of
December 31, 2008 and 2007 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, 2008 and 2007
related to the Specialty Lines segment, $139 million of which related to CNA Surety. During 2008,
the Company determined that other intangible assets of $1 million related to the Specialty Lines
segment were impaired. Goodwill and indefinite-lived intangible assets are tested for impairment
annually or when certain triggering events require such tests.
77
Earnings (Loss) Per Share Data
Earnings (loss) per share available to common stockholders is based on weighted average outstanding
shares. Basic earnings (loss) per share is computed by dividing net income (loss) from continuing
operations attributable to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution that
could occur if securities or other contracts to issue common stock were exercised or converted into
common stock. Approximately 1.6 million, 300 thousand and 600 thousand shares, for the years ended
December 31, 2008, 2007 and 2006, attributable to exercises under stock-based employee compensation
plans, were excluded from the calculation of diluted earnings per share because they were
antidilutive.
In November 2008, the Company sold $1.25 billion of a new series of preferred stock, designated the
2008 Senior Preferred Stock (2008 Senior Preferred), to Loews. The 2008 Senior Preferred accrues
cumulative dividends at an initial rate of 10% per year. If declared, dividends are payable
quarterly and any dividends not declared or paid when due will be compounded quarterly. See Note L
for further details.
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 computation of earnings (loss) per share is as follows.
Earnings (Loss) Per Share
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
(In millions, except per share amounts) | ||||||||||||
Income (loss) from continuing operations |
$ | (308 | ) | $ | 857 | $ | 1,137 | |||||
Less: undeclared Series H Issue dividend through repurchase date |
| | (46 | ) | ||||||||
Less: declared 2008 Senior Preferred dividend |
(19 | ) | | | ||||||||
Income (loss) from continuing operations available to common stockholders |
$ | (327 | ) | $ | 857 | $ | 1,091 | |||||
Weighted average outstanding common stock and common stock equivalents |
269.4 | 271.5 | 262.1 | |||||||||
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 |
269.4 | 271.8 | 262.3 | |||||||||
Basic earnings (loss) per share from continuing operations available
to common stockholders |
$ | (1.21 | ) | $ | 3.15 | $ | 4.17 | |||||
Diluted earnings (loss) per share from continuing operations available
to common stockholders |
$ | (1.21 | ) | $ | 3.15 | $ | 4.16 | |||||
Dividends declared per common share |
$ | 0.45 | $ | 0.35 | $ | | ||||||
Supplementary Cash Flow Information
Cash payments made for interest were $139 million, $142 million and $109 million for the years
ended December 31, 2008, 2007 and 2006. Cash payments made for federal income taxes were $120
million, $420 million and $173 million for the years ended December 31, 2008, 2007 and 2006.
78
Accounting Pronouncements
Adopted as of December 31, 2008
Statement of Financial Accounting Standard (SFAS) No. 157, Fair Value Measurement (SFAS
157)
In September 2006, the FASB issued SFAS 157, which defines fair value, establishes a framework for
measuring fair value, specifies acceptable valuation techniques, prioritizes the inputs used in the
valuation techniques into a fair value hierarchy and expands the disclosure requirements for assets
and liabilities measured at fair value on a recurring and a non-recurring basis. The SFAS 157
hierarchy is based on observable inputs reflecting market data obtained from independent sources or
unobservable inputs reflecting the Companys market assumptions. This hierarchy requires the
Company to use observable market data, when available.
In February 2008, the FASB issued Staff Position SFAS 157-2, Effective Date of FASB Statement
No. 157 (FSP SFAS 157-2), which delays the effective date of SFAS 157 for all non-recurring
fair value measurements of nonfinancial assets and nonfinancial liabilities until the fiscal year
beginning after November 15, 2008. As a result, the Company partially applied the provisions of
SFAS 157 upon adoption at January 1, 2008. The Company will apply the provisions of SFAS 157 to
reporting units measured at fair value for the purposes of goodwill impairment testing or to
indefinite-lived intangible assets measured at fair value for impairment assessment as of January
1, 2009. Adoption of these provisions is not anticipated to impact the Companys financial
condition or results of operations.
The Companys adoption of SFAS 157 on January 1, 2008 had no impact on financial condition or
results of operations as of or for the year ended December 31, 2008. The Company has complied with
the disclosure requirements of SFAS 157 in Note D.
FASB Staff Position (FSP) FAS 157-3,
Determining the Fair Value of a Financial Asset in a
Market That Is Not Active (FSP FAS 157-3)
In October 2008, the FASB issued FSP FAS 157-3, which clarifies the application of SFAS 157 in an
inactive market. The FSP addresses application issues such as how managements internal
assumptions should be considered when measuring fair value when relevant observable data does not
exist, how observable market information in a market that is not active should be considered when
measuring fair value and how the use of market quotes should be considered when assessing the
relevance of observable and unobservable data available to measure fair value.
FSP FAS 157-3 was effective upon issuance. The Companys adoption of FSP FAS 157-3 had no impact
on financial condition or results of operations as of or for the year ended December 31, 2008.
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 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 Company did not select the fair
79
value option for any assets and liabilities currently held, therefore the Companys adoption of
SFAS 159 on January 1, 2008 had no impact on the Companys financial condition or results of
operations as of or for the year ended December 31, 2008.
FSP FIN 39-1,
Amendment of FASB Interpretation (FIN) No. 39 (FSP FIN 39-1)
In April 2007, the FASB issued FSP FIN 39-1, which amends FIN 39, Offsetting of Amounts Related
to Certain Contracts (FIN 39), by permitting a reporting entity to offset fair value amounts
recognized for the right to reclaim cash collateral or the obligation to return cash collateral
against fair value amounts recognized for derivative instruments executed with the same
counterparty under the same master netting arrangement that have been offset in the statement of
financial position in accordance with FIN 39. Additionally, FSP FIN 39-1 requires that a reporting
entity shall not offset fair value amounts recognized for derivative instruments without offsetting
fair value amounts recognized for the right to reclaim cash collateral or the obligation to return
cash collateral.
The Company adopted FSP FIN 39-1 in 2008, by electing to not offset cash collateral amounts
recognized for derivative instruments under the same master netting arrangements and as a result
will no longer offset fair value amounts recognized for derivative instruments. The Company
presented the effect of adopting FSP FIN 39-1 as a change in accounting principle through
retrospective application. The effect on the Consolidated Balance Sheets as of December 31, 2008
and 2007 was an increase of $18 million and $27 million in Other invested assets and Other
liabilities. The Companys adoption of FSP FIN 39-1 had no impact on the Companys financial
condition or results of operations as of or for the year ended December 31, 2008.
FSP FAS 133-1 and FIN 45-4,
Disclosures About Credit Derivatives and Certain Guarantees: An
Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the
Effective Date of FASB Statement No. 161 (FSP FAS 133-1 and FIN 45-4)
In September 2008, the FASB issued FSP FAS 133-1 and FIN 45-4, which amends FASB Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities, to require disclosures by
sellers of credit derivatives regarding the nature, circumstances requiring performance and current
status of performance risk under the derivative. This FSP also requires disclosure of the maximum
amount of future payments under the derivatives, the fair value of the derivatives and the nature
of any recourse and collateral under the derivatives. This FSP also amends FASB Interpretation No.
45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, to require an additional disclosure about the current
status of the payment/performance risk of a guarantee. The Company has complied with the
disclosure requirements related to credit derivatives in Note C and guarantees in Note K.
FSP Emerging Issues Task Force (EITF) Issue No. 99-20-1,
Amendments to the Impairment and
Interest Income Measurement Guidance of EITF Issue 99-20 (FSP 99-20-1)
In January 2009, the FASB issued FSP 99-20-1, which amends EITF Issue No. 99-20, Recognition of
Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That
Continue to Be Held by a Transferor in Securitized Financial Assets, to achieve more consistent
determination of whether other-than-temporary impairments of available-for-sale or held-to-maturity
debt securities have occurred. Specifically, FSP 99-20-1 amends EITF 99-20 to align the impairment
guidance in EITF 99-20 with the impairment guidance in SFAS 115, Accounting for Certain
Investments in Debt and Equity Securities. CNA adopted this FSP as of December 31, 2008. The
adoption of FSP 99-20-1 did not have an impact on our financial condition or results of operations.
80
To be adopted after December 31, 2008
SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities (SFAS 161)
In March 2008, the FASB issued SFAS 161, which amends SFAS 133, Accounting for Derivative
Instruments and Hedging Activities, and requires enhanced disclosures regarding the use of
derivative instruments, how they are accounted for and how they affect an entitys financial
position, financial performance, and cash flows. SFAS 161 is effective for financial statements
issued for fiscal years and interim periods beginning after November 15, 2008. The adoption of
SFAS 161 will have no impact on our financial condition or results of operations.
SFAS No. 160, Noncontrolling Interest in Consolidated Financial Statements an amendment of
Accounting Research Bulletin 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 will have no impact on our financial condition or results of operations,
but will impact the presentation of minority interest on the consolidated financial statements.
FSP No. 132(R)-1, Employers Disclosures about Postretirement Benefit Plan Assets (FSP
132(R)-1)
In December 2008, the FASB issued FSP 132(R)-1, which requires additional disclosures regarding
plan assets and how investment allocation decisions are made, including the factors that are
pertinent to an understanding of investment policies and procedures, the major categories of plan
assets, the inputs and valuation techniques used to measure the fair value of plan assets, the
effect of fair value measurements using significant unobservable inputs (Level 3 of the SFAS 157
hierarchy) on changes in plan assets for the period, and significant concentrations of risk within
plan assets. The additional disclosures required by FSP 132(R)-1 are effective for fiscal years
ending after December 15, 2009. The adoption of this standard will have no impact on the Companys
financial condition or results of operations.
81
Note B. Investments
The significant components of net investment income are presented in the following table.
Net Investment Income
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
(In millions) | ||||||||||||
Fixed maturity securities |
$ | 1,984 | $ | 2,047 | $ | 1,842 | ||||||
Short term investments |
115 | 186 | 248 | |||||||||
Limited partnerships |
(379 | ) | 183 | 288 | ||||||||
Equity securities |
80 | 25 | 23 | |||||||||
Income (loss) from trading portfolio (a) |
(149 | ) | 10 | 103 | ||||||||
Interest on funds withheld and other deposits |
(2 | ) | (1 | ) | (68 | ) | ||||||
Other |
21 | 36 | 18 | |||||||||
Gross investment income |
1,670 | 2,486 | 2,454 | |||||||||
Investment expenses |
(51 | ) | (53 | ) | (42 | ) | ||||||
Net investment income |
$ | 1,619 | $ | 2,433 | $ | 2,412 | ||||||
(a) | The change in net unrealized gains (losses) on trading securities included in Net investment
income was $3 million and $(15) million for the years ended December 31, 2008 and 2007. There
was no change in net unrealized gains (losses) on trading securities included in Net
investment income for the year ended December 31, 2006. |
In 2008, the Company re-evaluated its classification of preferred stocks between redeemable and
non-redeemable and determined that certain securities that were previously classified as redeemable
preferred stock have characteristics similar to equities. These securities are presented as
preferred stock securities included in Equity securities on the December 31, 2008 Consolidated
Balance Sheet.
82
Net realized investment gains (losses) are presented in the following table.
Net Realized Investment Gains (Losses)
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
(In millions) | ||||||||||||
Net realized investment gains (losses): |
||||||||||||
Fixed maturity securities: |
||||||||||||
Gross realized gains: |
$ | 532 | $ | 486 | $ | 382 | ||||||
Gross realized losses: |
||||||||||||
Other-than-temporary impairments |
(1,081 | ) | (716 | ) | (168 | ) | ||||||
Trading |
(282 | ) | (248 | ) | (209 | ) | ||||||
Net realized investment gains (losses) on fixed maturity securities |
(831 | ) | (478 | ) | 5 | |||||||
Equity securities: |
||||||||||||
Gross realized gains: |
22 | 146 | 24 | |||||||||
Gross realized losses: |
||||||||||||
Other-than-temporary impairments |
(403 | ) | (25 | ) | (5 | ) | ||||||
Trading |
(109 | ) | (4 | ) | (3 | ) | ||||||
Net realized investment gains (losses) on equity securities |
(490 | ) | 117 | 16 | ||||||||
Other net realized investment gains |
24 | 50 | 65 | |||||||||
Net realized investment gains (losses), net of participating
policyholders and minority interest |
$ | (1,297 | ) | $ | (311 | ) | $ | 86 | ||||
Net change in unrealized gains (losses) in investments is presented in the following table.
Net Change in Unrealized Gains (Losses)
Years ended December 31 | 2008 | 2007 | 2006 | |||||||||
(In millions) | ||||||||||||
Net change in unrealized gains (losses) on investments: |
||||||||||||
Fixed maturity securities |
$ | (5,137 | ) | $ | (847 | ) | $ | 98 | ||||
Equity securities |
(347 | ) | (47 | ) | 78 | |||||||
Other |
5 | 2 | 2 | |||||||||
Total net change in unrealized gains (losses) on investments |
(5,479 | ) | (892 | ) | 178 | |||||||
Net change in unrealized gains (losses) on discontinued operations and other |
(12 | ) | 1 | (10 | ) | |||||||
Allocated to participating policyholders and minority interests |
48 | 3 | 4 | |||||||||
Deferred income tax (expense) benefit |
1,932 | 315 | (58 | ) | ||||||||
Net change in unrealized gains (losses) on investments |
$ | (3,511 | ) | $ | (573 | ) | $ | 114 | ||||
Net realized investment losses included $1,484 million, $741 million and $173 million of
other-than-temporary impairment (OTTI) losses for the years ended December 31, 2008, 2007 and 2006.
The 2008 OTTI losses were recorded primarily in the corporate and other taxable bonds,
asset-backed bonds and non-redeemable preferred equity securities sectors. The 2007 OTTI losses
were recorded primarily in the asset-backed bonds and corporate and other taxable bonds sectors.
The 2006 OTTI losses were recorded primarily in the corporate and other taxable bonds sector.
The 2008 OTTI losses were driven primarily by deteriorating world-wide economic conditions and the
resulting disruption of the financial and credit markets. Additional factors that contributed to
recognizing impairments in 2008 were the conservatorship of the government sponsored entities
Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation
(Freddie Mac) and the failure of several financial institutions. The 2007 OTTI losses were driven
mainly by credit market conditions and disruption caused by issues surrounding the sub-prime
residential mortgage (sub-prime) crisis. The OTTI losses for 2006 were 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.
83
An investment is impaired if the fair value of the investment is less than its cost adjusted for
accretion, amortization and OTTI, otherwise defined as an unrealized loss. When an investment is
impaired, the impairment is evaluated to determine whether it is temporary or other-than-temporary.
Significant judgment is required in the determination of whether an OTTI has occurred for an
investment. The Company follows a consistent and systematic process for determining and recording
an OTTI loss. The Company has established a committee responsible for the OTTI process. This
committee, referred to as the Impairment Committee, is made up of three officers appointed by the
Companys Chief Financial Officer. The Impairment Committee is responsible for analyzing all
securities in an unrealized loss position on at least a quarterly basis.
The Impairment Committees assessment of whether an OTTI loss should be recognized incorporates
both quantitative and qualitative information. The Impairment Committee considers a number of
factors including, but not limited to: (a) the length of time and the extent to which the fair
value has been less than amortized cost, (b) the financial condition and near term prospects of the
issuer, (c) the intent and ability of the Company to retain its investment for a period of time
sufficient to allow for an anticipated recovery in value, (d) whether the debtor is current on
interest and principal payments and (e) general market conditions and industry or sector specific
outlook.
As part of the Impairment Committees review of impaired asset-backed securities it also considers
results and analysis of cash flow modeling. The focus of this analysis is on assessing the
sufficiency and quality of the underlying collateral and timing of cash flows based on various
scenario tests. This additional data provides the Impairment Committee with additional context to
evaluate current market conditions to determine if the impairment is temporary in nature.
For securities considered to be OTTI, the security is adjusted to fair value and the resulting
losses are recognized in Realized investment gains (losses) on the Consolidated Statements of
Operations.
The significant credit spread widening in 2008 negatively impacted the fair value of several asset
classes resulting in material unrealized losses and impacted the unrealized loss aging as presented
in the tables below. The Companys assertion to hold until a recovery in value takes into account
a view on the estimated recovery horizon which in some cases may include maturity. Given the
prolonged nature of the current market downturn, the duration and severity of the unrealized losses
has progressed well beyond historical norms. The Company will continue to monitor these losses and
will assess all facts and circumstances as they become known which may result in changes to the
conclusions reached based on current facts and circumstances and additional OTTI losses.
84
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 | 12 Months | Fair | ||||||||||||||||
December 31, 2008 | Cost | Gains | 12 Months | or Greater | Value | |||||||||||||||
(In millions) | ||||||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||||||
U.S. Treasury securities and obligations of
government agencies |
$ | 2,862 | $ | 69 | $ | 1 | $ | | $ | 2,930 | ||||||||||
Asset-backed securities |
9,670 | 24 | 961 | 969 | 7,764 | |||||||||||||||
States, municipalities and political
subdivisions tax-exempt securities |
8,557 | 90 | 609 | 623 | 7,415 | |||||||||||||||
Corporate and other taxable bonds |
12,993 | 275 | 1,164 | 1,374 | 10,730 | |||||||||||||||
Redeemable preferred stock |
72 | 1 | 23 | 3 | 47 | |||||||||||||||
Total fixed maturity securities available-for-sale |
34,154 | 459 | 2,758 | 2,969 | 28,886 | |||||||||||||||
Total fixed maturity securities trading |
1 | | | | 1 | |||||||||||||||
Equity securities available-for-sale: |
||||||||||||||||||||
Common stock |
134 | 190 | 1 | 3 | 320 | |||||||||||||||
Preferred stock |
882 | 5 | 15 | 321 | 551 | |||||||||||||||
Total equity securities available-for-sale |
1,016 | 195 | 16 | 324 | 871 | |||||||||||||||
Total |
$ | 35,171 | $ | 654 | $ | 2,774 | $ | 3,293 | $ | 29,758 | ||||||||||
Summary of Fixed Maturity and Equity Securities
Cost or | Gross | Gross Unrealized Losses | Estimated | |||||||||||||||||
Amortized | Unrealized | Less than | 12 Months | Fair | ||||||||||||||||
December 31, 2007 | Cost | Gains | 12 Months | or Greater | 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 and other taxable bonds |
13,010 | 454 | 197 | 16 | 13,251 | |||||||||||||||
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 | |||||||||||||||
Total equity securities available-for-sale |
366 | 214 | 12 | | 568 | |||||||||||||||
Total |
$ | 34,754 | $ | 946 | $ | 674 | $ | 201 | $ | 34,825 | ||||||||||
85
The following table summarizes, for available-for-sale fixed income securities, preferred stocks
and common stocks in an unrealized loss position at December 31, 2008 and 2007, the aggregate fair
value and gross unrealized loss by length of time those securities have been continuously in an
unrealized loss position.
Unrealized Loss Aging
December 31, 2008 | December 31, 2007 | |||||||||||||||
Gross | Gross | |||||||||||||||
Estimated | Unrealized | Estimated | Unrealized | |||||||||||||
Fair Value | Loss | Fair Value | Loss | |||||||||||||
(In millions) | ||||||||||||||||
Fixed income securities: |
||||||||||||||||
Investment grade: |
||||||||||||||||
0-6 months |
$ | 6,749 | $ | 681 | $ | 4,771 | $ | 228 | ||||||||
7-11 months |
6,159 | 1,591 | 1,584 | 193 | ||||||||||||
12-24 months |
3,549 | 1,803 | 690 | 57 | ||||||||||||
Greater than 24 months |
1,778 | 509 | 3,869 | 138 | ||||||||||||