CNA FINANCIAL CORP - Annual Report: 2010 (Form 10-K)
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[Ö] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2010
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES 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)
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
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities Act. Yes Ö No...
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... No Ö
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 Ö No...
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes... No....
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. [Ö ]
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.... Accelerated filer Ö Non-accelerated filer (Do not check if a
smaller reporting company).... Smaller reporting company....
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes... No Ö
As of
February 17, 2011, 269,309,618 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, 2010 was
approximately $675 million based on the closing price of $25.56 per share of the common stock on
the New York Stock Exchange on June 30, 2010.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the CNA Financial Corporation Proxy Statement prepared for the 2011 annual meeting
of shareholders, pursuant to Regulation 14A, are incorporated by reference into Part III of this
Report.
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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 CNAF 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 certain other affiliates. Loews Corporation (Loews) owned approximately 90% of our
outstanding common stock as of December 31, 2010.
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 underwriters to
a wide variety of customers, including small, medium and large businesses, associations,
professionals and other groups.
Our core business, commercial property and casualty insurance operations, is reported in two
business segments: CNA Specialty and CNA Commercial. Our non-core businesses are managed in two
business segments: Life & Group Non-Core and Corporate & Other Non-Core. Each segment is managed
separately due to 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 to the Consolidated Financial Statements included under Item 8.
Competition
The property and casualty insurance industry is highly competitive both as to rate and service. We
compete with stock and 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, financial strength, ratings and quality of service, including claim
adjustment services.
There are approximately 2,400 individual companies that sell property and casualty insurance in the
United States. Based on 2009 statutory net written premiums, we are the seventh largest commercial
insurance writer and the 13th largest property and casualty insurance organization in the United
States.
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, prescribing the form and content of statutory financial reports,
and regulating capital adequacy and the type, quality and amount of investments permitted. Such
regulatory powers also extend to premium rate regulations, which require that rates not be
excessive, inadequate or unfairly discriminatory. In addition to regulation of dividends by
insurance subsidiaries, intercompany transfers of assets may be subject to prior notice or approval
by the state insurance regulators, depending on the size of such transfers and payments in relation
to the financial position of the insurance affiliates making the transfer or payment.
Insurers are also required by the states to provide coverage to insureds who would not otherwise be
considered eligible by the insurers. Each state dictates the types of insurance and the level of
coverage that must be provided to such involuntary risks. Our share of these involuntary risks is
mandatory and generally a function of our respective share of the voluntary market by line of
insurance in each state.
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.
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Although the federal government does 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 financial services reforms; various tax
proposals affecting insurance companies; and possible regulatory limitations, impositions and
restrictions arising from the Dodd-Frank Wall Street Reform and Consumer Protection Act, as well as
the Patient Protection and Affordable Care Act, both enacted in 2010.
Various legislative and regulatory efforts to reform the tort liability system have, and will
continue to, impact our industry. Although there has been some tort reform with positive impact to
the insurance industry, new causes of action and theories of damages continue to be proposed in
state court actions or by federal or state legislatures that continue to expand liability for
insurers and their policyholders. For example, some state legislatures have from time to time
considered legislation addressing direct actions against insurers related to bad faith claims. As
a result of this unpredictability in the law, insurance underwriting is expected to continue to be
difficult in commercial lines, professional liability and other specialty coverages.
The Dodd-Frank Wall Street Reform and Consumer Protection Act expands the federal presence in
insurance oversight and may increase the regulatory requirements to which we may be subject. The
Acts requirements include streamlining the state-based regulation of reinsurance and nonadmitted
insurance (property or casualty insurance placed from insurers that are eligible to accept
insurance, but are not licensed to write insurance in a particular state). The Act also
establishes a new Federal Insurance Office within the U.S. Department of the Treasury with powers
over all lines of insurance except health insurance, certain long-term care insurance and crop
insurance, to, among other things, monitor aspects of the insurance industry, identify issues in
the regulation of insurers that could contribute to a systemic crisis in the insurance industry or
the overall financial system, coordinate federal policy on international insurance matters and
preempt state insurance measures under certain circumstances. The Act calls for numerous studies
and contemplates further regulation.
The Patient Protection and Affordable Care Act and the related amendments in the Health Care and
Education Reconciliation Act may increase our operating costs and underwriting losses. This
landmark legislation may lead to numerous changes in the health care industry that could create
additional operating costs for us, particularly with respect to our workers compensation and long
term care products. These costs might arise through the increased use of health care services by
our claimants or the increased complexities in health care bills that could require additional
levels of review. In addition, due to the expected number of new participants in the health care
system and the potential for additional malpractice claims, we may experience increased
underwriting risk in the lines of our business that provide management and professional liability
insurance to individuals and businesses engaged in the health care industry. The lines of our
business that provide professional liability insurance to attorneys, accountants and other
professionals who advise clients regarding the health care reform legislation may also experience
increased underwriting risk due to the complexity of the legislation.
Employee Relations
As of December 31, 2010, we had approximately 8,000 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 health care programs. See
Note J to the Consolidated Financial Statements included under Item 8 for further discussion of our
benefit plans.
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Direct Written Premiums by Geographic Concentration
Set forth below is the distribution of our direct written premiums by geographic concentration.
Direct Written Premiums
Percent of Total | ||||||||||||
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
California |
9.3 | % | 9.1 | % | 9.2 | % | ||||||
New York |
6.8 | 6.8 | 6.9 | |||||||||
Texas |
6.5 | 6.6 | 6.2 | |||||||||
Florida |
6.1 | 6.2 | 6.5 | |||||||||
Illinois |
4.0 | 3.8 | 3.8 | |||||||||
Missouri |
4.0 | 3.6 | 3.1 | |||||||||
New Jersey |
3.5 | 3.7 | 3.8 | |||||||||
Pennsylvania |
3.4 | 3.2 | 3.3 | |||||||||
All other states, countries or political subdivisions (a) |
56.4 | 57.0 | 57.2 | |||||||||
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 6.9%, 7.0% and 7.4% of our direct written premiums were derived from outside of
the United States for the years ended December 31, 2010, 2009 and 2008. Premiums from any one
individual foreign country were not material to aggregate direct written premiums.
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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 subsidiaries, 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 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. The development amounts in the table below include the impact of commutations, but
exclude the impact of the provision for uncollectible reinsurance.
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Schedule of Loss Reserve Development
Calendar Year Ended | 2000 | 2001 (a) | 2002 (b) | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 (c) | |||||||||||||||||||||||||||||||||
(In millions) | ||||||||||||||||||||||||||||||||||||||||||||
Originally reported gross reserves for unpaid
claim and claim adjustment expenses |
$ | 26,510 | $ | 29,649 | $ | 25,719 | $ | 31,284 | $ | 31,204 | $ | 30,694 | $ | 29,459 | $ | 28,415 | $ | 27,475 | $ | 26,712 | $ | 25,412 | ||||||||||||||||||||||
Originally reported ceded recoverable |
7,333 | 11,703 | 10,490 | 13,847 | 13,682 | 10,438 | 8,078 | 6,945 | 6,213 | 5,524 | 6,060 | |||||||||||||||||||||||||||||||||
Originally reported net reserves for unpaid
claim and claim adjustment expenses |
$ | 19,177 | $ | 17,946 | $ | 15,229 | $ | 17,437 | $ | 17,522 | $ | 20,256 | $ | 21,381 | $ | 21,470 | $ | 21,262 | $ | 21,188 | $ | 19,352 | ||||||||||||||||||||||
Cumulative net paid as of: |
||||||||||||||||||||||||||||||||||||||||||||
One year later |
$ | 7,686 | $ | 5,981 | $ | 5,373 | $ | 4,382 | $ | 2,651 | $ | 3,442 | $ | 4,436 | $ | 4,308 | $ | 3,930 | $ | 3,762 | $ | - | ||||||||||||||||||||||
Two years later |
11,992 | 10,355 | 8,768 | 6,104 | 4,963 | 7,022 | 7,676 | 7,127 | 6,746 | - | - | |||||||||||||||||||||||||||||||||
Three years later |
15,291 | 12,954 | 9,747 | 7,780 | 7,825 | 9,620 | 9,822 | 9,102 | - | - | - | |||||||||||||||||||||||||||||||||
Four years later |
17,333 | 13,244 | 10,870 | 10,085 | 9,914 | 11,289 | 11,312 | - | - | - | - | |||||||||||||||||||||||||||||||||
Five years later |
17,775 | 13,922 | 12,814 | 11,834 | 11,261 | 12,465 | - | - | - | - | - | |||||||||||||||||||||||||||||||||
Six years later |
18,970 | 15,493 | 14,320 | 12,988 | 12,226 | - | - | - | - | - | - | |||||||||||||||||||||||||||||||||
Seven years later |
20,297 | 16,769 | 15,291 | 13,845 | - | - | - | - | - | - | - | |||||||||||||||||||||||||||||||||
Eight years later |
21,382 | 17,668 | 16,022 | - | - | - | - | - | - | - | - | |||||||||||||||||||||||||||||||||
Nine years later |
22,187 | 18,286 | - | - | - | - | - | - | - | - | - | |||||||||||||||||||||||||||||||||
Ten years later |
22,826 | - | - | - | - | - | - | - | - | - | - | |||||||||||||||||||||||||||||||||
Net reserves re-estimated as of: |
||||||||||||||||||||||||||||||||||||||||||||
End of initial year |
$ | 19,177 | $ | 17,946 | $ | 15,229 | $ | 17,437 | $ | 17,522 | $ | 20,256 | $ | 21,381 | $ | 21,470 | $ | 21,262 | $ | 21,188 | $ | 19,352 | ||||||||||||||||||||||
One year later |
21,502 | 17,980 | 17,650 | 17,671 | 18,513 | 20,588 | 21,601 | 21,463 | 21,021 | 20,643 | - | |||||||||||||||||||||||||||||||||
Two years later |
21,555 | 20,533 | 18,248 | 19,120 | 19,044 | 20,975 | 21,706 | 21,259 | 20,472 | - | - | |||||||||||||||||||||||||||||||||
Three years later |
24,058 | 21,109 | 19,814 | 19,760 | 19,631 | 21,408 | 21,609 | 20,752 | - | - | - | |||||||||||||||||||||||||||||||||
Four years later |
24,587 | 22,547 | 20,384 | 20,425 | 20,212 | 21,432 | 21,286 | - | - | - | - | |||||||||||||||||||||||||||||||||
Five years later |
25,594 | 22,983 | 21,076 | 21,060 | 20,301 | 21,326 | - | - | - | - | - | |||||||||||||||||||||||||||||||||
Six years later |
26,023 | 23,603 | 21,769 | 21,217 | 20,339 | - | - | - | - | - | - | |||||||||||||||||||||||||||||||||
Seven years later |
26,585 | 24,267 | 21,974 | 21,381 | - | - | - | - | - | - | - | |||||||||||||||||||||||||||||||||
Eight years later |
27,207 | 24,548 | 22,168 | - | - | - | - | - | - | - | - | |||||||||||||||||||||||||||||||||
Nine years later |
27,510 | 24,765 | - | - | - | - | - | - | - | - | - | |||||||||||||||||||||||||||||||||
Ten years later |
27,702 | - | - | - | - | - | - | - | - | - | - | |||||||||||||||||||||||||||||||||
Total net (deficiency) redundancy |
$ | (8,525 | ) | $ | (6,819 | ) | $ | (6,939 | ) | $ | (3,944 | ) | $ | (2,817 | ) | $ | (1,070 | ) | $ | 95 | $ | 718 | $ | 790 | $ | 545 | $ | - | ||||||||||||||||
Reconciliation to gross re-estimated reserves: |
||||||||||||||||||||||||||||||||||||||||||||
Net reserves re-estimated |
$ | 27,702 | $ | 24,765 | $ | 22,168 | $ | 21,381 | $ | 20,339 | $ | 21,326 | $ | 21,286 | $ | 20,752 | $ | 20,472 | $ | 20,643 | $ | - | ||||||||||||||||||||||
Re-estimated ceded recoverable |
11,397 | 16,911 | 16,279 | 14,639 | 13,507 | 10,846 | 8,541 | 7,180 | 6,168 | 5,559 | - | |||||||||||||||||||||||||||||||||
Total gross re-estimated reserves |
$ | 39,099 | $ | 41,676 | $ | 38,447 | $ | 36,020 | $ | 33,846 | $ | 32,172 | $ | 29,827 | $ | 27,932 | $ | 26,640 | $ | 26,202 | $ | - | ||||||||||||||||||||||
Total gross (deficiency) redundancy |
$ | (12,589 | ) | $ | (12,027 | ) | $ | (12,728 | ) | $ | (4,736 | ) | $ | (2,642 | ) | $ | (1,478 | ) | $ | (368 | ) | $ | 483 | $ | 835 | $ | 510 | $ | - | |||||||||||||||
Net (deficiency) redundancy related to: |
||||||||||||||||||||||||||||||||||||||||||||
Asbestos |
$ | (1,590 | ) | $ | (818 | ) | $ | (827 | ) | $ | (177 | ) | $ | (123 | ) | $ | (113 | ) | $ | (112 | ) | $ | (107 | ) | $ | (79 | ) | $ | - | $ | - | |||||||||||||
Environmental pollution |
(635 | ) | (288 | ) | (282 | ) | (209 | ) | (209 | ) | (159 | ) | (159 | ) | (159 | ) | (76 | ) | - | - | ||||||||||||||||||||||||
Total asbestos and environmental pollution |
(2,225 | ) | (1,106 | ) | (1,109 | ) | (386 | ) | (332 | ) | (272 | ) | (271 | ) | (266 | ) | (155 | ) | - | - | ||||||||||||||||||||||||
Core (Non-asbestos &
environmental pollution) |
(6,300 | ) | (5,713 | ) | (5,830 | ) | (3,558 | ) | (2,485 | ) | (798 | ) | 366 | 984 | 945 | 545 | - | |||||||||||||||||||||||||||
Total net (deficiency) redundancy |
$ | (8,525 | ) | $ | (6,819 | ) | $ | (6,939 | ) | $ | (3,944 | ) | $ | (2,817 | ) | $ | (1,070 | ) | $ | 95 | $ | 718 | $ | 790 | $ | 545 | $ | - | ||||||||||||||||
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(a) | Effective January 1, 2001, we established a new life insurance company, CNA Group Life
Assurance Company (CNAGLA). Further, on January 1, 2001 $1.1 billion of reserves were
transferred from CCC to CNAGLA. |
|
(b) | Effective October 31, 2002, we sold CNA Reinsurance Company Limited. As a result of the
sale, net reserves were reduced by $1.3 billion. |
|
(c) | Effective January 1, 2010, we ceded approximately $1.5 billion of net asbestos and
environmental pollution (A&EP) claim and allocated claim adjustment expense reserves relating
to our continuing operations under a retroactive reinsurance agreement with an aggregate limit
of $4 billion, as further discussed in Note F to the Consolidated Financial Statements
included under Item 8. |
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 to 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 www.sec.gov.
We also make available free of charge on or through our internet website (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 as soon as reasonably practicable after we electronically file such material with, or
furnish it to, the SEC. Copies of these reports may also be obtained, free of charge, upon written
request to: CNA Financial Corporation, 333 S. Wabash Avenue, Chicago, IL 60604, Attn. Jonathan D.
Kantor, Executive Vice President, General Counsel and Secretary.
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ITEM 1A. RISK FACTORS
Our business faces many risks. We have described below some of the more significant risks which we
face. There may be additional risks that we do not yet know of or that we do not currently
perceive to be significant that may also impact our business. Each of the risks and uncertainties
described below could lead to events or circumstances that have a material adverse effect on our
results of operations, equity, business and insurer financial strength and corporate debt ratings.
You should carefully consider and evaluate all of the information included in this Report and any
subsequent reports we may file with the SEC or make available to the public before investing in any
securities we issue.
If we determine that our recorded 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 claim and claim
adjustment expenses, including the estimated cost of the claims adjudication process, 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 net prior year 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. 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:
| the effects of recessionary economic conditions, which have resulted in an increase in the
number and size of claims due to corporate failures; these claims include both directors and
officers (D&O) and errors and omissions (E&O) insurance claims; |
|
| class action litigation relating to claims handling and other practices; and |
|
| mass tort claims, including bodily injury claims related to welding rods, benzene, lead,
noise induced hearing loss, injuries from various medical products including pharmaceuticals,
and various other chemical and radiation exposure claims. |
In light of the many uncertainties associated with establishing the estimates and making the
assumptions necessary to establish reserve levels, we review and change our reserve estimates in a
regular and ongoing process as experience develops and further claims are reported and settled. 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.
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We have exposures related to asbestos and environmental pollution (A&EP) claims, which could result
in additional losses.
Our property and casualty insurance subsidiaries also have exposures related to asbestos and
environmental pollution (A&EP) claims. Our experience has been that establishing claim and claim
adjustment expense reserves for casualty coverages relating to A&EP claims are subject to
uncertainties that are greater than those presented by other claims. Additionally, 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&EP. As a result, estimating the ultimate cost of both reported
and unreported A&EP claims is subject to a higher degree of variability.
On August 31, 2010, we completed a retroactive reinsurance transaction under which substantially
all of our legacy A&EP liabilities were ceded to National Indemnity Company, a subsidiary of
Berkshire Hathaway Inc., subject to an aggregate limit of $4 billion (Loss Portfolio Transfer). If
the other parties to the Loss Portfolio Transfer do not fully perform their obligations, our
liabilities for A&EP claims covered by the Loss Portfolio Transfer exceed the aggregate limit of $4
billion, or we determine we have exposures to A&EP claims not covered by the Loss Portfolio
Transfer, we may need to increase our recorded reserves which would result in a charge against our
earnings. These charges could be substantial. Additional information on this transaction is
included in Note F 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. These events can be natural or man-made, and may include hurricanes, windstorms,
earthquakes, hail, severe winter weather, fires, and acts of terrorism, and their frequency and
severity are inherently unpredictable. In addition, longer-term natural catastrophe trends may be
changing and new types of catastrophe losses may be developing due to climate change, a phenomenon
that has been associated with extreme weather events linked to rising temperatures, and includes
effects on global weather patterns, greenhouse gases, sea, land and air temperatures, sea levels,
rain, and snow.
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 frequency and 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. 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 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. 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 condition or have been downgraded by rating agencies. In
addition, reinsurers could dispute amounts which we believe are due to us. If we are not able to
collect the amounts due to us from reinsurers, our incurred losses will be higher. Additional
information on reinsurance is included in Note H to the Consolidated Financial Statements included
under Item 8.
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Our key assumptions used to determine reserves and deferred acquisition costs for our long term
care product offerings could vary significantly from actual experience.
Our reserves and deferred acquisition costs for our long term care product offerings are based on
certain key assumptions including morbidity, which is the frequency and severity of illness,
sickness and diseases contracted, policy persistency, which is the percentage of policies remaining
in force, interest rates and future health care cost trends. If actual experience differs from
these assumptions, the deferred acquisition cost asset may not be fully realized and the reserves
may not be adequate, requiring us to add to reserves, or take unfavorable development.
We have incurred and may continue to incur significant realized and unrealized investment losses
and volatility in net investment income arising from volatility in the capital and credit markets.
Our investment portfolio is exposed to various risks, such as interest rate, credit, and currency
risks, many of which are unpredictable. Investment returns are an important part of our overall
profitability. General economic conditions, changes in financial markets such as fluctuations in
interest rates, long term periods of low interest rates, credit conditions and currency, commodity
and stock prices, including the short and long-term effects of losses in relation to asset-backed
securities, and many other factors beyond our control can adversely affect the value of our
investments and the realization of investment income. Further, we invest a portion of our assets in
equity securities and limited partnerships which are subject to greater market volatility than our
fixed income investments. Limited partnership investments generally present greater market
volatility, higher illiquidity, and greater risk than fixed income investments. As a result of all
of these factors, we may not realize an adequate return on our investments, may incur losses on
sales of our investments, and may be required to write down the value of our investments.
Our valuation of investments and impairment of securities requires significant judgment.
We exercise significant judgment in analyzing and validating fair values, primarily provided by
third parties, for securities in our investment portfolio including those 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 residential and
commercial mortgage and other loan collateral can be particularly sensitive to fairly small changes
in actual collateral performance and assumptions as to future collateral performance.
Due to the inherent uncertainties involved with these types of risks and the resulting judgments,
we may incur unrealized losses and conclude that other-than-temporary write downs of our
investments are required. Additional information on our investment portfolio is included in the
MD&A under Item 7 and Notes B, C, and D 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. 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. During
periods in which price competition is high, we may lose business to competitors offering
competitive insurance products at lower prices. As a result, our premium levels and expense ratio
could be materially adversely impacted.
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
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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 or if we incur significant unrealized losses related to our investment portfolio, 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.
While Loews has provided us with substantial amounts of capital in prior years, Loews may be
restricted in its ability or may not be willing to provide additional capital support to us in the
future. If we are in need of additional capital, we may be required to secure this funding from
sources other than Loews. We may be limited in our ability to raise significant amounts of capital
on favorable terms or at all.
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. Ordinary dividend payments, or dividends that do
not require prior approval by the insurance subsidiaries domiciliary state departments of
insurance 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.
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 (S&P). Ratings reflect the rating agencys opinions of an insurance companys or insurance
holding companys financial strength, capital adequacy, operating performance, strategic position
and ability to meet its obligations to policyholders and debt holders.
Due to the intense competitive environment in which we operate, the uncertainty in determining
reserves and the potential for us to take material unfavorable development in the future, and
possible changes in the methodology or criteria applied by the rating agencies, the rating agencies
may take action to lower our ratings in the future. If our property and casualty insurance
financial strength ratings are downgraded below current levels, our business and results of
operations could be materially adversely affected. The severity of the impact on our business is
dependent on the level of downgrade and, for certain products, which rating agency takes the rating
action. Among the adverse effects in the event of such downgrades would be the inability to obtain
a material volume of business from certain major insurance brokers, the inability to sell a
material volume of our insurance products to certain markets, and the required collateralization of
certain future payment obligations or reserves.
In addition, it is possible that a lowering of the corporate 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 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
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our investors. Each state in which we do business has established supervisory agencies that
regulate the manner in which we do business. Their regulations relate to, among other things, the
following:
| standards of solvency including risk-based capital measurements; |
|
| restrictions on the nature, quality and concentration of investments; |
|
| restrictions on our ability to withdraw from unprofitable lines of insurance or
unprofitable market areas; |
|
| the required use of certain methods of accounting and reporting; |
|
| the establishment of reserves for unearned premiums, losses and other purposes; |
|
| potential assessments for funds necessary to settle covered claims against impaired,
insolvent or failed private or quasi-governmental insurers; |
|
| licensing of insurers and agents; |
|
| approval of policy forms; |
|
| limitations on the ability of our insurance subsidiaries to pay dividends to us; and |
|
| limitations on the ability to non-renew, cancel or change terms and conditions in policies. |
Regulatory powers also extend to premium rate regulations which require that rates not be
excessive, inadequate or unfairly discriminatory. The states in which we do business also require
us to provide coverage to persons whom we would not otherwise consider eligible. Each state
dictates the types of insurance and the level of coverage that must be provided to such involuntary
risks. Our share of these involuntary risks is mandatory and generally a function of our
respective share of the voluntary market by line of insurance in each state.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
The Chicago location, owned by CCC, a wholly-owned subsidiary of CNAF, houses our principal
executive offices. 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
|
763,322 | Principal executive offices of CNAF | ||||
401 Penn Street, Reading, Pennsylvania
|
190,677 | Property and casualty insurance offices | ||||
2405 Lucien Way, Maitland, Florida
|
116,948 | Property and casualty insurance offices | ||||
40 Wall Street, New York, New York
|
114,096 | 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
|
83,616 | Property and casualty insurance offices | ||||
600 N. Pearl Street, Dallas, Texas
|
65,752 | Property and casualty insurance offices | ||||
1249 S. River Road, Cranbury, New Jersey
|
50,366 | Property and casualty insurance offices | ||||
4267 Meridian Parkway, Aurora, Illinois
|
46,903 | Data center | ||||
675 Placentia Avenue, Brea, California
|
46,571 | 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 specific and significant legal proceedings is set forth in Note G to the
Consolidated Financial Statements included under Item 8.
We are also a party to routine litigation incidental to our business, which, based on the facts and
circumstances currently known, is not material to the business or financial condition of the
Company.
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PART II
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
OF EQUITY SECURITIES
Our common stock is listed on the New York Stock Exchange and the Chicago Stock Exchange under the
symbol CNA.
As of
February 17, 2011, we had 269,309,618 shares of common stock outstanding. Approximately 90%
of our outstanding common stock is owned by Loews. We had 1,519 stockholders of record as of
February 17, 2011 according to the records maintained by our transfer agent.
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. No repurchases were made in the fourth quarter of 2010.
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
2010 | 2009 | |||||||||||||||||||||||
Dividends | Dividends | |||||||||||||||||||||||
High | Low | Declared | High | Low | Declared | |||||||||||||||||||
Quarter: |
||||||||||||||||||||||||
First |
$ | 27.29 | $ | 21.71 | $ | - | $ | 17.43 | $ | 6.41 | $ | - | ||||||||||||
Second |
29.53 | 23.24 | - | 17.59 | 8.83 | - | ||||||||||||||||||
Third |
29.50 | 24.82 | - | 26.51 | 13.63 | - | ||||||||||||||||||
Fourth |
28.79 | 25.43 | - | 25.01 | 20.48 | - |
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, 2005 through December 31, 2010. The graph assumes that the value of the investment in
our common stock and for each index was $100 on December 31, 2005 and that dividends, if any, were
reinvested.
Stock Price Performance Graph
Company / Index | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | ||||||||||||||||||
CNA Financial Corporation |
100.00 | 123.19 | 103.91 | 51.47 | 75.14 | 84.69 | ||||||||||||||||||
S&P 500 Index |
100.00 | 115.79 | 122.16 | 76.96 | 97.33 | 111.99 | ||||||||||||||||||
S&P 500 Property & Casualty Insurance Index |
100.00 | 112.87 | 97.11 | 68.55 | 77.01 | 83.90 |
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ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial data. The table should be read in conjunction with
Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations and
Item 8 Financial Statements and Supplementary Data of this Form 10-K.
Selected Financial Data
As of and for the Years Ended | ||||||||||||||||||||
December 31 | 2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||||||
(In millions, except per share data) | ||||||||||||||||||||
Results of Operations: |
||||||||||||||||||||
Revenues |
$ | 9,209 | $ | 8,472 | $ | 7,799 | $ | 9,885 | $ | 10,376 | ||||||||||
Income (loss) from continuing
operations, net of tax |
$ | 779 | $ | 483 | $ | (251 | ) | $ | 905 | $ | 1,181 | |||||||||
Income (loss) from discontinued
operations, net of tax |
(21 | ) | (2 | ) | 9 | (6 | ) | (29 | ) | |||||||||||
Net (income) loss attributable to
noncontrolling interests, net of tax |
(68 | ) | (62 | ) | (57 | ) | (48 | ) | (44 | ) | ||||||||||
Net income (loss) attributable to CNA |
$ | 690 | $ | 419 | $ | (299 | ) | $ | 851 | $ | 1,108 | |||||||||
Basic Earnings (Loss) Per Share
Attributable to CNA Common
Stockholders: |
||||||||||||||||||||
Income (loss) from continuing
operations attributable to CNA
common stockholders |
$ | 2.36 | $ | 1.11 | $ | (1.21 | ) | $ | 3.15 | $ | 4.17 | |||||||||
Income (loss) from discontinued
operations attributable to CNA
common stockholders |
(0.08 | ) | (0.01 | ) | 0.03 | (0.02 | ) | (0.11 | ) | |||||||||||
Basic earnings (loss) per share
attributable to CNA common
stockholders |
$ | 2.28 | $ | 1.10 | $ | (1.18 | ) | $ | 3.13 | $ | 4.06 | |||||||||
Diluted Earnings (Loss) Per Share
Attributable to CNA Common
Stockholders: |
||||||||||||||||||||
Income (loss) from continuing
operations attributable to CNA
common stockholders |
$ | 2.36 | $ | 1.11 | $ | (1.21 | ) | $ | 3.15 | $ | 4.16 | |||||||||
Income (loss) from discontinued
operations attributable to CNA
common stockholders |
(0.08 | ) | (0.01 | ) | 0.03 | (0.02 | ) | (0.11 | ) | |||||||||||
Diluted earnings (loss) per share
attributable to CNA common
stockholders |
$ | 2.28 | $ | 1.10 | $ | (1.18 | ) | $ | 3.13 | $ | 4.05 | |||||||||
Dividends declared per common share |
$ | - | $ | - | $ | 0.45 | $ | 0.35 | $ | - | ||||||||||
Financial Condition: |
||||||||||||||||||||
Total investments |
$ | 42,655 | $ | 41,996 | $ | 35,003 | $ | 41,789 | $ | 44,096 | ||||||||||
Total assets |
55,331 | 55,298 | 51,688 | 56,759 | 60,283 | |||||||||||||||
Insurance reserves |
37,590 | 38,263 | 38,771 | 40,222 | 41,080 | |||||||||||||||
Long and short term debt |
2,651 | 2,303 | 2,058 | 2,157 | 2,156 | |||||||||||||||
Total CNA stockholders equity |
10,954 | 10,660 | 6,877 | 10,150 | 9,768 | |||||||||||||||
Book value per common share |
$ | 40.70 | $ | 35.91 | $ | 20.92 | $ | 37.36 | $ | 36.03 | ||||||||||
Statutory Surplus: |
||||||||||||||||||||
Combined Continental Casualty
Companies (a) |
$ | 9,821 | (b) | $ | 9,338 | $ | 7,819 | $ | 8,348 | $ | 8,056 | |||||||||
Life company |
498 | (b) | 448 | 487 | 471 | 687 |
(a) | Represents the combined statutory surplus of CCC and its subsidiaries, including the Life
company, as determined in accordance with statutory accounting practices as further discussed
in Note L to the Consolidated Financial Statements included under Item 8. |
|
(b) | Preliminary results. |
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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Overview
The following discussion should be read in conjunction with Item 1A Risk Factors, Item 6 Selected
Financial Data and Item 8 Financial Statements and Supplementary Data of this Form 10-K. References
to net operating income (loss), net realized investment gains (losses) and net income (loss) used
in this MD&A reflect amounts attributable to CNA, unless otherwise noted.
Agreement to Cede Asbestos and Environmental Pollution (A&EP) Liabilities to National Indemnity
Company (NICO)
As further discussed in Note F to the Consolidated Financial Statements included under Item 8, on
August 31, 2010, we completed a transaction with NICO, a subsidiary of Berkshire Hathaway Inc.,
under which substantially all of our legacy A&EP liabilities were ceded to NICO (Loss Portfolio
Transfer), subject to an aggregate limit of $4 billion. We recognized an after-tax loss of $365
million in the third quarter of 2010, of which $344 million related to our continuing operations.
Since a portion of the liabilities ceded related to our discontinued operations, we also recognized
an after-tax loss for discontinued operations of $21 million.
The net loss attributable to CNA of $365 million related primarily to the risk margin necessary to
secure the $4 billion of reinsurance protection on such a volatile component of our reserves.
However, we believe the benefits to CNA are compelling. The benefits include:
| improves our earnings outlook and financial stability by significantly mitigating A&EP
reserve risk going forward; |
||
| effectively eliminates credit risk on $1.2 billion of third party A&EP reinsurance
recoverables effective January 1, 2010; and |
||
| eliminates an area of uncertainty from the perspective of rating agencies. |
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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 |
19 | |||
Critical Accounting Estimates |
22 | |||
Reserves Estimates and Uncertainties |
24 | |||
Segment Results |
29 | |||
CNA Specialty |
30 | |||
CNA Commercial |
33 | |||
Life & Group Non-Core |
36 | |||
Corporate & Other Non-Core |
38 | |||
Investments |
39 | |||
Net Investment Income |
39 | |||
Net Realized Investment Gains (Losses) |
40 | |||
Duration |
42 | |||
Asset-Backed Exposure |
43 | |||
Short Term Investments |
43 | |||
Separate Accounts |
44 | |||
Liquidity and Capital Resources |
45 | |||
Cash Flows |
45 | |||
2008 Senior Preferred |
45 | |||
Liquidity |
46 | |||
Dividends |
46 | |||
CNA Surety |
46 | |||
Commitments, Contingencies and Guarantees |
47 | |||
Ratings |
48 | |||
Accounting Standards Updates |
48 | |||
Forward-Looking Statements |
49 |
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CONSOLIDATED OPERATIONS
Results of Operations
The following table includes the consolidated results of our operations. For more detailed
components of our business operations and the net operating income financial measure, see the
segment discussions within this MD&A.
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Revenues |
||||||||||||
Net earned premiums |
$ | 6,515 | $ | 6,721 | $ | 7,151 | ||||||
Net investment income |
2,316 | 2,320 | 1,619 | |||||||||
Other revenues |
292 | 288 | 326 | |||||||||
Total operating revenues |
9,123 | 9,329 | 9,096 | |||||||||
Claims, Benefits and Expenses |
||||||||||||
Net incurred claims and benefits |
4,955 | 5,267 | 5,703 | |||||||||
Policyholders dividends |
30 | 23 | 20 | |||||||||
Amortization of deferred acquisition costs |
1,387 | 1,417 | 1,467 | |||||||||
Other insurance related expenses |
797 | 781 | 694 | |||||||||
Other expenses |
928 | 444 | 477 | |||||||||
Total claims, benefits and expenses |
8,097 | 7,932 | 8,361 | |||||||||
Operating income from continuing operations before income tax |
1,026 | 1,397 | 735 | |||||||||
Income tax expense on operating income |
(297 | ) | (353 | ) | (145 | ) | ||||||
Net operating (income) loss, after-tax, attributable to noncontrolling interests |
(69 | ) | (62 | ) | (57 | ) | ||||||
Net operating income from continuing operations attributable to CNA |
660 | 982 | 533 | |||||||||
Net realized investment gains (losses), net of participating policyholders interests |
86 | (857 | ) | (1,297 | ) | |||||||
Income tax (expense) benefit on net realized investment gains (losses) |
(36 | ) | 296 | 456 | ||||||||
Net realized investment (gains) losses, after-tax, attributable to noncontrolling
interests |
1 | - | - | |||||||||
Net realized investment gains (losses) attributable to CNA |
51 | (561 | ) | (841 | ) | |||||||
Income (loss) from continuing operations attributable to CNA |
711 | 421 | (308 | ) | ||||||||
Income (loss) from discontinued operations attributable to CNA, net of income tax (expense) benefit of $0, $0 and $9 |
(21 | ) | (2 | ) | 9 | |||||||
Net income (loss) attributable to CNA |
$ | 690 | $ | 419 | $ | (299 | ) | |||||
2010 Compared with 2009
Net income improved $271 million in 2010 as compared with 2009. This improvement was driven by
significantly improved net realized investment results, partially offset by a decrease in net
operating income, primarily driven by the loss associated with the Loss Portfolio Transfer.
Excluding the loss associated with the Loss Portfolio Transfer, net income improved $636 million in
2010 as compared with 2009.
Net realized investment results improved $612 million in 2010 as compared with 2009. See the
Investments section of this MD&A for further discussion of net investment income and net realized
investment results.
Net operating income decreased $322 million in 2010 as compared with 2009. Excluding the loss
associated with the Loss Portfolio Transfer, net operating income increased $22 million in 2010 as
compared with 2009. Net operating income increased $49 million for our core segments, CNA
Specialty and CNA Commercial, primarily due to increased favorable net prior year development,
partially offset by decreased current accident year underwriting results, including higher
catastrophe losses, and decreased after-tax net investment income. Catastrophe losses were $79
million after-tax in 2010, as compared to catastrophe losses of $58 million after-tax in 2009. Net
operating loss increased $27 million for our non-core segments, as further discussed in the Life &
Group Non-Core and Corporate & Other Non-Core segments of this MD&A.
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As further discussed in Note O to the Consolidated Financial Statements included under Item 8, we
commenced a program during 2010 to significantly transform our Information Technology (IT)
organization and delivery model. We anticipate that the total costs for this program will be
approximately $38 million, of which $36 million was incurred during the year ended December 31,
2010. When the results of this program are fully operational, we anticipate significant annual
savings relative to our current annual level of IT spending. A significant portion of the annual
savings is anticipated to be achieved in 2011 with full annual savings in 2012. Some or all of
these estimated savings may be invested in IT or other enhancements necessary to support our
business strategies.
Favorable net prior year development of $594 million and $208 million was recorded in 2010 and 2009
related to our CNA Specialty, CNA Commercial and Corporate & Other Non-Core segments. Further
information on net prior year development for 2010 and 2009 is included in Note F to the
Consolidated Financial Statements included under Item 8.
Net earned premiums decreased $206 million in 2010 as compared with 2009 driven by a $176 million
decrease in CNA Commercial and an $18 million decrease in CNA Specialty. See the Segment Results
section of this MD&A for further discussion.
Net loss from discontinued operations increased $19 million in 2010 as compared to 2009 due to the
loss associated with the Loss Portfolio Transfer.
2009 Compared with 2008
Net results improved $718 million in 2009 as compared with 2008. This improvement was due to
increased net operating income and decreased net realized investment losses.
Net realized investment losses decreased $280 million in 2009 as compared with 2008. See the
Investments section of this MD&A for further discussion of net investment income and net realized
investment results.
Net operating income improved $449 million in 2009 as compared with 2008. Net operating income
increased $379 million for our core segments, CNA Specialty and CNA Commercial, and net operating
loss decreased $70 million for our non-core segments. This improvement was primarily due to higher
net investment income and lower catastrophe losses. Net investment income in 2008 included indexed
group annuity trading portfolio losses of $146 million. This trading portfolio supported the
indexed group annuity portion of our pension deposit business which was exited during 2008, and
these losses were substantially offset by a corresponding decrease in the policyholders funds
reserves supported by the trading portfolio. Excluding the trading portfolio losses in 2008, net
investment income increased $555 million primarily driven by limited partnership income.
Catastrophe losses were $58 million after-tax in 2009, as compared to catastrophe impacts of $239
million after-tax in 2008. Partially offsetting these favorable items was an unfavorable change in
current accident year underwriting results excluding catastrophes.
Results for the year ended December 31, 2009 included expense of $45 million related to our pension
and postretirement plans, compared with a benefit of $14 million for the year ended December 31,
2008.
In 2008, the amount due from policyholders related to losses under deductible policies within CNA
Commercial Lines was reduced by $90 million for insolvent insureds. The reduction of this amount,
which was reflected as unfavorable net prior year reserve development in 2008, 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.
Favorable net prior year development of $208 million and $80 million was recorded in 2009 and 2008
related to our CNA Specialty, CNA Commercial and Corporate & Other Non-Core segments. Excluding
the impact of the $90 million of unfavorable net prior year reserve development discussed above,
which had no net impact on the results of operations, favorable net prior year development was $170
million in 2008. Further information on net prior year development for 2009 and 2008 is included
in Note F to the Consolidated Financial Statements included under Item 8.
Net earned premiums decreased $430 million in 2009 as compared with 2008, driven by a $58 million
decrease in CNA Specialty and a $355 million decrease in CNA Commercial. See the Segment Results
section of this MD&A for further discussion.
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Results from discontinued operations decreased $11 million in 2009 as compared to 2008. The 2008
results were 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.
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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 to the Consolidated Financial Statements included under Item 8 should be read
in conjunction with this section to assist with obtaining an understanding of the underlying
accounting policies related to these estimates. Due to the inherent uncertainties involved with
these types of judgments, actual results could differ significantly from estimates and may have a
material adverse impact on our results of operations and/or equity.
Insurance Reserves
Insurance reserves are established for both short and long-duration insurance contracts.
Short-duration contracts are primarily related to property and casualty insurance policies where
the reserving process is based on actuarial estimates of the amount of loss, including amounts for
known and unknown claims. Long-duration contracts typically include traditional life insurance,
payout annuities and long term care products and are estimated using actuarial estimates about
mortality, morbidity and persistency as well as assumptions about expected investment returns. The
reserve for unearned premiums on property and casualty and accident and health contracts represents
the portion of premiums written related to the unexpired terms of coverage. The inherent risks
associated with the reserving process are discussed in the Reserves Estimates and Uncertainties
section below.
Reinsurance and Insurance Receivables
An exposure exists with respect to the collectibility of property and casualty and life reinsurance
ceded to the extent that any reinsurer is unable to meet its obligations or disputes the
liabilities we have ceded under reinsurance agreements. An allowance for uncollectible reinsurance
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 receivables are included in Note H to the Consolidated Financial Statements included
under Item 8.
Additionally, an exposure exists with respect to amounts due from policyholders related to
insurance contracts, including amounts due from insureds under high deductible policies. An
allowance for uncollectible insurance receivables is recorded on the basis of periodic evaluations
of balances due from insureds currently or in the future, managements experience and current
economic conditions.
If actual experience differs from the estimates made by management in determining the allowances
for uncollectible reinsurance and insurance receivables, net receivables as reflected on our
Consolidated Balance Sheets may not be collected. Therefore, our results of operations and/or
equity could be materially adversely impacted.
Valuation of Investments and Impairment of Securities
We classify our fixed maturity securities and equity securities as either available-for-sale or
trading which are both carried at fair value. The determination of fair value requires us to make
a significant number of assumptions and judgments, particularly with respect to asset-backed
securities. Due to the level of uncertainty related to changes in the fair value of these assets,
it is possible that changes in the near term could have an adverse material impact on our results
of operations and/or equity.
Our investment portfolio is subject to market declines below amortized cost that may be
other-than-temporary and therefore result in the recognition of impairment losses in earnings.
Factors considered in the determination
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of whether or not a decline is other-than-temporary include a current intention to sell the
security or an indication that a credit loss exists. Significant judgment exists regarding the
evaluation of the financial condition and expected near-term and long-term prospects of the issuer,
the relevant industry conditions and trends, and whether we expect to receive cash flows sufficient
to recover the entire amortized cost basis of the security. We have an Impairment Committee which
reviews the investment portfolio on at least a quarterly basis, with ongoing analysis as new
information becomes available. Further information on our process for evaluating impairments is
included in Note B to the Consolidated Financial Statements included under Item 8.
Long Term Care Products and Payout Annuity Contracts
Reserves for our long term care products and payout annuity contracts and deferred acquisition
costs for our long term care products are based on certain assumptions including morbidity,
mortality, 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, which were generally established at time of issue, 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 and/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
economic 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 Health and Group Benefits Program, 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 5.375% and 4.375% were the appropriate discount rates as
of December 31, 2010 to calculate our accrued pension and postretirement liabilities. Accordingly,
the 5.375% and 4.375% rates will also be used to determine our 2011 pension and postretirement
expense. At December 31, 2009, the discount rates used to calculate our accrued pension and
postretirement liabilities were 5.700% and 5.500%.
Further information on our pension and postretirement benefit obligations is included in Note J to
the Consolidated Financial Statements included under Item 8.
Income Taxes
We account for income 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 basis 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.
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Reserves Estimates and Uncertainties
We maintain loss 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 results of operations
in the period that the need for such adjustments is determined. The carried case and IBNR reserves
as of each balance sheet date are provided in the Segment Results section of this MD&A and in Note
F to 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:
| the effects of recessionary economic conditions, which have resulted in an increase in
the number and size of claims due to corporate failures; these claims include both
directors and officers (D&O) and errors and omissions (E&O) insurance claims; |
||
| class action litigation relating to claims handling and other practices; and |
||
| mass tort claims, including bodily injury claims related to welding rods, benzene,
lead, noise induced hearing loss, injuries from various medical products including
pharmaceuticals, and various other chemical and radiation exposure claims. |
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.
Our property and casualty insurance subsidiaries also have actual and potential exposures related
to asbestos and environmental pollution (A&EP) claims. Our experience has been that establishing
reserves for casualty coverages relating to A&EP claims and claim adjustment expenses are subject
to uncertainties that are greater than those presented by other claims. Additionally, 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&EP. As a result, estimating the ultimate cost of both reported and
unreported A&EP claims are subject to a higher degree of variability.
To mitigate the risks posed by our exposure to A&EP claims and claim adjustment expenses, as
further discussed in Note F to the Consolidated Financial Statements included under Item 8, on
August 31, 2010 we completed a transaction with NICO, a subsidiary of Berkshire Hathaway Inc.,
under which substantially all of our legacy A&EP liabilities were ceded to NICO effective January
1, 2010.
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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 or 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, with the exception of certain run-off products which are analyzed on a periodic
basis. 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).
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 professional liability, other professional liability coverages, assumed
reinsurance run-off and products liability. Short-tail exposures include property, commercial
automobile physical damage, marine and warranty. CNA Specialty and CNA Commercial contain both
long-tail and short-tail exposures. Corporate & Other Non-Core contains long-tail exposures.
Various methods are used to project ultimate loss for both long-tail and short-tail exposures
including, but not limited to, the following:
| paid development; |
||
| incurred development; |
||
| loss ratio; |
||
| Bornhuetter-Ferguson using paid loss; |
||
| Bornhuetter-Ferguson using incurred loss; |
||
| frequency times severity; and |
||
| stochastic modeling. |
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 consideration 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.
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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 for immature accident periods or 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 method using paid loss is a combination of the paid development method and
the loss ratio method. This 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. This 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 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 method using incurred loss is similar to the Bornhuetter-Ferguson method
using paid loss 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 frequency times severity 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 trends
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.
Stochastic modeling produces a range of possible outcomes based on varying assumptions related to
the particular product being modeled. For some products, we use models which rely on historical
development patterns at an aggregate level, while other products are modeled using individual claim
variability assumptions supplied by the claims department. In either case, multiple simulations
are run and the results are analyzed to produce a range of potential outcomes. The results will
typically include a mean and percentiles of the possible reserve distribution which aid in the
selection of a point estimate.
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.
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We will use the loss ratio, Bornhuetter-Ferguson and frequency times severity 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 the loss ratio,
Bornhuetter-Ferguson and frequency times severity methods for short-tail exposures.
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.
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, pricing and underwriting trends in
the insurance market, and legal, judicial, social and economic trends.
Our recorded reserves reflect our best estimate as of a particular point in time based upon known
facts, consideration of the factors cited above, 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 recorded reserves are modestly higher than the actuarial point estimate. For both
CNA Commercial and CNA Specialty, the difference between our reserves and the actuarial point
estimate is primarily driven by uncertainty with respect to immature accident years, claim cost
inflation, changes in claims handling, tort reform roll-backs which may adversely impact claim
costs, and the effects from the economy. For Corporate & Other Non-Core, the difference between
our reserves and the actuarial point estimate is primarily driven by the potential tail volatility
of run-off exposures.
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 significant factors affecting
our reserve estimates for particular types of business. These significant factors are the ones
that we believe 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 CNA Specialty, we believe a material deviation to our net reserves is reasonably possible
for professional liability and related business. This business includes professional
liability coverages provided to various professional firms, including architects, real estate
agents, 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, legislative changes 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 $450 million.
If the estimated claim severity
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decreases by 3%, we estimate that net reserves would decrease by approximately $150 million. Our
net reserves for this business were approximately $5.0 billion at December 31, 2010.
Within CNA Commercial, 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 CNA Commercial 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 $450 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 CNA Commercial
workers compensation were approximately $5.0 billion at December 31, 2010.
For CNA Commercial general liability, the most significant factor affecting reserve estimates is
claim severity. Claim severity is driven by changes in the cost of repairing or replacing property,
the cost of medical care, the cost of wage replacement, judicial decisions, legislation and other
factors. If the estimated claim severity for general liability increases by 6%, we estimate that
our net reserves would increase by approximately $200 million. If the estimated claim severity for
general liability decreases by 3%, we estimate that our net reserves would decrease by
approximately $100 million. Our net reserves for CNA Commercial general liability were
approximately $3.3 billion at December 31, 2010.
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 change
our reserves in prior periods and could lead to the identification of a need for additional
material increases or decreases in claim and claim adjustment expense reserves, which could
materially affect our results of operations, equity, business and insurer financial strength and
corporate debt ratings positively or negatively. See the Ratings section of this MD&A for further
information regarding our financial strength and corporate debt ratings.
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Segment Results
The following discusses the results of continuing operations for our operating segments.
We revised our reporting segments in the fourth quarter of 2010 for certain mass tort claims to
reflect the manner in which the Company is currently organized for purposes of making operating
decisions and assessing performance, as further discussed in Note N to the Consolidated Financial
Statements included under Item 8.
Our core property and casualty commercial insurance operations are reported in two business
segments: CNA Specialty and CNA Commercial. CNA Specialty provides a broad array of professional,
financial and specialty property and casualty products and services, primarily through insurance
brokers and managing general underwriters. CNA Commercial includes property and casualty coverages
sold to small businesses and middle market entities and organizations primarily through an
independent agency distribution system. CNA Commercial also includes commercial insurance and risk
management products sold to large corporations primarily through insurance brokers.
Our non-core operations are managed in two segments: Life & Group Non-Core and Corporate & Other
Non-Core. Life & Group Non-Core primarily includes the results of the life and group lines of
business that are in run-off. Corporate & Other Non-Core primarily includes certain corporate
expenses, including interest on corporate debt, and the results of certain property and casualty
business in run-off, including CNA Re and A&EP. Intersegment eliminations are also included in
this segment.
Our property and casualty field structure consists of 44 underwriting locations across the country.
There are three centralized processing operations which handle policy processing, billing and
collection activities, and also act as call centers to optimize service. The claims structure
consists of a centralized claim center designed to efficiently handle the high volume of low
severity claims including property damage, liability, and workers compensation medical only
claims, and 15 principal 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 (loss) attributable to CNA 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 guidance. See further discussion regarding how
we manage our business in Note N to the Consolidated Financial Statements included under Item 8.
In evaluating the results of our CNA Specialty and CNA Commercial 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
to the Consolidated Financial Statements included under Item 8.
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CNA SPECIALTY
Business Overview
CNA Specialty provides professional liability and other coverages through property and casualty
products and services, both domestically and abroad, through a network of brokers, independent
agencies and managing general underwriters. CNA Specialty provides solutions for managing the
risks of its clients, including architects, lawyers, accountants, health care professionals,
financial intermediaries and public and private companies. Product offerings also include surety
and fidelity bonds and vehicle warranty services.
CNA Specialty includes the following business groups:
Professional & Management Liability provides management and professional liability insurance and
risk management services and other specialized property and casualty coverages in the United
States. This group provides professional liability coverages to various professional firms,
including architects, real estate agents, small and mid-sized accounting firms, law firms and
technology firms. Professional & Management Liability 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 Professional & Management Liability are distributed through
brokers, agents and managing general underwriters. Professional & Management Liability, through
CNA HealthPro, also offers insurance products to serve the healthcare delivery system. Products
include professional liability and associated standard property and casualty coverages, and are
distributed on a national basis through brokers, agents and managing general underwriters. Key
customer segments include long term care facilities, allied health care providers, life sciences,
dental professionals and mid-size and large health care facilities.
International provides similar management and professional liability insurance and other
specialized property and casualty coverages in Canada and Europe.
Surety consists primarily of CNA Surety Corporation (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. We own
approximately 61% of CNA Surety.
Warranty and Alternative Risks provides extended service contracts and related products that
provide protection from the financial burden associated with mechanical breakdown and other related
losses, primarily for vehicles and portable electronic communication devices. These products are
distributed through and administered by a wholly owned subsidiary, CNA National Warranty
Corporation, or through third party administrators.
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The following table details results of operations for CNA Specialty.
Results of Operations
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions, except ratios) | ||||||||||||
Net written premiums |
$ | 2,691 | $ | 2,684 | $ | 2,719 | ||||||
Net earned premiums |
2,679 | 2,697 | 2,755 | |||||||||
Net investment income |
591 | 526 | 354 | |||||||||
Net operating income |
625 | 591 | 414 | |||||||||
Net realized investment gains (losses), after-tax |
20 | (123 | ) | (167 | ) | |||||||
Net income |
645 | 468 | 247 | |||||||||
Ratios |
||||||||||||
Loss and loss adjustment expense |
54.0 | % | 56.9 | % | 61.7 | % | ||||||
Expense |
30.5 | 29.3 | 27.3 | |||||||||
Dividend |
0.5 | 0.3 | 0.5 | |||||||||
Combined |
85.0 | % | 86.5 | % | 89.5 | % | ||||||
2010 Compared with 2009
Net written premiums for CNA Specialty increased $7 million in 2010 as compared with 2009. Net
written premiums increased in our professional management and liability lines of business. This
increase was partially offset by continued decreased insured exposures and lower rates in our
architects & engineers and CNA HealthPro lines of business due to current economic and competitive
market conditions. These conditions may continue to put ongoing pressure on premium and income
levels and the expense ratio. Net earned premiums decreased $18 million as compared with the same
period in 2009, due to the impact of decreased net written premiums in prior quarters.
CNA Specialtys average rate decreased 2% for 2010 and 2009 for policies that renewed in each
period. Retention rates of 86% and 84% were achieved for those policies that were available for
renewal in each period.
Net income improved $177 million in 2010 as compared with 2009. This increase was due to improved
net realized investment results and improved net operating income. See the Investments section of
this MD&A for further discussion of net investment income and net realized investment results.
Net operating income improved $34 million in 2010 as compared with 2009, primarily due to increased
favorable net prior year development and improved net investment income, partially offset by
decreased current accident year underwriting results.
The combined ratio improved 1.5 points in 2010 as compared with 2009. The loss ratio improved 2.9
points primarily due to increased favorable net prior year development, partially offset by the
impact of a higher current accident year loss ratio. The expense ratio increased 1.2 points
primarily related to higher underwriting expenses and higher commission rates. Underwriting
expenses were unfavorably impacted by higher employee-related costs and IT Transformation costs.
See the Consolidated Operations section of this MD&A for further discussion of IT Transformation
costs.
Favorable net prior year development of $344 million was recorded in 2010, compared to $224 million
in 2009. Further information on CNA Specialty net prior year development for 2010 and 2009 is
included in Note F to the Consolidated Financial Statements included under Item 8.
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The following table summarizes the gross and net carried reserves as of December 31, 2010 and 2009
for CNA Specialty.
Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
Claim and Claim Adjustment Expense Reserves
December 31 | 2010 | 2009 | ||||||
(In millions) | ||||||||
Gross Case Reserves |
$ | 2,341 | $ | 2,208 | ||||
Gross IBNR Reserves |
4,452 | 4,714 | ||||||
Total Gross Carried Claim and Claim Adjustment Expense Reserves |
$ | 6,793 | $ | 6,922 | ||||
Net Case Reserves |
$ | 1,992 | $ | 1,781 | ||||
Net IBNR Reserves |
3,926 | 4,085 | ||||||
Total Net Carried Claim and Claim Adjustment Expense Reserves |
$ | 5,918 | $ | 5,866 | ||||
2009 Compared with 2008
Net written premiums for CNA Specialty decreased $35 million in 2009 as compared with 2008. The
decrease in net written premiums was driven by our architects & engineers and surety bond lines of
business, as economic conditions led to decreased insured exposures. Net written premiums were
also unfavorably impacted by foreign exchange. Net earned premiums decreased $58 million as
compared with the same period in 2008, consistent with the trend of lower net written premiums.
CNA Specialtys average rate decreased 2% for 2009, as compared to a decrease of 4% for 2008 for
policies that renewed in each period. Retention rates of 84% and 85% were achieved for those
policies that were available for renewal in each period.
Net income improved $221 million in 2009 as compared with 2008. This increase was due to improved
net operating income and lower 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 improved $177 million in 2009 as compared with 2008, primarily due to higher
net investment income and increased favorable net prior year development.
The combined ratio improved 3.0 points in 2009 as compared with 2008. The loss ratio improved 4.8
points, primarily due to increased favorable net prior year development. The expense ratio
increased 2.0 points in 2009 as compared with 2008, primarily due to higher underwriting expenses
and the lower net earned premium base. Underwriting expenses increased primarily due to higher
employee-related costs.
Favorable net prior year development of $224 million was recorded in 2009, compared to $106 million
in 2008. Further information on CNA Specialty net prior year development for 2009 and 2008 is
included in Note F to the Consolidated Financial Statements included under Item 8.
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CNA COMMERCIAL
Business Overview
CNA Commercial works with an independent agency distribution system and a network of brokers to
market a broad range of property and casualty insurance products and services to small,
middle-market and large businesses and organizations domestically and abroad. Property products
include standard and excess property coverages, as well as marine coverage, and boiler and
machinery. Casualty products include standard casualty insurance products such as workers
compensation, general and product liability, commercial auto and umbrella coverages. 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, Commercial and
International insurance groups. Our Business insurance group serves our smaller commercial
accounts and the Commercial insurance group serves our middle markets and larger risks. In
addition, CNA Commercial 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 International insurance group primarily consists
of the commercial product lines of our operations in Europe, Canada, as well as Hawaii.
Also included in CNA Commercial is CNA Select Risk (Select Risk), which includes our excess and
surplus lines coverages. Select Risk provides specialized insurance for selected commercial risks
on both an individual customer and program basis. Customers insured by Select Risk are generally
viewed as higher risk and less predictable in exposure than those covered by standard insurance
markets. Select Risks products are distributed throughout the United States through specialist
producers, program agents and brokers.
The following table details the results of operations for CNA Commercial.
Results of Operations
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions, except ratios) | ||||||||||||
Net written premiums |
$ | 3,208 | $ | 3,448 | $ | 3,770 | ||||||
Net earned premiums |
3,256 | 3,432 | 3,787 | |||||||||
Net investment income |
873 | 935 | 612 | |||||||||
Net operating income |
509 | 494 | 292 | |||||||||
Net realized investment losses, after-tax |
(15 | ) | (236 | ) | (341 | ) | ||||||
Net income (loss) |
494 | 258 | (49 | ) | ||||||||
Ratios |
||||||||||||
Loss and loss adjustment expense |
66.8 | % | 70.5 | % | 73.1 | % | ||||||
Expense |
35.7 | 35.2 | 31.2 | |||||||||
Dividend |
0.4 | 0.3 | - | |||||||||
Combined |
102.9 | % | 106.0 | % | 104.3 | % | ||||||
2010 Compared with 2009
Net written premiums for CNA Commercial decreased $240 million in 2010 as compared with 2009.
Premiums written were unfavorably impacted by decreased insured exposures and decreased new
business as a result of competitive market conditions. Current economic conditions have led to
decreased insured exposures, such as in the construction industry due to smaller payrolls and
reduced project volume. These conditions may continue to put ongoing pressure on premium and income
levels and the expense ratio. Net earned premiums decreased $176 million in 2010 as compared with
2009, consistent with the trend of lower net written premiums.
CNA Commercials average rate increased 1% for 2010, as compared to flat rates for 2009 for the
policies that renewed during those periods. Retention rates of 79% and 81% were achieved for those
policies that were available for renewal in each period.
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Net income improved $236 million in 2010 as compared with 2009. This improvement was primarily due
to improved net realized investment results. See the Investments section of this MD&A for further
discussion of net investment income and net realized investment results.
Net operating income improved $15 million in 2010 as compared with 2009. This increase was
primarily due to increased favorable net prior year development, partially offset by lower net
investment income, and higher catastrophe losses.
The combined ratio improved 3.1 points in 2010 as compared with 2009. The loss ratio improved 3.7
points, primarily due to increased favorable net prior year development, partially offset by the
impact of higher catastrophe losses. Catastrophe losses were $113 million, or 3.5 points of the
loss ratio, for 2010, as compared to $82 million, or 2.4 points of the loss ratio, for 2009.
The expense ratio increased 0.5 points in 2010 as compared with 2009, primarily due to the
unfavorable impact of the lower net earned premium base. Underwriting expenses include the
unfavorable impact of the IT Transformation costs. See the Consolidated Operations section of this
MD&A for further discussion of IT Transformation costs.
Favorable net prior year development of $256 million was recorded in 2010, compared to favorable
net prior year development of $143 million in 2009. Further information on CNA Commercial net
prior year development for 2010 and 2009 is included in Note F to the Consolidated Financial
Statements included under Item 8.
The following table summarizes the gross and net carried reserves as of December 31, 2010 and 2009
for CNA Commercial.
Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
Claim and Claim Adjustment Expense Reserves
December 31 | 2010 | 2009 | ||||||
(In millions) | ||||||||
Gross Case Reserves |
$ | 6,390 | $ | 6,555 | ||||
Gross IBNR Reserves |
6,132 | 6,688 | ||||||
Total Gross Carried Claim and Claim Adjustment Expense Reserves |
$ | 12,522 | $ | 13,243 | ||||
Net Case Reserves |
$ | 5,349 | $ | 5,306 | ||||
Net IBNR Reserves |
5,292 | 5,691 | ||||||
Total Net Carried Claim and Claim Adjustment Expense Reserves |
$ | 10,641 | $ | 10,997 | ||||
2009 Compared with 2008
Net written premiums for CNA Commercial decreased $322 million in 2009 as compared with 2008.
Written premiums declined in most lines primarily due to general economic conditions. Economic
conditions led to decreased insured exposures, such as in small businesses and in the construction
industry due to smaller payrolls and reduced project volume. Net earned premiums decreased $355
million in 2009 as compared with 2008, consistent with the trend of lower net written premiums.
Premiums were also impacted by unfavorable premium development recorded in 2009 and unfavorable
foreign exchange.
CNA Commercials average rate was flat for 2009, as compared to a decrease of 4% for 2008 for the
policies that renewed during those periods. Retention rates of 81% were achieved for those
policies that were available for renewal in each period.
Net results improved $307 million in 2009 as compared with 2008. This improvement was due to
increased net operating income and decreased 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 improved $202 million in 2009 compared with 2008. This improvement was
primarily driven by higher net investment income and lower catastrophe losses. Partially
offsetting these favorable items was an unfavorable change in current accident year underwriting
results excluding catastrophes.
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The combined ratio increased 1.7 points in 2009 as compared with 2008. The loss ratio improved 2.6
points primarily due to lower catastrophe losses, partially offset by the impact of higher current
accident year non-catastrophe loss ratios and decreased favorable net prior year development.
Catastrophe losses were $82 million, or 2.4 points of the loss ratio, for 2009 as compared to $343
million, or 9.0 points of the loss ratio, for 2008. The current accident year loss ratio,
excluding catastrophe losses, was unfavorably impacted by loss experience in several lines of
business, including workers compensation and renewable energy, as well as several significant
property losses.
The expense ratio increased 4.0 points in 2009 as compared with 2008, primarily related to higher
underwriting expenses, unfavorable changes in estimates for insurance-related assessments and the
lower net earned premium base. Underwriting expenses increased primarily due to higher
employee-related costs.
In 2008, the amount due from policyholders related to losses under deductible policies within CNA
Commercial Lines was reduced by $90 million for insolvent insureds. The reduction of this amount,
which was reflected as unfavorable net prior year reserve development in 2008, 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.
Favorable net prior year development of $143 million was recorded in 2009, compared to favorable
net prior year development of $97 million in 2008. 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 $187 million. Further information
on CNA Commercial net prior year development for 2009 and 2008 is included in Note F to the
Consolidated Financial Statements included under Item 8.
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LIFE & GROUP NON-CORE
Business Overview
The Life & Group Non-Core segment primarily includes the results of the life and group lines of
business that are 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 retain 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 | 2010 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Net earned premiums |
$ | 582 | $ | 595 | $ | 612 | ||||||
Net investment income |
715 | 664 | 484 | |||||||||
Net operating loss |
(87 | ) | (16 | ) | (108 | ) | ||||||
Net realized investment gains (losses), after-tax |
33 | (153 | ) | (236 | ) | |||||||
Net loss |
(54 | ) | (169 | ) | (344 | ) |
2010 Compared with 2009
Net earned premiums for Life & Group Non-Core decreased $13 million in 2010 as compared with 2009.
Net earned premiums relate primarily to the individual and group long term care businesses.
Net loss decreased $115 million in 2010 as compared with 2009. This improvement was primarily due
to improved net realized investment results. See the Investments section of this MD&A for further
discussion of net realized investment results. In addition, 2009 results included the unfavorable
impact of a $28 million after-tax legal accrual as discussed further below. The accrual was
subsequently decreased in 2010, resulting in a favorable impact of $12 million after-tax.
Favorable reserve development arising from a commutation of an assumed reinsurance agreement in
2010 also contributed to the improvement.
These favorable impacts were partially offset by a $61 million after-tax gain recognized in 2009,
net of reinsurance, arising from a settlement reached with Willis Limited that resolved litigation
related to the placement of personal accident reinsurance.
The favorable impacts were also partially offset by an increase to payout annuity benefit reserves
resulting from unlocking assumptions due to loss recognition, unfavorable results in our long term
care business and less favorable performance on our pension deposit business.
Certain of the separate account investment contracts related to our pension deposit business
guarantee principal and an annual minimum rate of interest, for which we recorded an additional
pretax liability of $68 million in Policyholders funds during 2008 due to declines in the fair
value of the investments supporting this business at that time. During 2009, we decreased this
pretax liability by $42 million, and during 2010, we decreased the pretax liability by $24 million,
based on increases in the fair value of these investments during those periods.
2009 Compared with 2008
Net earned premiums for Life & Group Non-Core decreased $17 million in 2009 as compared with 2008.
Net loss decreased $175 million in 2009 as compared with 2008. This improvement was primarily due
to improved net realized investment results, and favorable performance on our remaining pension
deposit business and a settlement reached with Willis Limited both as discussed above.
These favorable impacts were partially offset by unfavorable results in our long term care business
and a $28 million after-tax legal accrual recorded in the second quarter of 2009 related to a
previously held limited partnership investment. The limited partnership investment supported the
indexed group annuity portion of our pension deposit business.
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Net investment income for the year ended December 31, 2008 included trading portfolio losses of
$146 million, which were substantially offset by a corresponding decrease in the policyholders
funds reserves supported by the trading portfolio. This trading portfolio supported the indexed
group annuity portion of our pension deposit business. During 2008, we settled these liabilities
with policyholders with no material impact to results of operations. That business had a net loss
of $22 million for the year ended December 31, 2008.
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CORPORATE & OTHER NON-CORE
Overview
Corporate & Other Non-Core primarily includes certain corporate expenses, including interest on
corporate debt, and the results of certain property and casualty business in run-off, including CNA
Re and A&EP. In 2010, we ceded substantially all of our legacy A&EP liabilities under the Loss
Portfolio Transfer, as further discussed in Note F to the Consolidated Financial Statements
included under Item 8.
The following table summarizes the results of operations for the Corporate & Other Non-Core
segment, including A&EP and intersegment eliminations.
Results of Operations
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Net investment income |
$ | 137 | $ | 195 | $ | 169 | ||||||
Net operating loss |
(387 | ) | (87 | ) | (65 | ) | ||||||
Net realized investment gains (losses), after-tax |
13 | (49 | ) | (97 | ) | |||||||
Net loss |
(374 | ) | (136 | ) | (162 | ) |
2010 Compared with 2009
Net loss increased $238 million in 2010 as compared with 2009, driven by the after-tax net loss of
$344 million as a result of the Loss Portfolio Transfer, as previously discussed in this MD&A. Net
results were also impacted by lower net investment income and higher interest expense. Partially
offsetting these unfavorable items were decreased unfavorable net prior year development and
improved net realized investment results. See the Investments section of this MD&A for further
discussion of net investment income and net realized investment results.
Unfavorable net prior year development of $6 million was recorded in 2010, and unfavorable net
prior year development of $159 million was recorded in 2009 which included $79 million for asbestos
exposures and $76 million for environmental pollution exposures. Further information on Corporate
& Other Non-Core net prior year development for 2009 is included in Note F to the Consolidated
Financial Statements included under Item 8.
The following table summarizes the gross and net carried reserves as of December 31, 2010 and 2009
for Corporate & Other Non-Core.
Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
Claim and Claim Adjustment Expense Reserves
December 31 | 2010 | 2009 | ||||||
(In millions) | ||||||||
Gross Case Reserves |
$ | 1,430 | $ | 1,503 | ||||
Gross IBNR Reserves |
2,012 | 2,265 | ||||||
Total Gross Carried Claim and Claim Adjustment Expense Reserves |
$ | 3,442 | $ | 3,768 | ||||
Net Case Reserves |
$ | 461 | $ | 935 | ||||
Net IBNR Reserves |
257 | 1,404 | ||||||
Total Net Carried Claim and Claim Adjustment Expense Reserves |
$ | 718 | $ | 2,339 | ||||
2009 Compared with 2008
Net loss decreased $26 million in 2009 as compared with 2008, primarily due to improved net
realized investment results and higher net investment income. Partially offsetting these favorable
items was increased unfavorable net prior year development primarily related to A&EP.
Unfavorable net prior year development of $159 million was recorded in 2009, compared to
unfavorable net prior year development of $123 million in 2008. Further information on Corporate &
Other Non-Core net prior year development for 2009 and 2008 is included in Note F to the
Consolidated Financial Statements included under Item 8.
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INVESTMENTS
Net Investment Income
The significant components of net investment income are presented in the following table.
Net Investment Income
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Fixed maturity securities |
$ | 2,051 | $ | 1,941 | $ | 1,984 | ||||||
Short term investments |
15 | 36 | 115 | |||||||||
Limited partnerships |
249 | 315 | (379 | ) | ||||||||
Equity securities |
32 | 49 | 80 | |||||||||
Mortgage loans |
2 | - | - | |||||||||
Trading portfolio indexed group annuity |
- | - | (146 | ) | ||||||||
Trading portfolio other |
13 | 23 | (3 | ) | ||||||||
Other |
8 | 6 | 19 | |||||||||
Gross investment income |
2,370 | 2,370 | 1,670 | |||||||||
Investment expenses |
(54 | ) | (50 | ) | (51 | ) | ||||||
Net investment income |
$ | 2,316 | $ | 2,320 | $ | 1,619 | ||||||
Net investment income decreased $4 million in 2010 as compared with 2009. This decrease was
primarily driven by less favorable income from our limited partnership investments, substantially
offset by an investment shift during 2010 from lower yielding short term and tax-exempt securities
to higher yielding taxable fixed maturity securities. The unfavorable year-over-year comparison in
income from our limited partnership investments was driven by significant returns from our limited
partnership investments in 2009. Limited partnership investments generally present greater market
volatility, higher illiquidity and greater risk than fixed income investments. The limited
partnership investments are managed as an overall portfolio in an effort to mitigate the greater
levels of volatility, illiquidity and risk that are present in the individual partnership
investments.
Net investment income increased $701 million in 2009 as compared with 2008. Excluding indexed
group annuity trading portfolio losses of $146 million in 2008, net investment income increased
$555 million primarily driven by improved results from limited partnership investments. This
increase was partially offset by the impact of lower risk free and short term interest rates.
Limited partnership income in 2009 was driven by improved performance across many limited
partnerships and included individual partnership performance that ranged from a positive $120
million to a negative $59 million. The indexed group annuity trading portfolio losses in 2008 were
substantially offset by a corresponding decrease in the policyholders funds reserves supported by
the trading portfolio, which was included in Insurance claims and policyholders benefits on the
Consolidated Statements of Operations. We exited the indexed group annuity business in 2008.
The fixed maturity investment portfolio and short term investments provided a pretax effective
income yield of 5.3%, 5.1% and 5.6% for the years ended December 31, 2010, 2009 and 2008.
Tax-exempt municipal bonds generated $263 million, $381 million and $360 million of net investment
income for the years ended December 31, 2010, 2009 and 2008.
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Net Realized Investment Gains (Losses)
The components of net realized investment results are presented in the following table.
Net Realized Investment Gains (Losses)
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Fixed maturity securities: |
||||||||||||
U.S. Treasury and obligations of government agencies |
$ | 3 | $ | (53 | ) | $ | 235 | |||||
Asset-backed |
44 | (778 | ) | (476 | ) | |||||||
States, municipalities and political subdivisions |
(128 | ) | (20 | ) | 53 | |||||||
Foreign government |
2 | 38 | 7 | |||||||||
Corporate and other bonds |
164 | (345 | ) | (650 | ) | |||||||
Redeemable preferred stock |
7 | (9 | ) | - | ||||||||
Total fixed maturity securities |
92 | (1,167 | ) | (831 | ) | |||||||
Equity securities |
(2 | ) | 243 | (490 | ) | |||||||
Derivative securities |
(1 | ) | 51 | (19 | ) | |||||||
Short term investments and other |
(3 | ) | 16 | 43 | ||||||||
Net realized investment gains (losses), net of participating
policyholders interests |
86 | (857 | ) | (1,297 | ) | |||||||
Income tax (expense) benefit on net realized investment gains (losses) |
(36 | ) | 296 | 456 | ||||||||
Net realized investment (gains) losses, after-tax, attributable to
noncontrolling interests |
1 | - | - | |||||||||
Net realized investment gains (losses) attributable to CNA |
$ | 51 | $ | (561 | ) | $ | (841 | ) | ||||
Net realized investment results improved $612 million for 2010 as compared with 2009, driven
by significantly lower other-than-temporary impairment (OTTI) losses recognized in earnings.
Further information on our realized gains and losses, including our OTTI losses and impairment
decision process, is set forth in Note B to the Consolidated Financial Statements included under
Item 8. During the second quarter of 2009, the Company adopted updated accounting guidance, which
amended the OTTI loss model for fixed maturity securities, as discussed in Note A to the
Consolidated Financial Statements included under Item 8.
Net realized investment losses decreased $280 million for 2009 as compared with 2008, driven by a
realized investment gain related to a common stock holding and decreased OTTI losses recognized in
earnings. Included in the 2009 net realized gains for equity securities was $370 million related
to the sale of our holdings of Verisk Analytics Inc., which began trading on October 7, 2009 after
an initial public offering. Since our cost basis in this position was zero, the entire amount was
recognized as a pretax realized investment gain.
Our fixed maturity portfolio consists primarily of high quality bonds, 91% and 90% of which were
rated as investment grade (rated BBB- or higher) at December 31, 2010 and 2009. The classification
between investment grade and non-investment grade is based on a ratings methodology that takes into
account ratings from two major providers, S&P and Moodys, in that order of preference. If a
security is not rated by these providers, we formulate an internal rating. For securities with
credit support from third party guarantees, the rating reflects the greater of the underlying
rating of the issuer or the insured rating.
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The following table summarizes the ratings of our fixed maturity portfolio at carrying value.
Fixed Maturity Ratings
December 31 | 2010 | % | 2009 | % | ||||||||||||
(In millions) | ||||||||||||||||
U.S. Government and Agencies |
$ | 3,534 | 9 | % | $ | 3,705 | 10 | % | ||||||||
AAA rated |
4,419 | 12 | 5,855 | 17 | ||||||||||||
AA and A rated |
15,665 | 42 | 12,464 | 35 | ||||||||||||
BBB rated |
10,425 | 28 | 10,122 | 28 | ||||||||||||
Non-investment grade |
3,534 | 9 | 3,466 | 10 | ||||||||||||
Total |
$ | 37,577 | 100 | % | $ | 35,612 | 100 | % | ||||||||
Non-investment grade fixed maturity securities, as presented in the table below, include
high-yield securities rated below BBB- by bond rating agencies and 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 amortized cost of our
non-investment grade fixed maturity bond portfolio was $3,490 million and $3,637 million at
December 31, 2010 and 2009. The following table summarizes the ratings of this portfolio at
carrying value.
Non-investment Grade
December 31 | 2010 | % | 2009 | % | ||||||||||||
(In millions) | ||||||||||||||||
BB |
$ | 1,492 | 42 | % | $ | 1,352 | 39 | % | ||||||||
B |
1,163 | 33 | 1,255 | 36 | ||||||||||||
CCC - C |
801 | 23 | 761 | 22 | ||||||||||||
D |
78 | 2 | 98 | 3 | ||||||||||||
Total |
$ | 3,534 | 100 | % | $ | 3,466 | 100 | % | ||||||||
Included within the fixed maturity portfolio are securities that contain credit support from
third party guarantees from mono-line insurers. At December 31, 2010, $428 million of the carrying
value of the fixed maturity portfolio had a third party guarantee that increased the underlying
average rating of those securities from AA- to AA+. Of this amount, over 94% was within the
states, municipalities and political subdivisions securities sector. This third party credit
support on states, municipalities, and political subdivisions securities is provided by two
mono-line insurers, the largest exposure based on fair value being Assured Guaranty Ltd. at more
than 99%.
At December 31, 2010 and 2009, approximately 98% and 99% of the fixed maturity portfolio was issued
by U.S. Government and Agencies or was rated by S&P or Moodys. The remaining bonds were rated by
other rating agencies or internally.
The carrying value of fixed maturity and equity securities that trade in illiquid private placement
markets at December 31, 2010 was $340 million, which represents approximately 0.8% of our total
investment portfolio. These securities were in a net unrealized gain position of $15 million at
December 31, 2010.
The gross unrealized loss on available-for-sale fixed maturity securities was $795 million
at December 31, 2010. The following table provides the maturity profile for these
available-for-sale fixed maturity securities. Securities not due at a single date are allocated
based on weighted average life.
Maturity Profile
Percent of | Percent of | |||||||
Fair Value | Unrealized Loss | |||||||
Due in one year or less |
5 | % | 4 | % | ||||
Due after one year through five years |
19 | 11 | ||||||
Due after five years through ten years |
26 | 24 | ||||||
Due after ten years |
50 | 61 | ||||||
Total |
100 | % | 100 | % | ||||
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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 effective durations of fixed maturity securities, short term investments, non-redeemable
preferred stocks and interest rate derivatives are presented in the table below. Short term
investments are net of securities lending collateral, if any, and accounts payable and receivable
amounts for securities purchased and sold, but not yet settled.
Effective Durations
December 31, 2010 | December 31, 2009 | |||||||||||||||
Effective Duration | Effective Duration | |||||||||||||||
Fair Value | (In years) | Fair Value | (In years) | |||||||||||||
(In millions) | ||||||||||||||||
Segregated investments |
$ | 11,516 | 10.9 | $ | 10,376 | 11.2 | ||||||||||
Other interest sensitive investments |
28,405 | 4.6 | 29,665 | 4.0 | ||||||||||||
Total Fair Value |
$ | 39,921 | 6.4 | $ | 40,041 | 5.8 | ||||||||||
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.
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Asset-Backed Exposure
Asset-Backed Distribution
Security Type | ||||||||||||||||
December 31, 2010 | RMBS (a) | CMBS (b) | Other ABS (c) | Total | ||||||||||||
(In millions) | ||||||||||||||||
U.S. Government Agencies |
$ | 3,367 | $ | 30 | $ | - | $ | 3,397 | ||||||||
AAA |
1,172 | 194 | 551 | 1,917 | ||||||||||||
AA |
206 | 257 | 154 | 617 | ||||||||||||
A |
190 | 246 | 26 | 462 | ||||||||||||
BBB |
228 | 116 | 19 | 363 | ||||||||||||
Non-investment grade and equity tranches |
927 | 150 | 13 | 1,090 | ||||||||||||
Total Fair Value |
$ | 6,090 | $ | 993 | $ | 763 | $ | 7,846 | ||||||||
Total Amortized Cost |
$ | 6,254 | $ | 994 | $ | 753 | $ | 8,001 | ||||||||
Sub-prime (included above) |
||||||||||||||||
Fair Value |
$ | 483 | $ | - | $ | - | $ | 483 | ||||||||
Amortized Cost |
$ | 527 | $ | - | $ | - | $ | 527 | ||||||||
Alt-A (included above) |
||||||||||||||||
Fair Value |
$ | 632 | $ | - | $ | - | $ | 632 | ||||||||
Amortized Cost |
$ | 662 | $ | - | $ | - | $ | 662 |
(a) | Residential mortgage-backed securities (RMBS) |
|
(b) | Commercial mortgage-backed securities (CMBS) |
|
(c) | Other asset-backed securities (Other ABS) |
The exposure to sub-prime residential mortgage (sub-prime) collateral and Alternative A
residential mortgages that have lower than normal standards of loan documentation (Alt-A)
collateral is measured by the original deal structure. Of the securities with sub-prime exposure,
approximately 74% were rated investment grade, while 87% of the Alt-A securities were rated
investment grade. At December 31, 2010, $6 million of the carrying value of the sub-prime and
Alt-A securities carried a third-party guarantee.
Pretax OTTI losses of $27 million for securities with sub-prime and Alt-A exposure were included in
the $77 million of pretax OTTI losses related to asset-backed securities recognized in earnings on
the Consolidated Statement of Operations for the year ended December 31, 2010. If additional
deterioration in the underlying collateral occurs beyond our current expectations, additional OTTI
losses may be recognized in earnings. See Note B to the Consolidated Financial Statements included
under Item 8 for additional information related to unrealized losses on asset-backed securities.
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, | December 31, | |||||||
2010 | 2009 | |||||||
(In millions) | ||||||||
Short term investments available-for-sale: |
||||||||
Commercial paper |
$ | 686 | $ | 185 | ||||
U.S. Treasury securities |
903 | 3,025 | ||||||
Money market funds |
94 | 179 | ||||||
Other |
532 | 560 | ||||||
Total short term investments |
$ | 2,215 | $ | 3,949 | ||||
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Separate Accounts
The following table summarizes the bond ratings of the investments, at estimated fair value,
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 | 2010 | % | 2009 | % | ||||||||||||
(In millions) | ||||||||||||||||
U.S. Government Agencies |
$ | 53 | 13 | % | $ | 67 | 18 | % | ||||||||
AAA rated |
18 | 5 | 17 | 5 | ||||||||||||
AA and A rated |
214 | 53 | 176 | 46 | ||||||||||||
BBB rated |
99 | 24 | 93 | 24 | ||||||||||||
Non-investment grade |
21 | 5 | 27 | 7 | ||||||||||||
Total |
$ | 405 | 100 | % | $ | 380 | 100 | % | ||||||||
At December 31, 2010 and 2009, approximately 97% of the separate account portfolio was issued
by U.S. Government and affiliated agencies or was rated by S&P or Moodys. The remaining bonds
were rated by other rating agencies or internally.
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LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Our principal operating cash flow sources are premiums and investment income from our insurance
subsidiaries. Our primary operating cash flow uses are payments for claims, policy benefits and
operating expenses.
For 2010, net cash used by operating activities was $89 million as compared with net cash provided
by operating activities of $1,258 million for 2009. As further discussed in Note F to the
Consolidated Financial Statements included under Item 8 and previously referenced in this MD&A, on
August 31, 2010, we completed the Loss Portfolio Transfer transaction. As a result of this
transaction, operating cash flows were reduced by $1.9 billion related to the initial net cash
settlement. Additionally, during 2010 operating cash flows were increased by $153 million related
to net cash inflows primarily from sales of trading securities, because cash receipts and cash
payments resulting from purchases and sales of trading securities are reported as cash flows
related to operating activities. Operating cash flows were reduced by $164 million in 2009 related
to net cash outflows which increased the size of the trading portfolio held at December 31, 2009.
Excluding the items above, net cash generated by our business operations was approximately $1,650
million and $1,422 million for 2010 and 2009.
For 2009, net cash provided by operating activities was $1,258 million as compared with $1,558
million in 2008. Cash provided by operating activities in 2008 was favorably impacted by
increased net sales of trading securities to fund policyholders withdrawals of investment contract
products issued by us, which are reflected as financing cash flows. The primary source of these
cash flows was the indexed group annuity portion of our pension deposit business which we exited in
2008. Additionally, during the second quarter of 2009 we resumed the use of a trading portfolio
for income enhancement purposes. Operating cash flows were reduced by $164 million related to net
cash outflows which increased the size of the trading portfolio held at December 31, 2009. Cash
provided by operating activities in 2009 was favorably impacted by decreased loss payments as
compared to 2008, and tax recoveries in 2009 compared with tax payments in 2008.
Cash flows from investing activities include the purchase and sale of available-for-sale financial
instruments. Additionally, cash flows from investing activities may include the purchase and sale
of businesses, land, buildings, equipment and other assets not generally held for sale.
Net cash provided by investing activities was $767 million for 2010, as compared with net cash used
by investing activities of $1,093 million and $1,908 million for 2009 and 2008. Cash flows from
investing activities are 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. Net cash provided by investing activities in 2010
primarily related to the sale of short term investments. The cash provided by investing activities
was used to fund the initial net cash settlement with NICO referenced above.
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 flows used by financing activities were $742 million and $120 million in 2010 and 2009.
Net cash flows provided by financing activities were $347 million in 2008. Net cash used by
financing activities in 2010 was primarily related to payments to redeem the outstanding 2008
Senior Preferred as discussed below and the repayment of $150 million on a credit facility,
partially offset by $495 million in net proceeds from the issuance of ten-year senior notes.
2008 Senior Preferred
In 2008, we issued, and Loews purchased, 12,500 shares of CNAF non-voting cumulative senior
preferred stock for $1.25 billion. We used the majority of the proceeds 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. As of December 31, 2010, we have fully redeemed
all 12,500 shares originally issued, through a series of redemptions during 2009 and 2010. The
redemptions were funded by the issuance of debt and the partial repayment of the surplus note.
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Dividends of $76 million, $122 million and $19 million on the 2008 Senior Preferred were declared
and paid for the years ended December 31, 2010, 2009 and 2008.
Liquidity
We believe that our present cash flows from operations, investing activities and financing
activities are sufficient to fund our current and expected working capital and debt obligation
needs and we do not expect this to change in the near term. Additionally, we have the full limit
of $250 million available under a revolving credit facility.
We have an effective automatic shelf registration statement under which we may issue debt,
equity or hybrid securities. In February of 2011, we issued $400 million of 5.75% senior notes due
August 15, 2021 in a public offering. Subsequently, we announced the redemption of the outstanding
$400 million aggregate principal amount of 6.00% senior notes due August 15, 2011, plus accrued and
unpaid interest thereon, and other required payments. We anticipate the redemption to be completed
on or about March 18, 2011.
Dividends
On February 4, 2011, our Board of Directors declared a quarterly dividend of $0.10 per share,
payable March 2, 2011 to shareholders of record on February 16, 2011. The declaration and payment
of future dividends to holders of our common stock is at the discretion of our Board of Directors
and will depend on many factors, including our earnings, financial condition, business needs, and
regulatory constraints.
Our ability to pay dividends and other credit obligations is significantly dependent on receipt of
dividends from our subsidiaries. The payment of dividends to us by our insurance subsidiaries
without prior approval of the insurance department of each subsidiarys domiciliary jurisdiction is
limited by formula. Dividends in excess of these amounts are subject to prior approval by the
respective state insurance departments.
Further information on our dividends from subsidiaries is provided in Note L to the Consolidated
Financial Statements included under Item 8.
CNA Surety
On November 1, 2010, we announced our proposal to acquire all of the outstanding shares of common
stock of CNA Surety that are not currently owned by us for $22 per share in cash. On February 4,
2011, CNA Surety announced that our proposal substantially undervalued CNA Surety; however, it
would consider another proposal. We are evaluating CNA Suretys response and considering options
that are in the best interests of our stockholders. There is no assurance that the acquisition
will be completed or, if so, that the anticipated benefits of the acquisition will be realized.
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Commitments, Contingencies, and Guarantees
We have various commitments, contingencies and guarantees which arose in 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, 2010 is presented in the following table.
Contractual Commitments
December 31, 2010 | More than 5 | |||||||||||||||||||
Total | Less than 1 year | 1-3 years | 3-5 years | years | ||||||||||||||||
(In millions) | ||||||||||||||||||||
Debt (a) |
$ | 3,831 | $ | 570 | $ | 357 | $ | 798 | $ | 2,106 | ||||||||||
Lease obligations |
168 | 38 | 65 | 40 | 25 | |||||||||||||||
Claim and claim expense reserves (b) |
27,238 | 5,769 | 7,850 | 4,126 | 9,493 | |||||||||||||||
Future policy benefits reserves (c) |
13,101 | 173 | 602 | 320 | 12,006 | |||||||||||||||
Policyholder funds reserves (c) |
137 | 23 | 13 | 5 | 96 | |||||||||||||||
Guaranteed payment contracts (d) |
28 | 27 | 1 | - | - | |||||||||||||||
Total (e) |
$ | 44,503 | $ | 6,600 | $ | 8,888 | $ | 5,289 | $ | 23,726 | ||||||||||
(a) | Includes estimated future interest payments. |
|
(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, 2010. See the Reserves
Estimates and Uncertainties section of this MD&A for further information. |
|
(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, 2010. Future policy benefit
reserves of $747 million and policyholder fund reserves of $37 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 to the Consolidated Financial
Statements under Item 8. |
|
(d) | Primarily relating to outsourced services and software. |
|
(e) | Does not include expected estimated contribution of $73 million to our pension and
postretirement plans in 2011. |
Further information on our commitments, contingencies and guarantees is provided in Notes B,
C, F, G, I and K to the Consolidated Financial Statements included under Item 8.
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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.
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 | Corporate Debt Ratings | |||||||
Property & Casualty | Life | CNAF | Continental | |||||
CCC Group | CAC | Senior Debt | Senior Debt | |||||
A.M. Best
|
A | A- | bbb | Not rated | ||||
Moodys
|
A3 | Not rated | Baa3 | Baa3 | ||||
S&P
|
A- | Not rated | BBB- | BBB- |
A.M. Best, Moodys and S&P currently maintain a stable outlook on the Company.
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.
Downgrades of our corporate debt ratings could result in adverse effects upon our liquidity position,
including negatively impacting our ability to access
capital markets, and increasing our financing costs.
Further, 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 corporate 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 Standards Updates
For discussion of accounting standards updates that have been adopted or will be adopted in the
future, see Note A to the Consolidated Financial Statements included under Item 8.
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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; volatility in
investment returns; expected cost savings and other results from our expense reduction activities;
and our proposed actions in response to trends in our business. Forward-looking statements, by
their nature, are subject to a variety of inherent risks and uncertainties that could cause actual
results to differ materially from the results projected in the forward-looking statement. We
cannot control many of these risks and uncertainties. These risks and uncertainties include, but
are not limited to, the following:
Company-Specific Factors
| the risks and uncertainties associated with our loss reserves, as outlined in the
Critical Accounting Estimates and the Reserves Estimates and Uncertainties sections
included in this MD&A, including the sufficiency of the reserves and the possibility for
future increases; |
|
| the risk that the other parties to the transaction in which, subject to certain
limitations, we ceded our legacy A&EP liabilities will not fully perform their obligations to
CNA, the uncertainty in estimating loss reserves for A&EP liabilities and the possible
continued exposure of CNA to liabilities for A&EP claims that are not covered under the terms
of the transaction; |
|
| the performance of reinsurance companies under reinsurance contracts with us; and |
|
| the consummation of contemplated transactions. |
Industry and General Market Factors
| the impact of competitive products, policies and pricing and the competitive
environment in which we operate, including changes in our book of business; |
|
| product and policy availability and demand and market responses, including the
level of ability to obtain rate increases and decline or non-renew under priced accounts, to
achieve premium targets and profitability and to realize growth and retention estimates; |
|
| general economic and business conditions, including recessionary conditions that
may decrease the size and number of our insurance customers and create additional losses to
our lines of business, especially those that provide management and professional liability
insurance, as well as surety bonds, to businesses engaged in real estate, financial services
and professional services, and inflationary pressures on medical care costs, construction
costs and other economic sectors that increase the severity of claims; |
|
| conditions in the capital and credit markets, including continuing uncertainty and
instability in these markets, as well as the overall economy, and their impact on the returns,
types, liquidity and valuation of our investments; |
|
| conditions in the capital and credit markets that may limit our ability to raise
significant amounts of capital on favorable terms, as well as restrictions on the ability or
willingness of Loews to provide additional capital support to us; and |
|
| the possibility of changes in our ratings by ratings agencies, including the
inability to access certain markets or distribution channels and the required
collateralization of future payment obligations as a result of such changes, and changes in
rating agency policies and practices. |
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Regulatory Factors
| regulatory initiatives and compliance with governmental regulations, judicial
interpretations within the regulatory framework, including interpretation of policy
provisions, decisions regarding coverage and theories of liability, 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 as well as
the new federal financial regulatory reform of the insurance industry established by the
Dodd-Frank Wall Street Reform and Consumer Protection Act; |
|
| increased operating costs and underwriting losses arising from the Patient
Protection and Affordable Care Act and the related amendments in the Health Care and Education
Reconciliation Act, as well as health care reform proposals at the state level; and |
|
| 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. |
Impact of Catastrophic Events and Related Developments
| weather and other natural physical events, including the severity and frequency of
storms, hail, snowfall and other winter conditions, natural disasters such as hurricanes and
earthquakes, as well as climate change, including effects on 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; and |
|
| the occurrence of epidemics. |
Our forward-looking statements speak only as of the date on which they are made and we do not
undertake any obligation to update or revise any forward-looking statement to reflect events or
circumstances after the date of the statement, even if our expectations or any related events or
circumstances change.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our financial instruments are exposed to various risks, such as interest rate risk, equity price
risk, credit risk and foreign 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
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 generally
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 changes (inclusive of credit spread) by revaluing
financial assets and liabilities using a variety of different interest rates. The Company uses
duration and convexity at the security level to estimate the change in fair value that would result
from a change in each securitys yield. Duration measures the price sensitivity of an asset to
changes in the yield rate. Convexity measures how the duration of the asset changes with interest
rates. The duration and convexity analysis takes into account the unique characteristics (e.g.,
call and put options and prepayment expectations) of each security in determining the hypothetical
change in fair value. The analysis is performed at the security level and aggregated up to the
asset category levels for reporting in the tables below.
The evaluation is performed by applying an instantaneous change in yield 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, 2010 and 2009 due to an instantaneous change in the
yield of the security at the end of the period 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, 2010 and 2009,
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, 2010 and 2009, with all other variables
held constant. Our equity holdings were assumed to be highly and positively correlated with the
S&P 500.
The value of limited partnerships can be affected by changes in equity markets as well as changes
in interest rates. A model was developed to analyze the observed changes in the value of limited
partnerships held by the Company over a multiple year period along with the corresponding changes
in various equity indices and interest rates. The result of the model allowed us to estimate the
change in value of limited partnerships when equity markets decline by 10% and 25% and interest
rates increase by 100 and 150 basis points.
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
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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.
The following tables present the estimated effects on the fair value of our financial instruments
at December 31, 2010 and 2009, due to an increase in yield 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) | ||||||||||||||||
Foreign | ||||||||||||||||
Market | Interest | Currency | Equity Price | |||||||||||||
December 31, 2010 | Value | Rate Risk | Risk | Risk | ||||||||||||
(In millions) | ||||||||||||||||
General account: |
||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||
U.S. Treasury and obligations of government agencies |
$ | 137 | $ | (4 | ) | $ | - | $ | - | |||||||
Asset-backed |
7,846 | (376 | ) | (2 | ) | - | ||||||||||
States, municipalities and political subdivisions |
7,889 | (799 | ) | - | - | |||||||||||
Foreign government |
620 | (18 | ) | (60 | ) | - | ||||||||||
Corporate and other bonds |
21,025 | (1,216 | ) | (100 | ) | - | ||||||||||
Redeemable preferred stock |
54 | (3 | ) | - | (2 | ) | ||||||||||
Total fixed maturity securities available-for-sale |
37,571 | (2,416 | ) | (162 | ) | (2 | ) | |||||||||
Fixed maturity securities trading |
6 | - | - | - | ||||||||||||
Equity securities available-for-sale |
440 | (26 | ) | - | (44 | ) | ||||||||||
Short term investments |
2,215 | (7 | ) | (21 | ) | - | ||||||||||
Limited partnerships |
2,309 | 1 | - | (52 | ) | |||||||||||
Other invested assets |
114 | (7 | ) | - | - | |||||||||||
Total general account |
42,655 | (2,455 | ) | (183 | ) | (98 | ) | |||||||||
Separate accounts: |
||||||||||||||||
Fixed maturity securities |
405 | (18 | ) | - | - | |||||||||||
Equity securities |
22 | - | - | (2 | ) | |||||||||||
Short term investments |
19 | - | - | - | ||||||||||||
Total separate accounts |
446 | (18 | ) | - | (2 | ) | ||||||||||
Derivative financial instruments, included in Other liabilities |
(2 | ) | - | 2 | - | |||||||||||
Total securities |
$ | 43,099 | $ | (2,473 | ) | $ | (181 | ) | $ | (100 | ) | |||||
Long term debt (carrying value) |
$ | 2,251 | $ | (127 | ) | $ | - | $ | - | |||||||
52
Table of Contents
Market Risk Scenario 1 | ||||||||||||||||
Increase (Decrease) | ||||||||||||||||
Foreign | ||||||||||||||||
Market | Interest | Currency | Equity Price | |||||||||||||
December 31, 2009 | Value | Rate Risk | Risk | Risk | ||||||||||||
(In millions) | ||||||||||||||||
General account: |
||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||
U.S. Treasury and obligations of government agencies |
$ | 199 | $ | (5 | ) | $ | - | $ | - | |||||||
Asset-backed |
8,353 | (232 | ) | (2 | ) | - | ||||||||||
States, municipalities and political subdivisions |
7,124 | (700 | ) | - | - | |||||||||||
Foreign government |
479 | (11 | ) | (44 | ) | - | ||||||||||
Corporate and other bonds |
19,229 | (1,131 | ) | (87 | ) | - | ||||||||||
Redeemable preferred stock |
54 | (3 | ) | - | (2 | ) | ||||||||||
Total fixed maturity securities available-for-sale |
35,438 | (2,082 | ) | (133 | ) | (2 | ) | |||||||||
Fixed maturity securities trading |
174 | (17 | ) | - | - | |||||||||||
Equity securities available-for-sale |
644 | - | - | (65 | ) | |||||||||||
Short term investments |
3,949 | (12 | ) | (32 | ) | - | ||||||||||
Limited partnerships |
1,787 | 1 | - | (59 | ) | |||||||||||
Other invested assets |
4 | 20 | - | - | ||||||||||||
Total general account |
41,996 | (2,090 | ) | (165 | ) | (126 | ) | |||||||||
Separate accounts: |
||||||||||||||||
Fixed maturity securities |
380 | (15 | ) | - | - | |||||||||||
Equity securities |
32 | - | - | (3 | ) | |||||||||||
Short term investments |
6 | - | - | - | ||||||||||||
Total separate accounts |
418 | (15 | ) | - | (3 | ) | ||||||||||
Derivative financial instruments, included in Other liabilities |
(11 | ) | 1 | - | - | |||||||||||
Total securities |
$ | 42,403 | $ | (2,104 | ) | $ | (165 | ) | $ | (129 | ) | |||||
Long term debt (carrying value) |
$ | 2,303 | $ | (109 | ) | $ | - | $ | - | |||||||
53
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The following tables present the estimated effects on the fair value of our financial
instruments at December 31, 2010 and 2009, due to an increase in yield 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) | ||||||||||||||||
Foreign | ||||||||||||||||
Market | Interest | Currency | Equity Price | |||||||||||||
December 31, 2010 | Value | Rate Risk | Risk | Risk | ||||||||||||
(In millions) | ||||||||||||||||
General account: |
||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||
U.S. Treasury and obligations of government agencies |
$ | 137 | $ | (6 | ) | $ | - | $ | - | |||||||
Asset-backed |
7,846 | (570 | ) | (5 | ) | - | ||||||||||
States, municipalities and political subdivisions |
7,889 | (1,153 | ) | - | - | |||||||||||
Foreign government |
620 | (26 | ) | (119 | ) | - | ||||||||||
Corporate and other bonds |
21,025 | (1,784 | ) | (199 | ) | - | ||||||||||
Redeemable preferred stock |
54 | (5 | ) | - | (5 | ) | ||||||||||
Total fixed maturity securities available-for-sale |
37,571 | (3,544 | ) | (323 | ) | (5 | ) | |||||||||
Fixed maturity securities trading |
6 | - | - | - | ||||||||||||
Equity securities available-for-sale |
440 | (44 | ) | (1 | ) | (110 | ) | |||||||||
Short term investments |
2,215 | (10 | ) | (42 | ) | - | ||||||||||
Limited partnerships |
2,309 | 1 | - | (130 | ) | |||||||||||
Other invested assets |
114 | (11 | ) | 1 | - | |||||||||||
Total general account |
42,655 | (3,608 | ) | (365 | ) | (245 | ) | |||||||||
Separate accounts: |
||||||||||||||||
Fixed maturity securities |
405 | (26 | ) | - | - | |||||||||||
Equity securities |
22 | - | - | (5 | ) | |||||||||||
Short term investments |
19 | - | - | - | ||||||||||||
Total separate accounts |
446 | (26 | ) | - | (5 | ) | ||||||||||
Derivative financial instruments, included in Other liabilities |
(2 | ) | - | 3 | - | |||||||||||
Total securities |
$ | 43,099 | $ | (3,634 | ) | $ | (362 | ) | $ | (250 | ) | |||||
Long term debt (carrying value) |
$ | 2,251 | $ | (187 | ) | $ | - | $ | - | |||||||
54
Table of Contents
Market Risk Scenario 2 | ||||||||||||||||
Increase (Decrease) | ||||||||||||||||
Foreign | ||||||||||||||||
Market | Interest | Currency | Equity Price | |||||||||||||
December 31, 2009 | Value | Rate Risk | Risk | Risk | ||||||||||||
(In millions) | ||||||||||||||||
General account: |
||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||
U.S. Treasury and obligations of government agencies |
$ | 199 | $ | (7 | ) | $ | - | $ | - | |||||||
Asset-backed |
8,353 | (318 | ) | (4 | ) | - | ||||||||||
States, municipalities and political subdivisions |
7,124 | (1,013 | ) | - | - | |||||||||||
Foreign government |
479 | (17 | ) | (89 | ) | - | ||||||||||
Corporate and other bonds |
19,229 | (1,641 | ) | (172 | ) | - | ||||||||||
Redeemable preferred stock |
54 | (5 | ) | - | (5 | ) | ||||||||||
Total fixed maturity securities available-for-sale |
35,438 | (3,001 | ) | (265 | ) | (5 | ) | |||||||||
Fixed maturity securities trading |
174 | (19 | ) | - | - | |||||||||||
Equity securities available-for-sale |
644 | - | (1 | ) | (161 | ) | ||||||||||
Short term investments |
3,949 | (19 | ) | (64 | ) | - | ||||||||||
Limited partnerships |
1,787 | 1 | - | (148 | ) | |||||||||||
Other invested assets |
4 | 30 | - | - | ||||||||||||
Total general account |
41,996 | (3,008 | ) | (330 | ) | (314 | ) | |||||||||
Separate accounts: |
||||||||||||||||
Fixed maturity securities |
380 | (22 | ) | - | - | |||||||||||
Equity securities |
32 | - | - | (8 | ) | |||||||||||
Short term investments |
6 | - | - | - | ||||||||||||
Total separate accounts |
418 | (22 | ) | - | (8 | ) | ||||||||||
Derivative financial instruments, included in Other liabilities |
(11 | ) | - | - | - | |||||||||||
Total securities |
$ | 42,403 | $ | (3,030 | ) | $ | (330 | ) | $ | (322 | ) | |||||
Long term debt (carrying value) |
$ | 2,303 | $ | (160 | ) | $ | - | $ | - | |||||||
55
Table of Contents
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CNA Financial Corporation
Consolidated Statements of Operations
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions, except per share data) | ||||||||||||
Revenues |
||||||||||||
Net earned premiums |
$ | 6,515 | $ | 6,721 | $ | 7,151 | ||||||
Net investment income |
2,316 | 2,320 | 1,619 | |||||||||
Net realized investment gains (losses), net of participating
policyholders interests: |
||||||||||||
Other-than-temporary impairment losses |
(254 | ) | (1,657 | ) | (1,484 | ) | ||||||
Portion of other-than-temporary impairment losses recognized
in Other comprehensive income |
22 | 305 | - | |||||||||
Net other-than-temporary impairment losses recognized in earnings |
(232 | ) | (1,352 | ) | (1,484 | ) | ||||||
Other net realized investment gains |
318 | 495 | 187 | |||||||||
Net realized investment gains (losses), net of participating
policyholders interests |
86 | (857 | ) | (1,297 | ) | |||||||
Other revenues |
292 | 288 | 326 | |||||||||
Total revenues |
9,209 | 8,472 | 7,799 | |||||||||
Claims, Benefits and Expenses |
||||||||||||
Insurance claims and policyholders benefits |
4,985 | 5,290 | 5,723 | |||||||||
Amortization of deferred acquisition costs |
1,387 | 1,417 | 1,467 | |||||||||
Other operating expenses (Note F) |
1,568 | 1,097 | 1,037 | |||||||||
Interest |
157 | 128 | 134 | |||||||||
Total claims, benefits and expenses |
8,097 | 7,932 | 8,361 | |||||||||
Income (loss) from continuing operations before income tax |
1,112 | 540 | (562 | ) | ||||||||
Income tax (expense) benefit |
(333 | ) | (57 | ) | 311 | |||||||
Income (loss) from continuing operations |
779 | 483 | (251 | ) | ||||||||
Income (loss) from discontinued operations, net of income tax
(expense) benefit of $0, $0 and $9 (Note F) |
(21 | ) | (2 | ) | 9 | |||||||
Net income (loss) |
758 | 481 | (242 | ) | ||||||||
Net (income) loss attributable to noncontrolling interests |
(68 | ) | (62 | ) | (57 | ) | ||||||
Net income (loss) attributable to CNA |
$ | 690 | $ | 419 | $ | (299 | ) | |||||
Income (Loss) Attributable to CNA Common Stockholders |
||||||||||||
Income (loss) from continuing operations attributable to CNA |
$ | 711 | $ | 421 | $ | (308 | ) | |||||
Dividends on 2008 Senior Preferred |
(76 | ) | (122 | ) | (19 | ) | ||||||
Income (loss) from continuing operations attributable to CNA common
stockholders |
635 | 299 | (327 | ) | ||||||||
Income (loss) from discontinued operations attributable to CNA common
stockholders |
(21 | ) | (2 | ) | 9 | |||||||
Income (loss) attributable to CNA common stockholders |
$ | 614 | $ | 297 | $ | (318 | ) | |||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
56
Table of Contents
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions, except per share data) | ||||||||||||
Basic and Diluted Earnings (Loss)
Per Share Attributable to CNA
Common Stockholders |
||||||||||||
Income (loss) from continuing
operations attributable to CNA
common stockholders |
$ | 2.36 | $ | 1.11 | $ | (1.21 | ) | |||||
Income (loss) from discontinued
operations attributable to CNA
common stockholders |
(0.08 | ) | (0.01 | ) | 0.03 | |||||||
Basic and diluted earnings (loss)
per share attributable to CNA
common stockholders |
$ | 2.28 | $ | 1.10 | $ | (1.18 | ) | |||||
Weighted Average Outstanding Common
Stock and Common Stock Equivalents |
||||||||||||
Basic |
269.1 | 269.0 | 269.4 | |||||||||
Diluted |
269.5 | 269.1 | 269.4 | |||||||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
57
Table of Contents
CNA Financial Corporation
Consolidated Statements of Comprehensive Income (Loss)
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||||||||||||||
(In millions) | Tax | After-tax | Tax | After-tax | Tax | After-tax | ||||||||||||||||||
Other Comprehensive Income (Loss) |
||||||||||||||||||||||||
Changes in: |
||||||||||||||||||||||||
Net unrealized gains (losses) on investments
with other-than-temporary impairments |
$ | (47 | ) | $ | 86 | $ | 52 | $ | (95 | ) | $ | - | $ | - | ||||||||||
Net unrealized gains (losses) on other
investments |
(269 | ) | 505 | (2,024 | ) | 3,741 | 1,926 | (3,553 | ) | |||||||||||||||
Net unrealized gains (losses) on investments |
(316 | ) | 591 | (1,972 | ) | 3,646 | 1,926 | (3,553 | ) | |||||||||||||||
Net unrealized gains (losses) on discontinued
operations and other |
(2 | ) | 9 | (2 | ) | 9 | 6 | (6 | ) | |||||||||||||||
Foreign currency translation adjustment |
- | 49 | - | 117 | - | (153 | ) | |||||||||||||||||
Pension and postretirement benefits |
(18 | ) | 35 | (8 | ) | 15 | 194 | (363 | ) | |||||||||||||||
Allocation to participating policyholders |
- | (23 | ) | - | (40 | ) | - | 32 | ||||||||||||||||
Other comprehensive income (loss) |
$ | (336 | ) | 661 | $ | (1,982 | ) | 3,747 | $ | 2,126 | (4,043 | ) | ||||||||||||
Net income (loss) |
758 | 481 | (242 | ) | ||||||||||||||||||||
Comprehensive income (loss) |
1,419 | 4,228 | (4,285 | ) | ||||||||||||||||||||
Changes in: |
||||||||||||||||||||||||
Net unrealized (gains) losses on investments
attributable to noncontrolling interests |
(10 | ) | (24 | ) | 11 | |||||||||||||||||||
Pension and postretirement benefits
attributable to noncontrolling interests |
(2 | ) | (2 | ) | 5 | |||||||||||||||||||
Other comprehensive (income) loss attributable to
noncontrolling interests |
(12 | ) | (26 | ) | 16 | |||||||||||||||||||
Net (income) loss attributable to noncontrolling
interests |
(68 | ) | (62 | ) | (57 | ) | ||||||||||||||||||
Comprehensive (income) loss attributable to
noncontrolling interests |
(80 | ) | (88 | ) | (41 | ) | ||||||||||||||||||
Total comprehensive income (loss) attributable to CNA |
$ | 1,339 | $ | 4,140 | $ | (4,326 | ) | |||||||||||||||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
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Table of Contents
CNA Financial Corporation
Consolidated Balance Sheets
December 31 | 2010 | 2009 | ||||||
(In millions, except share data) | ||||||||
Assets |
||||||||
Investments: |
||||||||
Fixed maturity securities at fair value (amortized cost of $36,427 and $35,602) |
$ | 37,577 | $ | 35,612 | ||||
Equity securities at fair value (cost of $422 and $633) |
440 | 644 | ||||||
Limited partnership investments |
2,309 | 1,787 | ||||||
Other invested assets |
27 | 4 | ||||||
Mortgage loans |
87 | - | ||||||
Short term investments |
2,215 | 3,949 | ||||||
Total investments |
42,655 | 41,996 | ||||||
Cash |
77 | 140 | ||||||
Reinsurance receivables (less allowance for uncollectible receivables of $125 and $351) |
7,079 | 6,581 | ||||||
Insurance receivables (less allowance for uncollectible receivables of $160 and $202) |
1,557 | 1,656 | ||||||
Accrued investment income |
425 | 416 | ||||||
Deferred acquisition costs |
1,079 | 1,108 | ||||||
Deferred income taxes |
667 | 1,333 | ||||||
Property and equipment at cost (less accumulated depreciation of $543 and $498) |
333 | 360 | ||||||
Goodwill and other intangible assets |
141 | 141 | ||||||
Other assets (includes $139 and $320 due from Loews Corporation) |
868 | 1,144 | ||||||
Separate account business |
450 | 423 | ||||||
Total assets |
$ | 55,331 | $ | 55,298 | ||||
Liabilities and Equity |
||||||||
Liabilities: |
||||||||
Insurance reserves: |
||||||||
Claim and claim adjustment expenses |
$ | 25,496 | $ | 26,816 | ||||
Unearned premiums |
3,203 | 3,274 | ||||||
Future policy benefits |
8,718 | 7,981 | ||||||
Policyholders funds |
173 | 192 | ||||||
Participating policyholders funds |
60 | 56 | ||||||
Short term debt |
400 | - | ||||||
Long term debt |
2,251 | 2,303 | ||||||
Other liabilities |
3,056 | 3,087 | ||||||
Separate account business |
450 | 423 | ||||||
Total liabilities |
43,807 | 44,132 | ||||||
Commitments and contingencies (Notes B, C, G, I , and K) |
||||||||
Equity: |
||||||||
Preferred stock (12,500,000 shares authorized) 2008 Senior Preferred (no par value; $100,000 stated value; no shares and 10,000 shares issued and outstanding held by Loews Corporation) |
- | 1,000 | ||||||
Common stock ($2.50 par value; 500,000,000 shares authorized; 273,040,243 shares
issued; 269,139,198 and 269,026,759 shares outstanding) |
683 | 683 | ||||||
Additional paid-in capital |
2,200 | 2,177 | ||||||
Retained earnings |
7,876 | 7,264 | ||||||
Accumulated other comprehensive income (loss) |
326 | (325 | ) | |||||
Treasury stock (3,901,045 and 4,013,484 shares), at cost |
(105 | ) | (109 | ) | ||||
Notes receivable for the issuance of common stock |
(26 | ) | (30 | ) | ||||
Total CNA stockholders equity |
10,954 | 10,660 | ||||||
Noncontrolling interests |
570 | 506 | ||||||
Total equity |
11,524 | 11,166 | ||||||
Total liabilities and equity |
$ | 55,331 | $ | 55,298 | ||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
59
Table of Contents
CNA Financial Corporation
Consolidated Statements of Cash Flows
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Cash Flows from Operating Activities |
||||||||||||
Net income (loss) |
$ | 758 | $ | 481 | $ | (242 | ) | |||||
Adjustments to reconcile net income (loss) to net cash flows
provided by operating activities: |
||||||||||||
(Income) loss from discontinued operations |
21 | 2 | (9 | ) | ||||||||
Loss on disposal of property and equipment |
- | 14 | 1 | |||||||||
Deferred income tax expense (benefit) |
327 | 177 | (174 | ) | ||||||||
Trading portfolio activity |
153 | (164 | ) | 644 | ||||||||
Net realized investment (gains) losses, net of
participating policyholders interests |
(86 | ) | 857 | 1,297 | ||||||||
Equity method investees |
(136 | ) | (223 | ) | 446 | |||||||
Amortization of investments |
(117 | ) | (198 | ) | (278 | ) | ||||||
Depreciation |
78 | 86 | 78 | |||||||||
Changes in: |
||||||||||||
Receivables, net |
(406 | ) | 976 | 987 | ||||||||
Accrued investment income |
(15 | ) | (60 | ) | (26 | ) | ||||||
Deferred acquisition costs |
29 | 17 | 36 | |||||||||
Insurance reserves |
(805 | ) | (612 | ) | (590 | ) | ||||||
Other assets |
142 | 99 | (241 | ) | ||||||||
Other liabilities |
53 | (174 | ) | (372 | ) | |||||||
Other, net |
5 | 3 | 9 | |||||||||
Total adjustments |
(757 | ) | 800 | 1,808 | ||||||||
Net cash flows provided by operating activities-continuing operations |
$ | 1 | $ | 1,281 | $ | 1,566 | ||||||
Net cash flows used by operating activities-discontinued operations |
$ | (90 | ) | $ | (23 | ) | $ | (8 | ) | |||
Net cash flows provided (used) by operating activities-total |
$ | (89 | ) | $ | 1,258 | $ | 1,558 | |||||
Cash Flows from Investing Activities |
||||||||||||
Purchases of fixed maturity securities |
$ | (16,704 | ) | $ | (24,189 | ) | $ | (48,404 | ) | |||
Proceeds from fixed maturity securities: |
||||||||||||
Sales |
12,514 | 19,245 | 41,749 | |||||||||
Maturities, calls and redemptions |
3,340 | 3,448 | 4,092 | |||||||||
Purchases of equity securities |
(99 | ) | (269 | ) | (205 | ) | ||||||
Proceeds from sales of equity securities |
341 | 901 | 220 | |||||||||
Origination of mortgage loans |
(87 | ) | - | - | ||||||||
Change in short term investments |
1,629 | (327 | ) | 1,032 | ||||||||
Change in other investments |
(263 | ) | 140 | (295 | ) | |||||||
Purchases of property and equipment |
(53 | ) | (63 | ) | (104 | ) | ||||||
Dispositions |
66 | - | - | |||||||||
Other, net |
7 | (2 | ) | (11 | ) | |||||||
Net cash flows provided (used) by investing activities-continuing
operations |
$ | 691 | $ | (1,116 | ) | $ | (1,926 | ) | ||||
Net cash flows provided by investing activities-discontinued operations |
$ | 76 | $ | 23 | $ | 18 | ||||||
Net cash flows provided (used) by investing activities-total |
$ | 767 | $ | (1,093 | ) | $ | (1,908 | ) | ||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
60
Table of Contents
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Cash Flows from Financing Activities |
||||||||||||
Dividends paid to Loews for 2008 Senior Preferred |
$ | (76 | ) | $ | (122 | ) | $ | (19 | ) | |||
Dividends paid to common stockholders |
- | - | (122 | ) | ||||||||
Proceeds from the issuance of debt |
495 | 350 | 250 | |||||||||
Principal payments on debt |
(150 | ) | (100 | ) | (350 | ) | ||||||
Policyholders investment contract net deposits (withdrawals) |
(6 | ) | (11 | ) | (604 | ) | ||||||
Payments to redeem 2008 Senior Preferred |
(1,000 | ) | (250 | ) | - | |||||||
Proceeds from the issuance of 2008 Senior Preferred |
- | - | 1,250 | |||||||||
Stock options exercised |
11 | 1 | 1 | |||||||||
Purchase of treasury stock |
- | - | (70 | ) | ||||||||
Other, net |
(16 | ) | 12 | 11 | ||||||||
Net cash flows provided (used) by financing activities-continuing
operations |
$ | (742 | ) | $ | (120 | ) | $ | 347 | ||||
Net cash flows provided (used) by financing activities-discontinued
operations |
$ | - | $ | - | $ | - | ||||||
Net cash flows provided (used) by financing activities-total |
$ | (742 | ) | $ | (120 | ) | $ | 347 | ||||
Effect of foreign exchange rate changes on cash-continuing operations |
1 | 10 | (13 | ) | ||||||||
Net change in cash |
$ | (63 | ) | $ | 55 | $ | (16 | ) | ||||
Net cash transactions from continuing operations to discontinued operations |
(14 | ) | - | 17 | ||||||||
Net cash transactions to discontinued operations from continuing operations |
14 | - | (17 | ) | ||||||||
Cash, beginning of year |
140 | 85 | 101 | |||||||||
Cash, end of year |
$ | 77 | $ | 140 | $ | 85 | ||||||
Cash-continuing operations |
$ | 77 | $ | 140 | $ | 85 | ||||||
Cash-discontinued operations |
- | - | - | |||||||||
Cash-total |
$ | 77 | $ | 140 | $ | 85 | ||||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
61
Table of Contents
CNA Financial Corporation
Consolidated Statements of Stockholders Equity
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Preferred Stock |
||||||||||||
Balance, beginning of period |
$ | 1,000 | $ | 1,250 | $ | - | ||||||
Issuance of 2008 Senior Preferred |
- | - | 1,250 | |||||||||
Redemption of 2008 Senior Preferred |
(1,000 | ) | (250 | ) | - | |||||||
Balance, end of period |
- | 1,000 | 1,250 | |||||||||
Common Stock |
||||||||||||
Balance, beginning and end of period |
683 | 683 | 683 | |||||||||
Additional Paid-in Capital |
||||||||||||
Balance, beginning of period |
2,177 | 2,174 | 2,169 | |||||||||
Stock based compensation |
1 | 2 | 5 | |||||||||
Other |
22 | 1 | - | |||||||||
Balance, end of period |
2,200 | 2,177 | 2,174 | |||||||||
Retained Earnings |
||||||||||||
Balance, beginning of period |
7,264 | 6,845 | 7,285 | |||||||||
Cumulative effect adjustment from change in
other-than-temporary impairment accounting guidance as of
April 1, 2009, net of tax |
- | 122 | - | |||||||||
Cumulative effect adjustment from change in credit
derivatives accounting guidance as of July 1, 2010, net of
tax |
(2 | ) | - | - | ||||||||
Dividends paid to common stockholders |
- | - | (122 | ) | ||||||||
Dividends paid to Loews Corporation for 2008 Senior Preferred |
(76 | ) | (122 | ) | (19 | ) | ||||||
Net income (loss) attributable to CNA |
690 | 419 | (299 | ) | ||||||||
Balance, end of period |
7,876 | 7,264 | 6,845 | |||||||||
Accumulated Other Comprehensive Income (Loss) |
||||||||||||
Balance, beginning of period |
(325 | ) | (3,924 | ) | 103 | |||||||
Cumulative effect adjustment from change in
other-than-temporary impairment accounting guidance as of
April 1, 2009, net of tax |
- | (122 | ) | - | ||||||||
Cumulative effect adjustment from change in credit
derivatives accounting guidance as of July 1, 2010, net of
tax |
2 | - | - | |||||||||
Other comprehensive income (loss) attributable to CNA |
649 | 3,721 | (4,027 | ) | ||||||||
Balance, end of period |
326 | (325 | ) | (3,924 | ) | |||||||
Treasury Stock |
||||||||||||
Balance, beginning of period |
(109 | ) | (109 | ) | (39 | ) | ||||||
Stock-based compensation and other |
4 | - | - | |||||||||
Purchase of treasury stock |
- | - | (70 | ) | ||||||||
Balance, end of period |
(105 | ) | (109 | ) | (109 | ) | ||||||
Notes Receivable for the Issuance of Common Stock |
||||||||||||
Balance, beginning of period |
(30 | ) | (42 | ) | (51 | ) | ||||||
Decrease in notes receivable for the issuance of common stock |
4 | 12 | 9 | |||||||||
Balance, end of period |
(26 | ) | (30 | ) | (42 | ) | ||||||
Total CNA Stockholders Equity |
10,954 | 10,660 | 6,877 | |||||||||
Noncontrolling Interests |
||||||||||||
Balance, beginning of period |
506 | 420 | 385 | |||||||||
Net income |
68 | 62 | 57 | |||||||||
Other comprehensive income (loss) |
12 | 26 | (16 | ) | ||||||||
Other |
(16 | ) | (2 | ) | (6 | ) | ||||||
Balance, end of period |
570 | 506 | 420 | |||||||||
Total Equity |
$ | 11,524 | $ | 11,166 | $ | 7,297 | ||||||
The accompanying Notes are an integral part of these Consolidated Financial Statements.
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Notes to Consolidated Financial Statements
Note A. Summary of Significant Accounting Policies
Basis of Presentation
The Consolidated Financial Statements include the accounts of CNA Financial Corporation (CNAF) and
its controlled subsidiaries. Collectively, CNAF and its subsidiaries are referred to as CNA or the
Company. CNAs property and casualty and the remaining life & group insurance operations are
primarily conducted by Continental Casualty Company (CCC), The Continental Insurance Company (CIC),
Continental Assurance Company (CAC) and CNA Surety Corporation (CNA Surety). The Company owned
approximately 61% of the outstanding common stock of CNA Surety as of December 31, 2010. Loews
Corporation (Loews) owned approximately 90% of the outstanding common stock of CNAF as of December
31, 2010.
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
The Companys core property and casualty insurance operations are reported in two business
segments: CNA Specialty and CNA Commercial. The Companys non-core operations are managed in two
segments: Life & Group Non-Core and Corporate & Other Non-Core. In the fourth quarter of 2010, the
Company revised its segments, as further discussed in Note N.
The Company 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 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, warranty and claims administration. The Companys
products and services are marketed through independent agents, brokers, and managing general
underwriters.
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.
Insurance receivables are presented at unpaid balances net of an allowance for uncollectible
receivables, which 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. Amounts are
considered past due based on policy payment terms. Insurance receivables and any related allowance
are written off after collection efforts have been exhausted or a negotiated settlement is reached.
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.
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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&EP), workers 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 discussion 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 $1.4 billion and $1.5 billion as of
December 31, 2010 and 2009. A significant portion of these amounts are 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.
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 both
December 31, 2010 and 2009. At December 31, 2010 and 2009, the discounted reserves for unfunded
structured settlements were $713 million and $746 million, net of discount of $1.1 billion in both
periods.
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 ranging from 3.0% to 6.5% at both December 31, 2010 and 2009. At December 31,
2010 and 2009, such discounted reserves totaled $1.9 billion and $1.7 billion, net of discount of
$487 million and $482 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, 2010 and 2009, and mortality, morbidity and withdrawal
assumptions were generally established at the time of issue. Expense assumptions include the
estimated effects of inflation and expenses to be incurred beyond the premium paying period.
Policyholders funds reserves: Policyholders funds reserves primarily include reserves for
investment contracts without life contingencies. For these contracts, policyholder liabilities are
equal to the accumulated policy account values, which consist of an accumulation of deposit
payments plus credited interest, less withdrawals and amounts assessed through the end of the
period. 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 were
presented on the Consolidated Statements of Cash Flows in Cash flows from financing activities, as
Policyholders investment contract net deposits (withdrawals). Cash flows related to proceeds from
the liquidation of the related assets supporting the policyholder liabilities were presented on the
Consolidated Statements of Cash Flows in Cash flows from operating activities, as Trading portfolio
activity.
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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, 2010 and 2009, the liability balances were $160 million and $167 million. As of
December 31, 2010 and 2009, included in Other assets on the Consolidated Balance Sheets were $3
million and $5 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: Reinsurance accounting allows for contractual cash flows to be reflected as premiums
and losses. To qualify for reinsurance accounting, reinsurance agreements must include risk
transfer. To meet risk transfer requirements, a reinsurance contract must include both insurance
risk, consisting of underwriting and timing risk, and a reasonable possibility of a significant
loss for the assuming entity.
Reinsurance receivables related to paid losses are presented at unpaid balances. Reinsurance
receivables related to unpaid losses are estimated in a manner consistent with claim and claim
adjustment expense reserves or future policy benefits reserves. Reinsurance receivables are
reported net of an allowance for uncollectible amounts 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.
The allowance for uncollectible reinsurance receivables is estimated on the basis of periodic
evaluations of balances due from reinsurers, reinsurer solvency, managements experience and
current economic conditions. Changes in the allowance for uncollectible reinsurance receivables
are presented as a component of Insurance claims and policyholders benefits on the Consolidated
Statements of Operations.
Amounts are considered past due based on the reinsurance contract terms. Reinsurance receivables
related to paid losses and any related allowance are written off after collection efforts have been
exhausted or a negotiated settlement is reached with the reinsurer. Reinsurance receivables related
to paid losses from insolvent insurers are written off when the settlement due from the estate can
be reasonably estimated. At the time reinsurance receivables related to paid losses are written
off, any required adjustment to reinsurance receivables related to unpaid losses is recorded 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, 2010 and 2009, the Company had $23 million and $21
million recorded as deposit assets and $114 million and $112 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 anticipated 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.
Limitations exist on the amount of income from participating life insurance contracts that may be
distributed to stockholders, and therefore the share of income on these policies that cannot be
distributed to stockholders is excluded from Stockholders equity by a charge to operations and
other comprehensive income 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.
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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. Anticipated investment income
is considered in the determination of the recoverability of deferred acquisition costs.
Adjustments, if necessary, are recorded in current results of operations. Deferred acquisition
costs are presented 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 that were not anticipated in the original
contract are not 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. A life settlement contract is a
contract between the owner of a life insurance policy (the policy owner) and a third-party investor
(investor). Under a life settlement contract, the Company obtained the ownership and beneficiary
rights of an underlying life insurance policy.
The Company accounts for its investments in life settlement contracts using the fair value method.
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 Statements of Operations. The fair value of the Companys
investments in life settlement contracts were $129 million and $130 million at December 31, 2010
and 2009, 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.
The following table details the values for life settlement contracts. The determination of fair
value is discussed in Note D.
December 31, 2010 | Fair Value of Life Settlement | Face Amount of Life Insurance | ||||||||||
Number of Life | Contracts | Policies | ||||||||||
Settlement Contracts | (In millions) | (In millions) | ||||||||||
Estimated maturity during: |
||||||||||||
2011 |
80 | $ | 21 | $ | 55 | |||||||
2012 |
70 | 17 | 49 | |||||||||
2013 |
70 | 14 | 45 | |||||||||
2014 |
60 | 12 | 41 | |||||||||
2015 |
60 | 10 | 39 | |||||||||
Thereafter |
563 | 55 | 369 | |||||||||
Total |
903 | $ | 129 | $ | 598 | |||||||
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 inforce policy based upon the Companys
estimated mortality rates, which may vary due to the relatively small size of the portfolio of life
settlement contracts. The number of life settlement contracts presented in the table above is
based upon the average face amount of inforce policies estimated to mature in each future year.
The increase in fair value recognized for the years ended December 31, 2010, 2009 and 2008 on
contracts still being held was $10 million, $10 million and $17 million. The gains recognized
during the years ended December 31, 2010, 2009 and 2008 on contracts that matured were $19 million,
$24 million and $30 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
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recorded for separate account liabilities. Fee income accruing to the Company related to separate
accounts is primarily included within Other revenue on the Consolidated Statements of Operations.
Certain of the separate account investment contracts related to the Companys pension deposit
business guarantee principal and an annual 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. 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 Policyholders funds liabilities due to declines in the fair
value of the related separate account assets. During 2009, the Company decreased this pretax
liability by $42 million, and during 2010, the Company decreased this pretax liability by $24
million, based on increases in the fair value of separate account assets during those periods. If
the fair value of the related assets supporting the business increases to a level that exceeds the
aggregate contract value, the amount of any such increase will accrue to the Companys benefit to
the extent of any remaining additional liability in Policyholders funds.
Investments
Valuation of investments: The Company 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. Changes in fair value related to available-for-sale
securities are reported as a component of Other comprehensive income. To the extent that unrealized
gains on fixed income securities supporting certain annuities with life contingencies would result
in a premium deficiency if those gains were realized, the related increase in insurance reserves
for future policy benefits is recorded, net of tax, as a reduction of unrealized net capital gains
through Other comprehensive income. The amortized cost of fixed maturity securities
classified as available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity, which are included in Net investment income on the Consolidated Statements
of Operations. Investment valuations are adjusted and losses may be recognized as Net realized
investment losses on the Consolidated Statements of Operations when a decline in value is
determined by the Company to be other-than-temporary. See the Accounting Standards Update section
of this note for further information regarding the Companys recognition and presentation of
other-than-temporary impairments.
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.
Mortgage loans are commercial in nature and are carried at unpaid principal balance, net of
unamortized fees and any valuation allowance. Mortgage loans are considered to be impaired loans
when it is probable that contractual principal and interest payments will not be collected. A
valuation allowance is established for impaired loans to the extent that the present value of
expected future cash flows discounted at the loans original effective interest rate exceeds the
carrying value of the loan. Interest income from mortgage loans is recognized on an accrual basis
using the effective yield method. Accrual of income is generally suspended for mortgage loans that
are impaired and collection of principal and interest payments is unlikely. Mortgage loans are
considered past due when full principal or interest payments have not been received according to
contractual terms.
Other invested assets include certain derivative securities and securities for which the fair value
option was elected as a result of the adoption of the updated embedded credit derivative accounting
guidance. See the Accounting Standards Update section of this note for further information
regarding the Companys recognition and presentation of securities with embedded credit
derivatives.
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Short term investments are carried at fair value.
Realized investment gains (losses): All securities sold resulting in investment gains and losses
are recorded on the trade date, except for bank loan participations which are recorded on the date
that the legal agreements are finalized. Realized investment gains and losses are determined on
the basis of the cost or amortized cost of the specific securities sold.
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, based on enacted tax rates and other provisions of the tax law. The effect
of a change in tax laws or rates on deferred tax assets and liabilities is recognized in income in
the period in which such change is enacted. 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
The Company recognizes the overfunded or underfunded status of its defined benefit plans in Other
assets or Other liabilities on the Consolidated Balance Sheets. Changes in funded status related
to prior service costs and credits and actuarial gains and losses are recognized in the year in
which the changes occur through Other comprehensive income. Annual service cost, interest cost,
expected return on plan assets, amortization of prior service costs and credits, and amortization
of actuarial gains and losses are recognized on the Consolidated Statements of Operations.
Effective January 1, 2009, due to the significant number of inactive participants in the plan, the
Company amortizes actuarial gains/losses over the average remaining life expectancy of the inactive
participants for the CNA Retirement Plan. Previously, the Company amortized actuarial gains/losses
over the average remaining service period of the active participants. This change resulted in an
increase to net income of $20 million, net of taxes, for the year ended December 31, 2009.
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 either translated at the exchange rate on the date of the transaction or at the
average exchange rates. Foreign currency transaction losses of $19 million, $14 million and $35
million were included in determining net income (loss) for the years ended December 31, 2010, 2009
and 2008.
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 as of December 31, 2010 and
2009 primarily represent the excess of purchase price over the fair value of the net assets of
acquired entities and businesses. As of December 31, 2010 and 2009, $139 million of the balance
related to CNA Surety. Goodwill and indefinite-lived intangible assets are tested for impairment
annually or when certain triggering events require such tests.
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Earnings (Loss) Per Share Data
Earnings (loss) per share attributable to the Companys common stockholders is based on weighted
average outstanding shares. Basic earnings (loss) per share excludes the impact of dilutive
securities and is computed by dividing net income (loss) attributable to CNA by the weighted
average number of common shares outstanding for the period. Diluted earnings (loss) per share
reflects the potential dilution that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock.
For the years ended December 31, 2010 and 2009, approximately 380 thousand and 120 thousand
potential shares attributable to exercises under stock-based employee compensation plans were
included in the calculation of diluted earnings per share. For those same periods, approximately
1.2 million and 1.7 million potential shares attributable to exercises under stock-based employee
compensation plans were not included in the calculation of diluted earnings per share because the
effect would have been antidilutive. For the year ended December 31, 2008, as a result of the net
loss, none of the 1.6 million potential shares attributable to exercises under stock-based employee
compensation plans were included in the calculation of loss per share as the effect would have been
antidilutive.
Supplementary Cash Flow Information
Cash payments made for interest were $145 million, $124 million and $139 million for the years
ended December 31, 2010, 2009 and 2008. Cash refunds received for income taxes amounted to $175
million and $117 million for the years ended December 31, 2010 and 2009. Cash payments made for
income taxes were $120 million for the year ended December 31, 2008.
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Accounting Standards Updates
Adopted
Variable Interest Entities
In June 2009, the Financial Accounting Standards Board (FASB) issued updated accounting guidance
which amended the requirements for determination of the primary beneficiary of a variable interest
entity, required an ongoing assessment of whether an entity is the primary beneficiary and required
enhanced interim and annual disclosures. The updated accounting guidance was effective for annual
reporting periods beginning after November 15, 2009, except for investment company type entities
for which the requirements under this guidance have been deferred. The adoption of this updated
accounting guidance as of January 1, 2010 had no impact on the Companys financial condition or
results of operations.
Scope Exception Related to Credit Derivatives
In March 2010, the FASB issued updated accounting guidance which amended the accounting and
reporting requirements related to derivatives to provide clarifying language regarding when
embedded credit derivative features, including those in synthetic collateralized debt and loan
obligations, are considered embedded derivatives subject to potential bifurcation. Transition
provisions include an option at adoption to measure an investment in its entirety at fair value
with subsequent changes in fair value recognized in earnings (the fair value option). The adoption
of this updated accounting guidance as of July 1, 2010 resulted in a cumulative effect adjustment
of $2 million, net of tax, which was reclassified to Retained earnings from Accumulated other
comprehensive income (AOCI) on the Consolidated Statement of Equity and was attributable to gross
unrealized losses on securities with embedded credit derivative features for which the fair value
option was elected. These securities are included in Other invested assets on the Consolidated
Balance Sheet at December 31, 2010. Subsequent fair value changes are included in Other net
realized investment gains on the Consolidated Statement of Operations.
Recognition and Presentation of Other-Than-Temporary Impairments
In April 2009, the FASB issued updated accounting guidance, which amended the other-than-temporary
impairment (OTTI) loss model for fixed maturity securities. A fixed maturity security is impaired
if the fair value of the security is less than its amortized cost basis, which is its cost adjusted
for accretion, amortization and previously recorded OTTI losses. The updated accounting guidance
requires an OTTI loss equal to the difference between fair value and amortized cost to be
recognized in earnings if the Company intends to sell the fixed maturity security or if it is more
likely than not the Company will be required to sell the fixed maturity security before recovery of
its amortized cost basis.
The remaining fixed maturity securities in an unrealized loss position are evaluated to determine
if a credit loss exists. If the Company does not expect to recover the entire amortized cost basis
of a fixed maturity security, the security is deemed to be other-than-temporarily impaired for
credit reasons. For these securities, the updated accounting guidance requires the bifurcation of
OTTI losses into a credit component and a non-credit component. The credit component is recognized
in earnings and represents the difference between the present value of the future cash flows that
the Company expects to collect and a fixed maturity securitys amortized cost basis. The
non-credit component is recognized in other comprehensive income and represents the difference
between fair value and the present value of the future cash flows that the Company expects to
collect.
Prior to the adoption of the updated accounting guidance, OTTI losses were not bifurcated between
credit and non-credit components. The difference between fair value and amortized cost was
recognized in earnings for all securities for which the Company did not expect to recover the
amortized cost basis, or for which the Company did not have the ability and intent to hold until
recovery of fair value to amortized cost.
The adoption of this updated accounting guidance as of April 1, 2009 resulted in a cumulative
effect adjustment of $122 million, net of tax, which was reclassified to AOCI from Retained
earnings on the Consolidated Statement of Equity. The cumulative effect adjustment represents the
non-credit component of those previously impaired fixed maturity securities that were still
considered OTTI, and the entire amount previously recorded as an OTTI loss on fixed maturity
securities no longer considered OTTI as of April 1, 2009.
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Recently issued accounting standard to be adopted
Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts
In October 2010, the FASB issued updated accounting guidance which limits the capitalization of
costs incurred to acquire or renew insurance contracts to those that are incremental direct costs
of successful contract acquisitions. The updated accounting guidance is effective for fiscal
years, and interim periods within those fiscal years, beginning after December 15, 2011 with
prospective or retrospective application allowed. The Company is currently assessing the impact
this updated accounting guidance will have on its financial condition and results of operations,
and expects that amounts capitalized under the updated guidance will be less than under the
Companys current accounting practice.
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Note B. Investments
The significant components of net investment income are presented in the following table.
Net Investment Income
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Fixed maturity securities |
$ | 2,051 | $ | 1,941 | $ | 1,984 | ||||||
Short term investments |
15 | 36 | 115 | |||||||||
Limited partnerships |
249 | 315 | (379 | ) | ||||||||
Equity securities |
32 | 49 | 80 | |||||||||
Mortgage loans |
2 | - | - | |||||||||
Trading portfolio indexed group annuity (a) |
- | - | (146 | ) | ||||||||
Trading portfolio other (b) |
13 | 23 | (3 | ) | ||||||||
Other |
8 | 6 | 19 | |||||||||
Gross investment income |
2,370 | 2,370 | 1,670 | |||||||||
Investment expenses |
(54 | ) | (50 | ) | (51 | ) | ||||||
Net investment income |
$ | 2,316 | $ | 2,320 | $ | 1,619 | ||||||
(a) The losses related to the indexed group annuity trading portfolio, including net
unrealized losses, were substantially offset by a corresponding change in the
policyholders funds reserves supported by this trading portfolio, which was included in
Insurance claims and policyholders benefits on the Consolidated Statements of Operations.
(b) There were no net unrealized gains (losses) related to changes in fair value on
trading securities still held included in net investment income for the year ended
December 31, 2010. The net unrealized losses related to changes in fair value on trading
securities still held included in net investment income were $5 million and $3 million for
the years ended December 31, 2009 and 2008.
As of December 31, 2010, the Company held seven non-income producing fixed maturity securities
aggregating $3 million of fair value. As of December 31, 2009, the Company held three non-income
producing fixed maturity securities aggregating $1 million of fair value. As of December 31, 2010
and 2009, no investments exceeded 10% of stockholders equity, other than investments in U.S.
Treasury and U.S. Government agency securities.
Net realized investment gains (losses) are presented in the following table.
Net Realized Investment Gains (Losses)
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Net realized investment gains (losses): |
||||||||||||
Fixed maturity securities: |
||||||||||||
Gross realized gains |
$ | 475 | $ | 500 | $ | 532 | ||||||
Gross realized losses |
(383 | ) | (1,667 | ) | (1,363 | ) | ||||||
Net realized investment gains (losses) on fixed maturity securities |
92 | (1,167 | ) | (831 | ) | |||||||
Equity securities: |
||||||||||||
Gross realized gains |
50 | 473 | 22 | |||||||||
Gross realized losses |
(52 | ) | (230 | ) | (512 | ) | ||||||
Net realized investment gains (losses) on equity securities |
(2 | ) | 243 | (490 | ) | |||||||
Derivatives |
(1 | ) | 51 | (19 | ) | |||||||
Short term investments and other (a) |
(3 | ) | 16 | 43 | ||||||||
Net realized investment gains (losses), net of participating
policyholders interests |
$ | 86 | $ | (857 | ) | $ | (1,297 | ) | ||||
(a) Includes net unrealized losses of $1 million for the year ended December 31, 2010,
related to changes in fair value on securities for which the fair value option was elected
as a result of the adoption of the updated embedded credit derivative accounting guidance
as of July 1, 2010.
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Net change in unrealized gains (losses) on investments is presented in the following table.
Net Change in Unrealized Gains (Losses)
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Net change in unrealized gains (losses) on investments: |
||||||||||||
Fixed maturity securities |
$ | 1,140 | $ | 5,278 | $ | (5,137 | ) | |||||
Equity securities |
7 | 156 | (347 | ) | ||||||||
Other |
(1 | ) | (4 | ) | 5 | |||||||
Total net change in unrealized gains (losses) on investments |
$ | 1,146 | $ | 5,430 | $ | (5,479 | ) | |||||
In 2010, the Company recorded additional future policy benefit reserves due to an increase in
unrealized appreciation on fixed income securities supporting certain annuities with life
contingencies, which resulted in a decrease to net unrealized gains on investments of $150 million,
net of tax.
The components of OTTI losses recognized in earnings by asset type are summarized in the following
table.
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||
U.S. Treasury and obligations of government agencies |
$ | - | $ | - | $ | 29 | ||||||
Asset-backed: |
||||||||||||
Residential mortgage-backed |
71 | 461 | 222 | |||||||||
Commercial mortgage-backed |
3 | 193 | 208 | |||||||||
Other asset-backed |
3 | 31 | 35 | |||||||||
Total asset-backed |
77 | 685 | 465 | |||||||||
States, municipalities and political subdivisions |
62 | 79 | 1 | |||||||||
Foreign government |
- | - | 2 | |||||||||
Corporate and other bonds |
68 | 357 | 583 | |||||||||
Redeemable preferred stock |
- | 9 | 1 | |||||||||
Total fixed maturity securities available-for-sale |
207 | 1,130 | 1,081 | |||||||||
Equity securities available-for-sale: |
||||||||||||
Common stock |
11 | 5 | 140 | |||||||||
Preferred stock |
14 | 217 | 263 | |||||||||
Total equity securities available-for-sale |
25 | 222 | 403 | |||||||||
Net OTTI losses recognized in earnings |
$ | 232 | $ | 1,352 | $ | 1,484 | ||||||
A security is impaired if the fair value of the security is less than its cost adjusted for
accretion, amortization and previously recorded OTTI losses, otherwise defined as an unrealized
loss. When a security 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 loss has occurred for a
security. 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 evaluating
securities in an unrealized loss position on at least a quarterly basis.
The Impairment Committees assessment of whether an OTTI loss has occurred incorporates both
quantitative and qualitative information. Fixed maturity securities that the Company intends to
sell, or it more likely than not will be required to sell before recovery of amortized cost, are
considered to be other-than-temporarily
impaired and the entire difference between the amortized cost basis and fair value of the security
is recognized as an OTTI loss in earnings. The remaining fixed maturity securities in an
unrealized loss position are evaluated to determine if a credit loss exists. In order to determine
if a credit loss exists, the factors considered
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by the Impairment Committee include (a) the
financial condition and near term prospects of the issuer, (b) whether the debtor is current on
interest and principal payments, (c) credit ratings of the securities and (d) general market
conditions and industry or sector specific outlook. The Company also considers results and analysis
of cash flow modeling for asset-backed securities, and when appropriate, other fixed maturity
securities. The focus of the analysis for asset-backed securities is on assessing the sufficiency
and quality of underlying collateral and timing of cash flows based on scenario tests. If the
present value of the modeled expected cash flows equals or exceeds the amortized cost of a
security, no credit loss is judged to exist and the asset-backed security is deemed to be
temporarily impaired. If the present value of the expected cash flows is less than amortized cost,
the security is judged to be other-than-temporarily impaired for credit reasons and that shortfall,
referred to as the credit component, is recognized as an OTTI loss in earnings. The difference
between the adjusted amortized cost basis and fair value, referred to as the non-credit component,
is recognized as OTTI in Other comprehensive income.
The Company performs the discounted cash flow analysis using stressed scenarios to determine future
expectations regarding recoverability. For asset-backed securities, significant assumptions enter
into these cash flow projections including delinquency rates, probable risk of default, loss
severity upon a default, over collateralization and interest coverage triggers, credit support from
lower level tranches and impacts of rating agency downgrades.
The Company applies the same impairment model as described above for the majority of the
non-redeemable preferred stock securities on the basis that these securities possess
characteristics similar to debt securities and that the issuers maintain their ability to pay
dividends. For all other equity securities, in determining whether the security is
other-than-temporarily impaired, 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 and (d) general market conditions and industry or sector
specific outlook.
Prior to the adoption of the updated accounting guidance related to OTTI in the second quarter of
2009 as further discussed in Note A, the Company applied the impairment model described in the
paragraph above to both fixed maturity and equity securities.
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The following tables provide a summary of fixed maturity and equity securities.
Summary of Fixed Maturity and Equity Securities
Cost or | Gross | Gross | Estimated | Unrealized | ||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | OTTI Losses | ||||||||||||||||
December 31, 2010 | Cost | Gains | Losses | Value | (Gains) | |||||||||||||||
(In millions) | ||||||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||||||
U.S. Treasury and obligations of government
agencies |
$ | 122 | $ | 16 | $ | 1 | $ | 137 | $ | - | ||||||||||
Asset-backed: |
||||||||||||||||||||
Residential mortgage-backed |
6,254 | 101 | 265 | 6,090 | 114 | |||||||||||||||
Commercial mortgage-backed |
994 | 40 | 41 | 993 | (2 | ) | ||||||||||||||
Other asset-backed |
753 | 18 | 8 | 763 | - | |||||||||||||||
Total asset-backed |
8,001 | 159 | 314 | 7,846 | 112 | |||||||||||||||
States, municipalities and political subdivisions |
8,157 | 142 | 410 | 7,889 | - | |||||||||||||||
Foreign government |
602 | 18 | - | 620 | - | |||||||||||||||
Corporate and other bonds |
19,492 | 1,603 | 70 | 21,025 | - | |||||||||||||||
Redeemable preferred stock |
47 | 7 | - | 54 | - | |||||||||||||||
Total fixed maturity securities available-for-sale |
36,421 | 1,945 | 795 | 37,571 | $ | 112 | ||||||||||||||
Total fixed maturity securities trading |
6 | - | - | 6 | ||||||||||||||||
Equity securities available-for-sale: |
||||||||||||||||||||
Common stock |
90 | 25 | - | 115 | ||||||||||||||||
Preferred stock |
332 | 2 | 9 | 325 | ||||||||||||||||
Total equity securities available-for-sale |
422 | 27 | 9 | 440 | ||||||||||||||||
Total |
$ | 36,849 | $ | 1,972 | $ | 804 | $ | 38,017 | ||||||||||||
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Summary of Fixed Maturity and Equity Securities
Cost or | Gross | Gross | Estimated | Unrealized | ||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | OTTI | ||||||||||||||||
December 31, 2009 | Cost | Gains | Losses | Value | Losses | |||||||||||||||
(In millions) | ||||||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||||||
U.S. Treasury and obligations of government
agencies |
$ | 184 | $ | 16 | $ | 1 | $ | 199 | $ | - | ||||||||||
Asset-backed: |
||||||||||||||||||||
Residential mortgage-backed |
7,469 | 72 | 604 | 6,937 | 246 | |||||||||||||||
Commercial mortgage-backed |
709 | 10 | 135 | 584 | 3 | |||||||||||||||
Other asset-backed |
858 | 14 | 40 | 832 | - | |||||||||||||||
Total asset-backed |
9,036 | 96 | 779 | 8,353 | 249 | |||||||||||||||
States, municipalities and political subdivisions |
7,280 | 203 | 359 | 7,124 | - | |||||||||||||||
Foreign government |
467 | 14 | 2 | 479 | - | |||||||||||||||
Corporate and other bonds |
18,410 | 1,107 | 288 | 19,229 | 26 | |||||||||||||||
Redeemable preferred stock |
51 | 4 | 1 | 54 | - | |||||||||||||||
Total fixed maturity securities available-for-sale |
35,428 | 1,440 | 1,430 | 35,438 | $ | 275 | ||||||||||||||
Total fixed maturity securities trading |
174 | - | - | 174 | ||||||||||||||||
Equity securities available-for-sale: |
||||||||||||||||||||
Common stock |
61 | 14 | 2 | 73 | ||||||||||||||||
Preferred stock |
572 | 40 | 41 | 571 | ||||||||||||||||
Total equity securities available-for-sale |
633 | 54 | 43 | 644 | ||||||||||||||||
Total |
$ | 36,235 | $ | 1,494 | $ | 1,473 | $ | 36,256 | ||||||||||||
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The following tables summarize the estimated fair value and gross unrealized losses of
available-for-sale fixed maturity and equity securities by the length of time in which the
securities have continuously been in a gross unrealized loss position.
Securities in a Gross Unrealized Loss Position
Less than 12 Months | Greater than 12 Months | Total | ||||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||
Estimated | Unrealized | Estimated | Unrealized | Estimated | Unrealized | |||||||||||||||||||
December 31, 2010 | Fair Value | Losses | Fair Value | Losses | Fair Value | Losses | ||||||||||||||||||
(In millions) | ||||||||||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||||||||||
U.S. Treasury and obligations of government
agencies |
$ | 8 | $ | 1 | $ | - | $ | - | $ | 8 | $ | 1 | ||||||||||||
Asset-backed: |
||||||||||||||||||||||||
Residential mortgage-backed |
1,800 | 52 | 1,801 | 213 | 3,601 | 265 | ||||||||||||||||||
Commercial mortgage-backed |
164 | 3 | 333 | 38 | 497 | 41 | ||||||||||||||||||
Other asset-backed |
122 | 1 | 60 | 7 | 182 | 8 | ||||||||||||||||||
Total asset-backed |
2,086 | 56 | 2,194 | 258 | 4,280 | 314 | ||||||||||||||||||
States, municipalities and political
subdivisions |
3,339 | 164 | 745 | 246 | 4,084 | 410 | ||||||||||||||||||
Corporate and other bonds |
1,719 | 34 | 405 | 36 | 2,124 | 70 | ||||||||||||||||||
Total fixed maturity securities available-for-sale |
7,152 | 255 | 3,344 | 540 | 10,496 | 795 | ||||||||||||||||||
Equity securities available-for-sale: |
||||||||||||||||||||||||
Preferred stock |
175 | 5 | 70 | 4 | 245 | 9 | ||||||||||||||||||
Total equity securities available-for-sale |
175 | 5 | 70 | 4 | 245 | 9 | ||||||||||||||||||
Total |
$ | 7,327 | $ | 260 | $ | 3,414 | $ | 544 | $ | 10,741 | $ | 804 | ||||||||||||
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Securities in a Gross Unrealized Loss Position
Less than 12 Months | Greater than 12 Months | Total | ||||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||
Estimated | Unrealized | Estimated | Unrealized | Estimated | Unrealized | |||||||||||||||||||
December 31, 2009 | Fair Value | Losses | Fair Value | Losses | Fair Value | Losses | ||||||||||||||||||
(In millions) | ||||||||||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||||||||||
U.S. Treasury and obligations of government
agencies |
$ | 21 | $ | 1 | $ | - | $ | - | $ | 21 | $ | 1 | ||||||||||||
Asset-backed: |
||||||||||||||||||||||||
Residential mortgage-backed |
1,945 | 43 | 3,069 | 561 | 5,014 | 604 | ||||||||||||||||||
Commercial mortgage-backed |
21 | 1 | 456 | 134 | 477 | 135 | ||||||||||||||||||
Other asset-backed |
170 | 1 | 119 | 39 | 289 | 40 | ||||||||||||||||||
Total asset-backed |
2,136 | 45 | 3,644 | 734 | 5,780 | 779 | ||||||||||||||||||
States, municipalities and political
subdivisions |
1,036 | 30 | 2,086 | 329 | 3,122 | 359 | ||||||||||||||||||
Foreign government |
154 | 1 | 7 | 1 | 161 | 2 | ||||||||||||||||||
Corporate and other bonds |
2,395 | 44 | 1,948 | 244 | 4,343 | 288 | ||||||||||||||||||
Redeemable preferred stock |
3 | - | 14 | 1 | 17 | 1 | ||||||||||||||||||
Total fixed maturity securities available-for-sale |
5,745 | 121 | 7,699 | 1,309 | 13,444 | 1,430 | ||||||||||||||||||
Equity securities available-for-sale: |
||||||||||||||||||||||||
Common stock |
8 | 1 | 12 | 1 | 20 | 2 | ||||||||||||||||||
Preferred stock |
- | - | 426 | 41 | 426 | 41 | ||||||||||||||||||
Total equity securities available-for-sale |
8 | 1 | 438 | 42 | 446 | 43 | ||||||||||||||||||
Total |
$ | 5,753 | $ | 122 | $ | 8,137 | $ | 1,351 | $ | 13,890 | $ | 1,473 | ||||||||||||
Activity for the year ended December 31, 2010 and for the period from April 1, 2009 to
December 31, 2009 related to the pretax fixed maturity credit loss component reflected within
Retained earnings for securities still held at December 31, 2010 and December 31, 2009 was as
follows.
Period from | |||||||||
(In millions) | Year ended | April 1, 2009 to | |||||||
December 31, 2010 | December 31, 2009 | ||||||||
Beginning balance of credit losses on fixed maturity securities |
$ | 164 | $ | 192 | |||||
Additional credit losses for which an OTTI loss was previously recognized |
37 | 93 | |||||||
Credit losses for which an OTTI loss was not previously recognized |
11 | 183 | |||||||
Reductions for securities sold during the period |
(62 | ) | (239 | ) | |||||
Reductions for securities the Company intends to sell or more likely than not will be required to sell |
(9 | ) | (65 | ) | |||||
Ending balance of credit losses on fixed maturity securities |
$ | 141 | $ | 164 | |||||
Based on current facts and circumstances, the Company has determined that no additional OTTI
losses related to the securities in an unrealized loss position presented in the December 31, 2010
Securities in a Gross Unrealized Loss Position table above are required to be recorded. A
discussion of some of the factors reviewed in making that determination is presented below.
The classification between investment grade and non-investment grade presented in the discussion
below is based on a ratings methodology that takes into account ratings from two major providers,
Standard & Poors (S&P) and Moodys Investor Services, Inc. (Moodys) in that order of preference.
If a security is not rated by these providers, the Company formulates an internal rating. For
securities with credit support from third party guarantees, the rating reflects the greater of the
underlying rating of the issuer or the insured rating.
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Asset-Backed Securities
The fair value of total asset-backed holdings at December 31, 2010 was $7,846 million which was
comprised of 2,086 different asset-backed structured securities. The fair value of these
securities does not tend to be influenced by the credit of the issuer but rather the
characteristics and projected cash flows of the underlying collateral. Each security has
deal-specific tranche structures, credit support that results from the unique deal structure,
particular collateral characteristics and other distinct security terms. As a result, seemingly
common factors such as delinquency rates and collateral performance affect each security
differently. Of these securities, 165 have underlying collateral that is either considered
sub-prime or Alt-A in nature. The exposure to sub-prime residential mortgage (sub-prime)
collateral and Alternative A residential mortgages that have lower than normal standards of loan
documentation (Alt-A) collateral is measured by the original deal structure.
Residential mortgage-backed securities include 214 structured securities that have at least one
trade lot in a gross unrealized loss position. In addition, there were 61 agency mortgage-backed
pass-through securities which are guaranteed by agencies of the U.S. Government that have at least
one trade lot in a gross unrealized loss position. The aggregate severity of the gross unrealized
loss was approximately 7% of amortized cost.
Commercial mortgage-backed securities include 36 securities that have at least one trade lot in a
gross unrealized loss position. The aggregate severity of the gross unrealized loss was
approximately 8% of amortized cost.
Other asset-backed securities include 15 securities that have at least one trade lot in a gross
unrealized loss position. The aggregate severity of the gross unrealized loss was approximately 4%
of amortized cost.
The following table summarizes asset-backed securities in a gross unrealized loss position by
ratings distribution at December 31, 2010.
Gross Unrealized Losses by Ratings Distribution
December 31, 2010
(In millions)
(In millions)
Gross | ||||||||||||
Amortized | Estimated | Unrealized | ||||||||||
Cost | Fair Value | Losses | ||||||||||
U.S. Government Agencies |
$ | 1,506 | $ | 1,461 | $ | 45 | ||||||
AAA |
1,225 | 1,158 | 67 | |||||||||
AA |
426 | 389 | 37 | |||||||||
A |
217 | 201 | 16 | |||||||||
BBB |
217 | 188 | 29 | |||||||||
Non-investment grade and equity tranches |
1,003 | 883 | 120 | |||||||||
Total |
$ | 4,594 | $ | 4,280 | $ | 314 | ||||||
The Company believes the unrealized losses are primarily attributable to broader economic
conditions, changes in interest rates, liquidity concerns and wider than historical bid/ask
spreads, and is not indicative of the quality of the underlying collateral. The Company has no
current intent to sell these securities, nor is it more likely than not that it will be required to
sell prior to recovery of amortized cost. Generally, non-investment grade securities consist of
investments which were investment grade at the time of purchase but have subsequently been
downgraded and primarily consist of holdings senior to the equity tranche. Additionally, the
Company believes that the unrealized losses on these securities were not due to factors regarding
the ultimate collection of principal and interest, collateral shortfalls, or substantial changes in
future cash flow expectations; accordingly, the Company has determined that there are no additional
OTTI losses to be recorded at December 31, 2010.
States, Municipalities and Political Subdivisions
The fair value of total states, municipalities and political subdivisions holdings at December 31,
2010 was $7,889 million. These holdings consist of both tax-exempt and taxable special revenue and
assessment bonds, representing 71% of the overall category, followed by general obligation
political subdivision bonds at 19% and state general obligation bonds at 10%.
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The unrealized losses on the Companys investments in this category are primarily due to the impact
of interest rate increases on securities held, as well as market conditions for tax-exempt bonds.
Securities with maturity
dates that exceed 20 years comprise 66% of the gross unrealized losses. The holdings for all
securities in this category include 568 securities that have at least one trade lot in a gross
unrealized loss position. The aggregate severity of the total gross unrealized losses was
approximately 9% of amortized cost.
The following table summarizes the ratings distribution of states, municipalities and political
subdivisions securities in a gross unrealized loss position at December 31, 2010.
Gross Unrealized Losses by Ratings Distribution
December 31, 2010
(In millions)
(In millions)
Gross | ||||||||||||
Amortized | Estimated | Unrealized | ||||||||||
Cost | Fair Value | Losses | ||||||||||
AAA |
$ | 995 | $ | 940 | $ | 55 | ||||||
AA |
2,612 | 2,327 | 285 | |||||||||
A |
802 | 742 | 60 | |||||||||
BBB |
69 | 60 | 9 | |||||||||
Non-investment grade |
16 | 15 | 1 | |||||||||
Total |
$ | 4,494 | $ | 4,084 | $ | 410 | ||||||
The largest exposures at December 31, 2010 as measured by gross unrealized losses were several
separate issues of Puerto Rico sales tax revenue bonds with gross unrealized losses of $101 million
and several separate issues of New Jersey transit revenue bonds with gross unrealized losses of $64
million. All of these securities are rated investment grade.
The Company has no current intent to sell these securities, nor is it more likely than not that it
will be required to sell prior to recovery of amortized cost. Additionally, the Company believes
that the unrealized losses on these securities were not due to factors regarding the ultimate
collection of principal and interest; accordingly, the Company has determined that there are no
additional OTTI losses to be recorded at December 31, 2010.
Contractual Maturity
The following table summarizes available-for-sale fixed maturity securities by contractual maturity
at December 31, 2010 and 2009. Actual maturities may differ from contractual maturities because
certain securities may be called or prepaid with or without call or prepayment penalties.
Securities not due at a single date are allocated based on weighted average life.
Contractual Maturity | December 31, 2010 | December 31, 2009 | ||||||||||||||
Cost or | Estimated | Cost or | Estimated | |||||||||||||
Amortized | Fair | Amortized | Fair | |||||||||||||
Cost | Value | Cost | Value | |||||||||||||
(In millions) | ||||||||||||||||
Due in one year or less |
$ | 1,515 | $ | 1,506 | $ | 1,240 | $ | 1,219 | ||||||||
Due after one year through five years |
11,198 | 11,653 | 10,046 | 10,244 | ||||||||||||
Due after five years through ten years |
10,022 | 10,425 | 10,646 | 10,538 | ||||||||||||
Due after ten years |
13,686 | 13,987 | 13,496 | 13,437 | ||||||||||||
Total |
$ | 36,421 | $ | 37,571 | $ | 35,428 | $ | 35,438 | ||||||||
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Auction Rate Securities
The fair value of auction rate securities held at December 31, 2010 was $357 million, $316 million
of which are collateralized by student loans and guaranteed by the Federal Family Education Loan
Program (FFELP). There were gross unrealized losses of $16 million and no gross unrealized gains
on these securities, primarily as a result of continued failed auctions and the resultant impact on
liquidity. The average rating on these holdings was AAA. At December 31, 2010, all auction rate
securities were paying at the applicable coupon rate in accordance with the terms of the security
agreements.
Limited Partnerships
The carrying value of limited partnerships as of December 31, 2010 and 2009 was $2,309 million and
$1,787 million, which includes undistributed earnings of $723 million and $507 million. Limited
partnerships comprising 45% of the total carrying value are reported on a current basis through
December 31, 2010 with no reporting lag, 41% are reported on a one month lag and the remainder are
reported on more than a one month lag. As of December 31, 2010 and 2009, the Company had 75 and 70
active limited partnership investments. The number of limited partnerships held and the strategies
employed provide diversification to the limited partnership portfolio and the overall invested
asset portfolio. The Company generally does not invest in highly leveraged partnerships.
Of the limited partnerships held, 85% and 89% at December 31, 2010 and 2009 employ strategies that
generate returns through investing in securities that are marketable while engaging in various
management techniques primarily in public fixed income and equity markets. These hedge fund
strategies include both long and short positions in fixed income, equity and derivative
instruments. The hedge fund strategies may seek to generate gains from mispriced or undervalued
securities, price differentials between securities, distressed investments, sector rotation, or
various arbitrage disciplines. Within hedge fund strategies, approximately 49% are equity related,
27% pursue a multi-strategy approach, 19% are focused on distressed investments and 5% are fixed
income related at December 31, 2010.
Limited partnerships representing 11% and 7% at December 31, 2010 and 2009 were invested in private
equity. The remaining were invested in various other partnerships including real estate. The ten
largest limited partnership positions held totaled $1,321 million and $1,178 million as of December
31, 2010 and 2009. Based on the most recent information available regarding the Companys
percentage ownership of the individual limited partnerships, the carrying value reflected on the
Consolidated Balance Sheets represents approximately 4% of the aggregate partnership equity at
December 31, 2010 and 2009, and the related income reflected on the Consolidated Statements of
Operations represents approximately 3% and 4% of the changes in partnership equity for all limited
partnership investments for the years ended December 31, 2010 and 2009. The individual
partnership that was the largest contributor to income in 2010 had a carrying value of $198 million
and $165 million at December 31, 2010 and December 31, 2009 with related income of $45 million,
$120 million, and $(51) million for the years ended December 31, 2010, 2009, and 2008. The Company
owned approximately 6% of this limited partnership at December 31, 2010.
The risks associated with limited partnership investments may include losses due to leveraging,
short-selling, derivatives or other speculative investment practices. The use of leverage
increases volatility generated by the underlying investment strategies.
The Companys limited partnership investments contain withdrawal provisions that generally limit
liquidity for a period of thirty days up to one year and in some cases do not permit withdrawals
until the termination of the partnership. Typically, withdrawals require advanced written notice
of up to 90 days.
Commercial Mortgage Loans
As of December 31, 2010, the carrying value of mortgage loans was $87 million, 40% of which are
credit tenant loans where lease payments directly service the loan. Risks related to the
recoverability of loan balances include declines in the estimated cash flows from underlying
property leases and creditworthiness of tenants of credit tenant loan properties. The Company
identifies loans for evaluation of impairment primarily based on the collection experience of each
loan. As of December 31, 2010, there were no loans past due or in non-accrual status, and no
valuation allowance was recorded.
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Investment Commitments
As of December 31, 2010, the Company had committed approximately $182 million to future capital
calls from various third-party limited partnership investments in exchange for an ownership
interest in the related partnerships.
The Company invests in various privately placed debt securities, including bank loans, as part of
its overall investment strategy and has committed to additional future purchases and sales. The
purchase and sale of these investments are recorded on the date that the legal agreements are
finalized and cash settlement is made. As of December 31, 2010, the Company had commitments to
purchase $196 million and sell $102 million of such investments.
As of December 31, 2010, the Company had mortgage loan commitments of $12 million representing
signed loan applications received and accepted. The mortgage loans are recorded once funded.
Investments on Deposit
Securities with carrying values of approximately $2.9 billion and $2.7 billion were deposited by
the Companys insurance subsidiaries under requirements of regulatory authorities as of December
31, 2010 and 2009.
Cash and securities with carrying values of approximately $6 million and $9 million were deposited
with financial institutions as collateral for letters of credit as of December 31, 2010 and 2009.
In addition, cash and securities were deposited in trusts with financial institutions to secure
reinsurance and other obligations with various third parties. The carrying values of these
deposits were approximately $298 million and $311 million as of December 31, 2010 and 2009.
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Note C. Derivative Financial Instruments
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.
The Company uses derivatives in the normal course of business, primarily in an attempt to reduce
its exposure to market risk (principally interest rate risk, equity price risk and foreign currency
risk) stemming from various assets and liabilities and credit risk (the ability of an obligor to
make timely payment of principal and/or interest). The Companys principal objective under such
risk strategies is to achieve the desired reduction in economic risk, even if the position does not
receive hedge accounting treatment.
The Companys use of derivatives is limited by statutes and regulations promulgated by the various
regulatory bodies to which it is subject, and by its own derivative policy. The derivative policy
limits the authorization to initiate derivative transactions to certain personnel. Derivatives
entered into for hedging, regardless of the choice to designate hedge accounting, shall have a
maturity that effectively correlates to the underlying hedged asset or liability. The policy
prohibits the use of derivatives containing greater than one-to-one leverage with respect to
changes in the underlying price, rate or index. The policy also prohibits the use of borrowed
funds, including funds obtained through securities lending, to engage in derivative transactions.
The Company has exposure to economic losses due to interest rate risk arising from changes in the
level of, or volatility of, interest rates. The Company attempts to mitigate its exposure to
interest rate risk in the normal course of portfolio management which includes rebalancing its
existing portfolios of assets and liabilities. In addition, various derivative financial
instruments are used to modify the interest rate risk exposures of certain assets and liabilities.
These strategies include the use of interest rate swaps, interest rate caps and floors, options,
futures, forwards and commitments to purchase securities. These instruments are generally used to
lock interest rates or market values, to shorten or lengthen durations of fixed maturity securities
or to hedge (on an economic basis) interest rate risks associated with investments and variable
rate debt.
The Company has exposure to equity price risk as a result of its investment in equity securities
and equity derivatives. Equity price risk results from changes in the level or volatility of
equity prices, which affect the value of equity securities, or instruments that derive their value
from such securities. The Company attempts to mitigate its exposure to such risks by limiting its
investment in any one security or index. The Company may also manage this risk by utilizing
instruments such as options, swaps, futures and collars to protect appreciation in securities held.
The Company has exposure to credit risk arising from the uncertainty associated with a financial
instrument obligors ability to make timely principal and/or interest payments. The Company
attempts to mitigate this risk by limiting credit concentrations, practicing diversification and
frequently monitoring the credit quality of issuers and counterparties. In addition, the Company
may utilize credit derivatives such as credit default swaps (CDS) to modify the credit risk
inherent in certain investments. CDS involve a transfer of credit risk from one party to another
in exchange for periodic payments.
Foreign currency risk arises from the possibility that changes in foreign currency exchange rates
will impact the fair value of financial instruments denominated in a foreign currency. The
Companys foreign transactions are primarily denominated in British pounds, Euros and Canadian
dollars. The Company typically manages this risk via asset/liability currency matching and through
the use of foreign currency forwards.
In addition to the derivatives used for risk management purposes described above, the Company may
also use derivatives for purposes of income enhancement. Income enhancement transactions are
entered into with the intention of providing additional income or yield to a particular portfolio
segment or instrument. Income enhancement transactions are limited in scope and primarily involve
the sale of covered options in which the Company receives a premium in exchange for selling a call
or put option.
The Company will also use CDS to sell credit protection against a specified credit event. In
selling credit protection, CDS are used to replicate fixed income securities when credit exposure
to certain issuers is not available or when it is economically beneficial to transact in the
derivative market compared to the cash market
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alternative. Credit risk includes both the default
event risk and market value exposure due to fluctuations in credit spreads. In selling CDS protection, the Company receives a periodic premium in exchange for
providing credit protection on a single name reference obligation or a credit derivative index. If
there is an event of default as defined by the CDS agreement, the Company is required to pay the
counterparty the referenced notional amount of the CDS contract and in exchange the Company is
entitled to receive the referenced defaulted security or the cash equivalent.
The tables below summarize open CDS contracts where the Company sold credit protection as of
December 31, 2010 and 2009. The fair value of the contracts represents the amounts that the
Company would receive or pay at those dates to exit the derivative positions. The maximum amount
of future payments assumes no residual value in the defaulted securities that the Company would
receive as part of the contract terminations and is equal to the notional value of the CDS
contracts.
Credit Ratings of Underlying Reference Obligations
December 31, 2010 | Fair Value of | Maximum Amount of | Weighted | |||||||||
(In millions) | Credit Default | Future Payments under | Average Years | |||||||||
Swaps | Credit Default Swaps | to Maturity | ||||||||||
BB rated |
$ | 1 | $ | 5 | 2.5 | |||||||
B rated |
- | 3 | 1.5 | |||||||||
Total |
$ | 1 | $ | 8 | 2.1 | |||||||
Credit Ratings of Underlying Reference Obligations
December 31, 2009 | Fair Value of | Maximum Amount of | Weighted | |||||||||
(In millions) | Credit Default | Future Payments under | Average Years | |||||||||
Swaps | Credit Default Swaps | to Maturity | ||||||||||
B rated |
$ | - | $ | 8 | 3.1 | |||||||
Total |
$ | - | $ | 8 | 3.1 | |||||||
Credit exposure associated with non-performance by the counterparties to derivative
instruments is generally limited to the uncollateralized fair value of the asset related to the
instruments recognized on the Consolidated Balance Sheets. The Company attempts to mitigate the
risk of non-performance by monitoring the creditworthiness of counterparties and diversifying
derivatives to multiple counterparties. The Company generally requires that all over-the-counter
derivative contracts be governed by an International Swaps and Derivatives Association (ISDA)
Master Agreement, and exchanges collateral under the terms of these agreements with its derivative
investment counterparties depending on the amount of the exposure and the credit rating of the
counterparty. The Company does not offset its net derivative positions against the fair value of
the collateral provided. The fair value of cash collateral provided by the Company was $2 million
and $7 million at December 31, 2010 and 2009. The fair value of cash collateral received from
counterparties was $1 million at December 31, 2010 and December 31, 2009.
Derivative securities are recorded at fair value. See Note D for information regarding the fair
value of derivatives securities. Changes in the fair value of derivatives not held in a trading
portfolio are reported in Net realized investment gains (losses) on the Consolidated Statements of
Operations. Changes in the fair value of derivatives held for trading purposes are reported in Net
investment income on the Consolidated Statements of Operations.
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A summary of the recognized gains (losses) related to derivative financial instruments follows.
Recognized Gains (Losses)
Years ended December 31 | 2010 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Without hedge designation |
||||||||||||
Interest rate swaps |
$ | - | $ | 61 | $ | (59 | ) | |||||
Credit default swaps purchased protection |
(1 | ) | (47 | ) | 86 | |||||||
Credit default swaps sold protection |
- | 3 | (35 | ) | ||||||||
Total return swaps |
- | (2 | ) | - | ||||||||
Futures sold, not yet purchased |
- | 21 | (11 | ) | ||||||||
Currency forwards |
- | - | 2 | |||||||||
Options embedded in convertible debt securities |
- | - | 1 | |||||||||
Equity warrants |
- | - | (2 | ) | ||||||||
Options written |
- | 15 | - | |||||||||
Total |
(1 | ) | 51 | (18 | ) | |||||||
Trading activities |
||||||||||||
Futures purchased |
- | - | (131 | ) | ||||||||
Futures sold, not yet purchased |
(1 | ) | (2 | ) | 1 | |||||||
Total |
$ | (2 | ) | $ | 49 | $ | (148 | ) | ||||
The Companys derivative activities in the trading portfolio in 2010 and 2009 are associated
with a trading portfolio utilized for income enhancement purposes. The Companys derivative
activities in the trading portfolio in 2008 were associated with its pension deposit business,
through which the Company was exposed to equity price risk associated with its indexed group
annuity contracts. A corresponding increase or decrease was reflected in the Policyholders funds
reserves supported by this trading portfolio, which was included in Insurance claims and
policyholders benefits on the Consolidated Statements of Operations. During 2008, the Company
exited the indexed group annuity portion of its pension deposit business.
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A summary of the aggregate contractual or notional amounts and gross estimated fair values related
to derivative financial instruments reported as Other invested assets or Other liabilities on the
Consolidated Balance Sheets follows. The contractual or notional amounts for derivatives are used
to calculate the exchange of contractual payments under the agreements and may not be
representative of the potential for gain or loss on these instruments.
Derivative Financial Instruments
Contractual/ | ||||||||||||
December 31, 2010 | Notional | Estimated Fair Value | ||||||||||
(In millions) | Amount | Asset | (Liability) | |||||||||
Without hedge designation |
||||||||||||
Credit default swaps purchased protection |
$ | 20 | $ | - | $ | (2 | ) | |||||
Credit default swaps sold protection |
8 | 1 | - | |||||||||
Currency forwards |
18 | - | - | |||||||||
Equity warrants |
3 | - | - | |||||||||
Total |
49 | 1 | (2 | ) | ||||||||
Trading activities |
||||||||||||
Futures sold, not yet purchased |
- | - | - | |||||||||
Total |
$ | 49 | $ | 1 | $ | (2 | ) | |||||
Derivative Financial Instruments
Contractual/ | ||||||||||||
December 31, 2009 | Notional | Estimated Fair Value | ||||||||||
(In millions) | Amount | Asset | (Liability) | |||||||||
Without hedge designation |
||||||||||||
Credit default swaps purchased protection |
$ | 116 | $ | - | $ | (11 | ) | |||||
Credit default swaps sold protection |
8 | - | - | |||||||||
Equity warrants |
2 | - | - | |||||||||
Total |
126 | - | (11 | ) | ||||||||
Trading activities |
||||||||||||
Futures sold, not yet purchased |
132 | - | - | |||||||||
Total |
$ | 258 | $ | - | $ | (11 | ) | |||||
During the year ended December 31, 2010 new derivative transactions entered into totaled
approximately $2.4 billion in notional value while derivative termination activity totaled
approximately $2.6 billion. The activity during the year ended December 31, 2010 was primarily
attributable to interest rate futures and forward commitments for mortgage-backed securities.
During the year ended December 31, 2009 new derivative transactions entered into totaled
approximately $19 billion in notional value while derivative termination activity totaled
approximately $20 billion. The activity during the year ended December 31, 2009 was primarily
attributable to interest rate futures, interest rate options and interest rate swaps.
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Note D. Fair Value
Fair value is the price that would be received upon sale of an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date. The
following fair value hierarchy is used in selecting inputs, with the highest priority given to
Level 1, as these are the most transparent or reliable.
Level 1 Quoted prices for identical instruments in active markets.
Level 2 Quoted prices for similar instruments in active markets; quoted prices for identical or
similar instruments in markets that are not active; and model-derived valuations in which all
significant inputs are observable in active markets.
Level 3 Valuations derived from valuation techniques in which one or more significant inputs are
not observable.
The Company attempts to establish fair value as an exit price in an orderly transaction consistent
with normal settlement market conventions. The Company is responsible for the valuation process
and seeks to obtain quoted market prices for all securities. When quoted market prices in active
markets are not available, the Company uses a number of methodologies to establish fair value
estimates including: discounted cash flow models, prices from recently executed transactions of
similar securities, or broker/dealer quotes, utilizing market observable information to the extent
possible. In conjunction with modeling activities, the Company may use external data as inputs.
The modeled inputs are consistent with observable market information, when available, or with the
Companys assumptions as to what market participants would use to value the securities. The
Company also uses pricing services as a significant source of data. The Company monitors all the
pricing inputs to determine if the markets from which the data is gathered are active. As further
validation of the Companys valuation process, the Company samples past fair value estimates and
compares the valuations to actual transactions executed in the market on similar dates.
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Assets and Liabilities Measured at Fair Value
Assets and liabilities measured at fair value on a recurring basis are summarized below.
Total | ||||||||||||||||
Assets/(Liabilities) | ||||||||||||||||
December 31, 2010 | Level 1 | Level 2 | Level 3 | at Fair Value | ||||||||||||
(in millions) | ||||||||||||||||
Assets |
||||||||||||||||
Fixed maturity securities: |
||||||||||||||||
U.S. Treasury securities and obligations of government agencies |
$ | 76 | $ | 61 | $ | - | $ | 137 | ||||||||
Asset-backed: |
||||||||||||||||
Residential mortgage-backed |
- | 5,323 | 767 | 6,090 | ||||||||||||
Commercial mortgage-backed |
- | 920 | 73 | 993 | ||||||||||||
Other asset-backed |
- | 404 | 359 | 763 | ||||||||||||
Total asset-backed |
- | 6,647 | 1,199 | 7,846 | ||||||||||||
States, municipalities and political subdivisions |
- | 7,623 | 266 | 7,889 | ||||||||||||
Foreign government |
115 | 505 | - | 620 | ||||||||||||
Corporate and other bonds |
- | 20,407 | 624 | 21,031 | ||||||||||||
Redeemable preferred stock |
3 | 48 | 3 | 54 | ||||||||||||
Total fixed maturity securities |
194 | 35,291 | 2,092 | 37,577 | ||||||||||||
Equity securities |
288 | 126 | 26 | 440 | ||||||||||||
Derivative and other financial instruments, included in Other invested assets |
- | - | 27 | 27 | ||||||||||||
Short term investments |
1,214 | 974 | 27 | 2,215 | ||||||||||||
Life settlement contracts, included in Other assets |
- | - | 129 | 129 | ||||||||||||
Discontinued operations investments, included in Other liabilities |
11 | 60 | - | 71 | ||||||||||||
Separate account business |
28 | 381 | 41 | 450 | ||||||||||||