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CNA FINANCIAL CORP - Quarter Report: 2011 September (Form 10-Q)



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
R QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2011
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number 1-5823
 
CNA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
 
36-6169860
(I.R.S. Employer
Identification No.)
333 S. Wabash
Chicago, Illinois
(Address of principal executive offices)
 
60604
(Zip Code)
(312) 822-5000
(Registrant’s telephone number, including area code)
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 R No o
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 R No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer £
 
Accelerated filer R
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No R
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding at October 28, 2011
Common Stock, Par value $2.50
 
269,274,900
Item Number
 
Page
Number
 
 
 
 
 
1.
 
 
 
 
 
 
 
2.
3.
4.
 
 
1.
6.

Table of Contents

CNA Financial Corporation
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Statements of Operations (Unaudited)
Periods ended September 30
Three Months
 
Nine Months
(In millions, except per share data)
2011
 
2010
 
2011
 
2010
Revenues
 
 
 
 
 
 
 
Net earned premiums
$
1,732

 
$
1,645

 
$
4,942

 
$
4,868

Net investment income
394

 
581

 
1,531

 
1,692

Net realized investment gains (losses), net of participating policyholders’ interests:
 
 
 
 

 
 
Other-than-temporary impairment losses
(75
)
 
(41
)
 
(136
)
 
(189
)
Portion of other-than-temporary impairments recognized in Other comprehensive income
(2
)
 
(3
)
 
(44
)
 
28

Net other-than-temporary impairment losses recognized in earnings
(77
)
 
(44
)
 
(180
)
 
(161
)
Other net realized investment gains
50

 
106

 
181

 
286

Net realized investment gains (losses), net of participating policyholders’ interests
(27
)
 
62

 
1

 
125

Other revenues
76

 
75

 
214

 
226

Total revenues
2,175

 
2,363

 
6,688

 
6,911

Claims, Benefits and Expenses
 
 
 
 
 
 
 
Insurance claims and policyholders’ benefits
1,400

 
1,344

 
4,131

 
3,799

Amortization of deferred acquisition costs
356

 
351

 
1,051

 
1,038

Other operating expenses
252

 
795

 
736

 
1,325

Interest
43

 
40

 
132

 
113

Total claims, benefits and expenses
2,051

 
2,530

 
6,050

 
6,275

Income (loss) from continuing operations before income tax
124

 
(167
)
 
638

 
636

Income tax (expense) benefit
(49
)
 
64

 
(198
)
 
(183
)
Income (loss) from continuing operations
75

 
(103
)
 
440

 
453

Income (loss) from discontinued operations, net of income tax (expense) benefit of -, $0, $0 and $0
—

 
(22
)
 
(1
)
 
(21
)
Net income (loss)
75

 
(125
)
 
439

 
432

Net (income) loss attributable to noncontrolling interests
—

 
(15
)
 
(15
)
 
(44
)
Net income (loss) attributable to CNA
$
75

 
$
(140
)
 
$
424

 
$
388

 
 
 
 
 
 
 
 
Income (Loss) Attributable to CNA Common Stockholders
 
 
 
 
 
 
 
Income (loss) from continuing operations attributable to CNA
$
75

 
$
(118
)
 
$
425

 
$
409

Dividends on 2008 Senior Preferred
—

 
(18
)
 
—

 
(68
)
Income (loss) from continuing operations attributable to CNA common stockholders
75

 
(136
)
 
425

 
341

Income (loss) from discontinued operations attributable to CNA common stockholders
—

 
(22
)
 
(1
)
 
(21
)
Income (loss) attributable to CNA common stockholders
$
75

 
$
(158
)
 
$
424

 
$
320

 
 
 
 
 
 
 
 
Basic and Diluted Earnings (Loss) Per Share Attributable to CNA Common Stockholders
 
 
 
 
 
 
 
Income (loss) from continuing operations attributable to CNA common stockholders
$
0.28

 
$
(0.51
)
 
$
1.58

 
$
1.27

Income (loss) from discontinued operations attributable to CNA common stockholders
—

 
(0.08
)
 
—

 
(0.08
)
Basic and diluted earnings (loss) per share attributable to CNA common stockholders
$
0.28

 
$
(0.59
)
 
$
1.58

 
$
1.19

Weighted Average Outstanding Common Stock and Common Stock Equivalents
 
 
 
 
 
 
 
Basic
269.3

 
269.2

 
269.3

 
269.1

Diluted
269.6

 
269.2

 
269.6

 
269.4


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

3
Table of Contents

CNA Financial Corporation
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Other Comprehensive Income, Net of Tax
 
 
 
 
 
 
 
Changes in:
 
 
 
 
 
 
 
Net unrealized gains (losses) on investments with other-than-temporary impairments
$
(14
)
 
$
39

 
$
25

 
$
81

Net unrealized gains on other investments
227

 
726

 
549

 
1,426

Net unrealized gains on investments
213

 
765

 
574

 
1,507

Net unrealized gains on discontinued operations and other
—

 
3

 
1

 
11

Foreign currency translation adjustment
(52
)
 
37

 
(22
)
 
44

Pension and postretirement benefits
1

 
2

 
3

 
5

Allocation to participating policyholders
(6
)
 
(9
)
 
(7
)
 
(37
)
Other comprehensive income, net of tax
156

 
798

 
549

 
1,530

Net income
75

 
(125
)
 
439

 
432

Comprehensive income
231

 
673

 
988

 
1,962

Changes in:
 
 
 
 
 
 
 
Net unrealized (gains) losses on investments attributable to noncontrolling interests
—

 
(13
)
 
(8
)
 
(27
)
Pension and postretirement benefits attributable to noncontrolling interests
—

 
—

 
—

 
(3
)
Other comprehensive (income) loss attributable to noncontrolling interests
—

 
(13
)
 
(8
)
 
(30
)
Net (income) loss attributable to noncontrolling interests
—

 
(15
)
 
(15
)
 
(44
)
Comprehensive (income) loss attributable to noncontrolling interests
—

 
(28
)
 
(23
)
 
(74
)
Total comprehensive income attributable to CNA
$
231

 
$
645

 
$
965

 
$
1,888

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

4
Table of Contents

CNA Financial Corporation
Condensed Consolidated Balance Sheets (Unaudited)
(In millions, except share data)
September 30,
2011
 
December 31,
2010
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities at fair value (amortized cost of $36,913 and $36,427)
$
39,456

 
$
37,577

Equity securities at fair value (cost of $316 and $422)
327

 
440

Limited partnership investments
2,371

 
2,309

Other invested assets
17

 
27

Mortgage loans
204

 
87

Short term investments
1,730

 
2,215

Total investments
44,105

 
42,655

Cash
84

 
77

Reinsurance receivables (less allowance for uncollectible receivables of $99 and $125)
6,723

 
7,079

Insurance receivables (less allowance for uncollectible receivables of $134 and $160)
1,694

 
1,557

Accrued investment income
467

 
425

Deferred acquisition costs
783

 
1,079

Deferred income taxes
205

 
667

Property and equipment at cost (less accumulated depreciation of $567 and $543)
324

 
333

Goodwill and other intangible assets
141

 
141

Other assets (includes $120 and $139 due from Loews Corporation)
900

 
868

Separate account business
418

 
450

Total assets
$
55,844

 
$
55,331

Liabilities and Equity
 
 
 
Liabilities:
 
 
 
Insurance reserves:
 
 
 
Claim and claim adjustment expenses
$
25,031

 
$
25,496

Unearned premiums
3,386

 
3,203

Future policy benefits
9,258

 
8,718

Policyholders’ funds
176

 
173

Participating policyholders’ funds
66

 
60

Short term debt
100

 
400

Long term debt
2,538

 
2,251

Other liabilities
2,915

 
3,056

Separate account business
418

 
450

Total liabilities
43,888

 
43,807

Commitments and contingencies (Notes C, D, G, and I)

 

Equity:
 
 
 
Common stock ($2.50 par value; 500,000,000 shares authorized; 273,040,243 shares issued; 269,274,900 and 269,139,198 shares outstanding)
683

 
683

Additional paid-in capital
2,144

 
2,200

Retained earnings
8,219

 
7,876

Accumulated other comprehensive income
886

 
326

Treasury stock (3,765,343 and 3,901,045 shares), at cost
(102
)
 
(105
)
Notes receivable for the issuance of common stock
(22
)
 
(26
)
Total CNA stockholders’ equity
11,808

 
10,954

Noncontrolling interests
148

 
570

Total equity
11,956

 
11,524

Total liabilities and equity
$
55,844

 
$
55,331

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

5
Table of Contents

CNA Financial Corporation
Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine months ended September 30
 
 
 
(In millions)
2011
 
2010
Cash Flows from Operating Activities
 
 
 
Net income
$
439

 
$
432

Adjustments to reconcile net income to net cash flows provided (used) by operating activities:
 
 
 
Loss from discontinued operations
1

 
21

Loss on disposal of property and equipment
8

 
—

Deferred income tax expense
153

 
163

Trading portfolio activity
(8
)
 
125

Net realized investment gains, net of participating policyholders’ interests
(1
)
 
(125
)
Equity method investees
80

 
(25
)
Amortization of investments
(47
)
 
(84
)
Depreciation
59

 
60

Changes in:
 
 
 
Receivables, net
267

 
(709
)
Accrued investment income
(42
)
 
(51
)
Deferred acquisition costs
(28
)
 
12

Insurance reserves
(5
)
 
(563
)
Other assets
110

 
168

Other liabilities
(181
)
 
(11
)
Other, net
10

 
3

Total adjustments
376

 
(1,016
)
Net cash flows provided (used) by operating activities-continuing operations
$
815

 
$
(584
)
Net cash flows used by operating activities-discontinued operations
$
(2
)
 
$
(89
)
Net cash flows provided (used) by operating activities-total
$
813

 
$
(673
)
Cash Flows from Investing Activities
 
 
 
Purchases of fixed maturity securities
$
(8,854
)
 
$
(12,981
)
Proceeds from fixed maturity securities:
 
 
 
Sales
5,900

 
9,263

Maturities, calls and redemptions
2,434

 
2,891

Purchases of equity securities
(51
)
 
(92
)
Proceeds from sales of equity securities
171

 
215

Origination of mortgage loans
(118
)
 
(70
)
Change in short term investments
499

 
1,752

Change in other investments
(137
)
 
(227
)
Purchases of property and equipment
(67
)
 
(38
)
Dispositions
—

 
65

Other, net
4

 
7

Net cash flows provided (used) by investing activities-continuing operations
$
(219
)
 
$
785

Net cash flows provided by investing activities-discontinued operations
$
2

 
$
75

Net cash flows provided (used) by investing activities-total
$
(217
)
 
$
860

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

6
Table of Contents

Nine months ended September 30
 
 
 
(In millions)
2011
 
2010
Cash Flows from Financing Activities
 
 
 
Acquisition of CNA Surety noncontrolling interest
$
(475
)
 
$
—

Dividends paid to common stockholders
(81
)
 
—

Dividends paid to Loews Corporation for 2008 Senior Preferred
—

 
(68
)
Payment to redeem 2008 Senior Preferred
—

 
(500
)
Proceeds from the issuance of debt
396

 
495

Repayment of debt
(420
)
 
(150
)
Stock options exercised
2

 
4

Other, net
(10
)
 
(26
)
Net cash flows used by financing activities-continuing operations
$
(588
)
 
$
(245
)
Net cash flows provided (used) by financing activities-discontinued operations
$
—

 
$
—

Net cash flows used by financing activities-total
$
(588
)
 
$
(245
)
Effect of foreign exchange rate changes on cash-continuing operations
(1
)
 
—

Net change in cash
$
7

 
$
(58
)
Net cash transactions from continuing operations to discontinued operations
—

 
(14
)
Net cash transactions to discontinued operations from continuing operations
—

 
14

Cash, beginning of year
77

 
140

Cash, end of period
$
84

 
$
82

 
 
 
 
Cash-continuing operations
$
84

 
$
82

Cash-discontinued operations
—

 
—

Cash-total
$
84

 
$
82

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

7
Table of Contents

CNA Financial Corporation
Condensed Consolidated Statements of Equity (Unaudited)
Nine months ended September 30
 
 
 
(In millions)
2011
 
2010
Preferred Stock
 
 
 
Balance, beginning of period
$
—

 
$
1,000

Redemption of 2008 Senior Preferred
—

 
(500
)
Balance, end of period
—

 
500

Common Stock
 
 
 
Balance, beginning of period
683

 
683

Balance, end of period
683

 
683

Additional Paid-in Capital
 
 
 
Balance, beginning of period
2,200

 
2,177

Stock-based compensation
3

 
1

Acquisition of CNA Surety noncontrolling interest
(60
)
 
—

Other
1

 
23

Balance, end of period
2,144

 
2,201

Retained Earnings
 
 
 
Balance, beginning of period
7,876

 
7,264

Cumulative effect adjustment from change in credit derivatives accounting guidance as of July 1, 2010, net of tax
—

 
(2
)
Dividends paid to common stockholders
(81
)
 
—

Dividends paid to Loews Corporation for 2008 Senior Preferred
—

 
(68
)
Net income attributable to CNA
424

 
388

Balance, end of period
8,219

 
7,582

Accumulated Other Comprehensive Income (Loss)
 
 
 
Balance, beginning of period
326

 
(325
)
Cumulative effect adjustment from change in credit derivatives accounting guidance as of July 1, 2010, net of tax
—

 
2

Other comprehensive income attributable to CNA
541

 
1,500

Acquisition of CNA Surety noncontrolling interest
19

 
—

Balance, end of period
886

 
1,177

Treasury Stock
 
 
 
Balance, beginning of period
(105
)
 
(109
)
Stock-based compensation
3

 
6

Balance, end of period
(102
)
 
(103
)
Notes Receivable for the Issuance of Common Stock
 
 
 
Balance, beginning of period
(26
)
 
(30
)
Decrease in notes receivable for the issuance of common stock
4

 
—

Balance, end of period
(22
)
 
(30
)
Total CNA Stockholders’ Equity
11,808

 
12,010

Noncontrolling Interests
 
 
 
Balance, beginning of period
570

 
506

Net income (loss)
15

 
44

Other comprehensive income (loss)
8

 
30

Acquisition of CNA Surety noncontrolling interest
(434
)
 
—

Other
(11
)
 
(25
)
Balance, end of period
148

 
555

Total Equity
$
11,956

 
$
12,565

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

8
Table of Contents

CNA Financial Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)

Note A. General
Basis of Presentation
The Condensed Consolidated Financial Statements (Unaudited) include the accounts of CNA Financial Corporation (CNAF) and its controlled subsidiaries. Collectively, CNAF and its controlled subsidiaries are referred to as CNA or the Company. CNA’s property and casualty and remaining life and group insurance operations are primarily conducted by Continental Casualty Company (CCC), The Continental Insurance Company, Western Surety Company and Continental Assurance Company. Loews Corporation (Loews) owned approximately 90% of the outstanding common stock of CNAF as of September 30, 2011.
The accompanying Condensed Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Certain financial information that is normally included in annual financial statements, including certain financial statement notes, prepared in accordance with GAAP, is not required for interim reporting purposes and has been condensed or omitted. These statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in CNAF’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) for the year ended December 31, 2010, including the summary of significant accounting policies in Note A. The preparation of Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the Condensed Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates.
The interim financial data as of September 30, 2011 and for the three and nine months ended September 30, 2011 and 2010 is unaudited. However, in the opinion of management, the interim data includes all adjustments, consisting of normal recurring accruals, necessary for a fair statement of the Company’s results for the interim periods. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. Intercompany amounts have been eliminated.
The Company has historically reported certain run-off insurance and reinsurance operations acquired in its merger with The Continental Corporation in 1995 as discontinued operations. Due to the immateriality of the remaining liabilities, effective in the third quarter of 2011, the Company is no longer reporting these run-off operations as discontinued operations.
First Insurance Company of Hawaii
The Company owns 50% of the common stock of First Insurance Company of Hawaii (FICOH). On August 11, 2011, CNA announced the sale of its noncontrolling interest in FICOH to Tokio Marine & Nichido Fire Insurance Co., Ltd., the other 50% shareholder.  The sale, which is subject to regulatory approval, is expected to close in the fourth quarter of 2011 and result in a modest gain. The Company previously anticipated recovering the undistributed earnings of FICOH at a dividend tax rate. As a result of the pending sale, the Company has increased income tax expense by $22 million to reflect the statutory tax rate.
CNA Surety Corporation
On June 10, 2011, CNA completed its previously announced acquisition of the noncontrolling interest of CNA Surety Corporation (CNA Surety). Previously the Company owned approximately 61% of the outstanding publicly-traded common stock of CNA Surety. CNA Surety is now a wholly-owned subsidiary of CCC, and, effective after the close of the stock market on June 10, 2011, trading in CNA Surety common stock ceased.

9
Table of Contents

The aggregate purchase price was approximately $475 million, based on the offer price of $26.55 per share and inclusive of the retirement of CNA Surety employee stock options. The amount paid to acquire the common stock of CNA Surety not owned by the Company in excess of the closing date noncontrolling interest included in the Company's equity of $434 million was reflected as an adjustment to Additional Paid-in Capital and Accumulated Other Comprehensive Income on the Condensed Consolidated Statement of Equity. During 2011, net income attributable to the noncontrolling interest in CNA Surety through the acquisition date of June 10, 2011 was $12 million and is reflected on the Condensed Consolidated Statement of Operations. For the three and nine months ended September 30, 2010, net income attributable to the noncontrolling interest in CNA Surety was $11 million and $30 million.
Reinsurance Receivables
The Company has established an allowance for uncollectible reinsurance receivables which relates to both amounts already billed on ceded paid losses as well as ceded reserves that will be billed when losses are paid in the future. The allowance for uncollectible reinsurance receivables is estimated on the basis of periodic evaluations of balances due from reinsurers, reinsurer creditworthiness, management’s experience and current economic conditions. Financial strength ratings are updated and reviewed on an annual basis or sooner if the Company becomes aware of significant changes related to a reinsurer. Because billed receivables are less than 5% of total reinsurance receivables, the age of the reinsurance receivables related to paid losses is not a significant input into the allowance analysis. During the three months ended September 30, 2011, the Company reduced its allowance for uncollectible reinsurance receivables by $15 million arising from a change in estimate. The additional reduction in the allowance primarily related to write-offs of reinsurance receivable balances.
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 intends to adopt this updated accounting guidance retrospectively and is currently assessing the impact it will have on its financial condition and results of operations. The Company preliminarily estimates that amounts capitalized under the current accounting guidance as of September 30, 2011 would be approximately $75 million to $130 million less under the updated guidance. Any reduction of capitalized costs will also necessitate a change in related deferred tax balances.

10
Table of Contents

Note B. Earnings (Loss) Per Share
Earnings (loss) per share attributable to the Company's common stockholders is based on the weighted average number of outstanding common shares. Basic earnings (loss) per share excludes the impact of dilutive securities and is computed by dividing net income (loss) 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 three and nine months ended September 30, 2011, approximately 279 thousand and 286 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 1.1 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 three months ended September 30, 2010, as a result of the net loss, none of the 2.3 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. For the nine months ended September 30, 2010, approximately 240 thousand potential shares attributable to exercises under stock-based employee compensation plans were included in the calculation of diluted earnings per share. For that same period, approximately 1.2 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.

11
Table of Contents

Note C. Investments
The significant components of net investment income are presented in the following table.
Net Investment Income
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Fixed maturity securities
$
494

 
$
511

 
$
1,505

 
$
1,540

Short term investments
2

 
2

 
6

 
13

Limited partnership investments
(93
)
 
68

 
32

 
136

Equity securities
4

 
7

 
16

 
26

Mortgage loans
2

 
1

 
6

 
1

Trading portfolio (a)
(1
)
 
4

 
5

 
10

Other
1

 
2

 
6

 
7

Gross investment income
409

 
595

 
1,576

 
1,733

Investment expense
(15
)
 
(14
)
 
(45
)
 
(41
)
Net investment income
$
394

 
$
581

 
$
1,531

 
$
1,692

____________________
(a)
The net unrealized losses related to changes in fair value on trading securities still held included in net investment income were $1 million for the three and nine months ended September 30, 2011. The net unrealized gains related to changes in fair value on trading securities still held included in net investment income were $1 million for the three and nine months ended September 30, 2010.
Net realized investment gains (losses) are presented in the following table.
Net Realized Investment Gains (Losses)
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Net realized investment gains (losses):
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Gross realized gains
$
56

 
$
121

 
$
233

 
$
352

Gross realized losses
(85
)
 
(45
)
 
(222
)
 
(183
)
Net realized investment gains (losses) on fixed maturity securities
(29
)
 
76

 
11

 
169

Equity securities:
 
 
 
 
 
 
 
Gross realized gains
1

 
3

 
7

 
7

Gross realized losses
(2
)
 
(20
)
 
(10
)
 
(49
)
Net realized investment losses on equity securities
(1
)
 
(17
)
 
(3
)
 
(42
)
Derivatives
1

 
(1
)
 
—

 
(1
)
Short term investments and other (a) (b)
2

 
4

 
(7
)
 
(1
)
Net realized investment gains (losses), net of participating policyholders’ interests
$
(27
)
 
$
62

 
$
1

 
$
125

____________________
(a)
The nine months ended September 30, 2011 includes a $9 million loss related to the early extinguishment of $400 million of senior notes originally due August 15, 2011.
(b)
Includes net unrealized gains (losses) related to changes in the fair value of securities for which the fair value option has been elected. There were no net unrealized gains (losses) included in the three months ended September 30, 2011, $1 million of net unrealized gains for the nine months ended September 30, 2011 and $2 million of net unrealized gains for the three and nine months ended September 30, 2010.


12
Table of Contents

The components of net other-than-temporary impairment (OTTI) losses recognized in earnings by asset type are summarized in the following table.
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
Corporate and other bonds
$
49

 
$
17

 
$
73

 
$
59

States, municipalities and political subdivisions
—

 
—

 
—

 
20

Asset-backed:
 
 
 
 
 
 
 
Residential mortgage-backed
21

 
18

 
95

 
55

Commercial mortgage-backed
—

 
—

 
—

 
2

Other asset-backed
4

 
—

 
4

 
2

Total asset-backed
25

 
18

 
99

 
59

Total fixed maturity securities available-for-sale
74

 
35

 
172

 
138

Equity securities available-for-sale:
 
 
 
 
 
 
 
Common stock
3

 
5

 
7

 
10

Preferred stock
—

 
4

 
1

 
13

Total equity securities available-for-sale
3

 
9

 
8

 
23

Net OTTI losses recognized in earnings
$
77

 
$
44

 
$
180

 
$
161

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 Company’s Chief Financial Officer. The Impairment Committee is responsible for evaluating all securities in an unrealized loss position on at least a quarterly basis.
The Impairment Committee’s 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. The factors considered 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. In subsequent reporting periods, a change in intent to sell or further credit impairment on a security whose fair value has not deteriorated will cause the non-credit component originally recorded as OTTI in Other comprehensive income to be recognized as an OTTI loss in earnings.

13
Table of Contents

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, and credit support from lower level tranches.
The Company applies the same impairment model as described above for the majority of 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.
The following tables provide a summary of fixed maturity and equity securities.
Summary of Fixed Maturity and Equity Securities
September 30, 2011
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
Unrealized
OTTI
Losses (Gains)
(In millions)
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
19,141

 
$
1,918

 
$
160

 
$
20,899

 
$
—

States, municipalities and political subdivisions
8,834

 
853

 
150

 
9,537

 
—

Asset-backed:
 

 
 

 
 

 
 

 
 

Residential mortgage-backed
5,812

 
199

 
161

 
5,850

 
82

Commercial mortgage-backed
1,255

 
55

 
61

 
1,249

 
(8
)
Other asset-backed
1,035

 
15

 
14

 
1,036

 
—

Total asset-backed
8,102

 
269

 
236

 
8,135

 
74

U.S. Treasury and obligations of government-sponsored enterprises
221

 
16

 
—

 
237

 
—

Foreign government
557

 
25

 
—

 
582

 
—

Redeemable preferred stock
49

 
8

 
—

 
57

 
—

Total fixed maturity securities available-for-sale
36,904

 
3,089

 
546

 
39,447

 
$
74

Total fixed maturity securities trading
9

 
—

 
—

 
9

 
 
Equity securities available-for-sale:
 
 
 
 
 
 
 
 
 
Common stock
103

 
19

 
2

 
120

 
 
Preferred stock
213

 
2

 
8

 
207

 
 
Total equity securities available-for-sale
316

 
21

 
10

 
327

 
 
Total
$
37,229

 
$
3,110

 
$
556

 
$
39,783

 
 

14
Table of Contents

Summary of Fixed Maturity and Equity Securities
December 31, 2010
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
Unrealized
OTTI
Losses (Gains)
(In millions)
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
19,492

 
$
1,603

 
$
70

 
$
21,025

 
$
—

States, municipalities and political subdivisions
8,157

 
142

 
410

 
7,889

 
—

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

U.S. Treasury and obligations of government-sponsored enterprises
122

 
16

 
1

 
137

 
—

Foreign government
602

 
18

 
—

 
620

 
—

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

 
 
At September 30, 2011 and December 31, 2010, net unrealized gains on investments included in Accumulated other comprehensive income (AOCI) supporting certain products within the Life & Group Non-Core segment were reduced by $467 million and $150 million, net of tax, resulting from a reduction of Deferred acquisition costs or an increase in Future policy benefit reserves.

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Table of Contents

The following tables summarize the estimated fair value and gross unrealized losses of available-for-sale fixed maturity and equity securities in a gross unrealized loss position by the length of time in which the securities have continuously been in that position.
Securities in a Gross Unrealized Loss Position
 
Less than 12 Months
 
Greater than 12 Months
 
Total
September 30, 2011
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
(In millions)
 
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
3,143

 
$
134

 
$
142

 
$
26

 
$
3,285

 
$
160

States, municipalities and political subdivisions
270

 
4

 
716

 
146

 
986

 
150

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
789

 
20

 
978

 
141

 
1,767

 
161

Commercial mortgage-backed
474

 
42

 
179

 
19

 
653

 
61

Other asset-backed
377

 
4

 
77

 
10

 
454

 
14

Total asset-backed
1,640

 
66

 
1,234

 
170

 
2,874

 
236

Total fixed maturity securities available-for-sale
5,053

 
204

 
2,092

 
342

 
7,145

 
546

Equity securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
Common stock
36

 
2

 
—

 
—

 
36

 
2

Preferred stock
129

 
7

 
19

 
1

 
148

 
8

Total equity securities available-for-sale
165

 
9

 
19

 
1

 
184

 
10

Total
$
5,218

 
$
213

 
$
2,111

 
$
343

 
$
7,329

 
$
556

 
Less than 12 Months
 
Greater than 12 Months
 
Total
December 31, 2010
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
(In millions)
 
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
1,719

 
$
34

 
$
405

 
$
36

 
$
2,124

 
$
70

States, municipalities and political subdivisions
3,339

 
164

 
745

 
246

 
4,084

 
410

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

U.S. Treasury and obligations of government-sponsored enterprises
8

 
1

 
—

 
—

 
8

 
1

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

The amount of pretax net unrealized gains (losses) on available-for-sale securities reclassified out of AOCI into earnings was $(29) million and $12 million for the three and nine months ended September 30, 2011 and $62 million and $133 million for the three and nine months ended September 30, 2010.

16
Table of Contents

The following table summarizes the activity for the three and nine months ended September 30, 2011 and 2010 related to the pretax credit loss component reflected in Retained earnings on fixed maturity securities still held at September 30, 2011 and 2010 for which a portion of an OTTI loss was recognized in Other comprehensive income.
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Beginning balance of credit losses on fixed maturity securities
$
82

 
$
171

 
$
141

 
$
164

Additional credit losses for securities for which an OTTI loss was previously recognized
11

 
4

 
29

 
26

Credit losses for securities for which an OTTI loss was not previously recognized
10

 
1

 
11

 
9

Reductions for securities sold during the period
(4
)
 
(27
)
 
(50
)
 
(50
)
Reductions for securities the Company intends to sell or more likely than not will be required to sell
—

 
(8
)
 
(32
)
 
(8
)
Ending balance of credit losses on fixed maturity securities
$
99

 
$
141

 
$
99

 
$
141

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 September 30, 2011 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 & Poor’s (S&P) and Moody’s Investors Service, Inc. (Moody’s) 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.
Corporate and Other Bonds
The unrealized losses on the Company’s investments in this category primarily relate to non-investment grade bonds and bonds within the financial industry sector. The financial industry sector holdings in this category include bonds with an aggregate fair value of $1,702 million and an aggregate amortized cost of $1,793 million as of September 30, 2011.
The following table summarizes corporate and other bonds in a gross unrealized loss position by ratings distribution at September 30, 2011.
Gross Unrealized Losses by Ratings Distribution
September 30, 2011
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
(In millions)
 
 
AAA
$
58

 
$
57

 
$
1

AA
202

 
196

 
6

A
1,018

 
975

 
43

BBB
1,280

 
1,219

 
61

Non-investment grade
887

 
838

 
49

Total
$
3,445

 
$
3,285

 
$
160

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 September 30, 2011.

17
Table of Contents

States, Municipalities and Political Subdivisions
The unrealized losses on the Company's investments in this category are primarily due to market conditions for zero coupon bonds, particularly for those with maturity dates that exceed 20 years. Yields for these securities continue to be higher than historical norms relative to after-tax returns on similar fixed income securities.
The following table summarizes the ratings distribution of states, municipalities and political subdivisions securities in a gross unrealized loss position at September 30, 2011.
Gross Unrealized Losses by Ratings Distribution
September 30, 2011
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
(In millions)
 
 
AAA
$
198

 
$
190

 
$
8

AA
485

 
378

 
107

A
370

 
340

 
30

BBB
67

 
63

 
4

Non-investment grade
16

 
15

 
1

Total
$
1,136

 
$
986

 
$
150

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 September 30, 2011.
Asset-Backed Securities
The fair value of total asset-backed holdings at September 30, 2011 was $8,135 million which was comprised of 2,054 different securities. The fair value of these securities tends to be influenced by the characteristics and projected cash flows of the underlying collateral rather than the credit of the issuer. 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, 132 had underlying collateral that was 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 included 149 non-agency structured securities that had at least one trade lot in a gross unrealized loss position. The aggregate severity of the gross unrealized loss for residential mortgage-backed securities was approximately 8% of amortized cost.
Commercial mortgage-backed securities included 66 securities that had at least one trade lot in a gross unrealized loss position. The aggregate severity of the gross unrealized loss was approximately 9% of amortized cost.
Other asset-backed securities included 46 securities that had at least one trade lot in a gross unrealized loss position. The aggregate severity of the gross unrealized loss was approximately 3% of amortized cost.

18
Table of Contents

The following table summarizes asset-backed securities in a gross unrealized loss position by ratings distribution at September 30, 2011.
Gross Unrealized Losses by Ratings Distribution
September 30, 2011
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
(In millions)
 
 
U.S. Government, Government Agencies, and Government-Sponsored Enterprises
$
481

 
$
465

 
$
16

AAA
762

 
734

 
28

AA
441

 
415

 
26

A
213

 
203

 
10

BBB
316

 
278

 
38

Non-investment grade
897

 
779

 
118

Total
$
3,110

 
$
2,874

 
$
236

The Company believes the unrealized losses are primarily attributable to broader economic conditions, changes in interest rates, wider than historical bid/ask spreads, and uncertainty with regard to the timing and amount of ultimate collateral realization, but are not indicative of the ultimate collectibility of the current carrying values of securities. 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; accordingly, the Company has determined that there are no additional OTTI losses to be recorded at September 30, 2011.
Contractual Maturity
The following table summarizes available-for-sale fixed maturity securities by contractual maturity at September 30, 2011 and December 31, 2010. 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
 
September 30, 2011
 
December 31, 2010
(In millions)
Cost or
Amortized
Cost
 
Estimated
Fair
Value
 
Cost or
Amortized
Cost
 
Estimated
Fair
Value
Due in one year or less
$
1,658

 
$
1,662

 
$
1,515

 
$
1,506

Due after one year through five years
12,947

 
13,407

 
11,198

 
11,653

Due after five years through ten years
8,447

 
8,941

 
10,022

 
10,425

Due after ten years
13,852

 
15,437

 
13,686

 
13,987

Total
$
36,904

 
$
39,447

 
$
36,421

 
$
37,571

Limited Partnerships
The carrying value of limited partnerships as of September 30, 2011 and December 31, 2010 was $2,371 million and $2,309 million. Limited partnerships comprising 57% of the total carrying value were reported on a current basis through September 30, 2011 with no reporting lag, 27% were reported on a one month lag and the remainder were reported on more than a one month lag. As of September 30, 2011 and December 31, 2010, the Company had 82 and 75 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.

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Table of Contents

Of the limited partnerships held, 81% and 85% at September 30, 2011 and December 31, 2010 employ hedge fund 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 45% were equity related, 32% pursued a multi-strategy approach, 19% were focused on distressed investments and 4% were fixed income related at September 30, 2011. Limited partnerships representing 14% and 11% at September 30, 2011 and December 31, 2010 were invested in private debt and equity. The remaining were invested in various other partnerships including real estate.
While the Company generally does not invest in highly leveraged partnerships, there are risks which may result in losses due to short-selling, derivatives or other speculative investment practices. The use of leverage increases volatility generated by the underlying investment strategies.
The Company's 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
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 loan's original effective interest rate is less than 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 payment is unlikely. Mortgage loans are considered past due when full principal or interest payments have not been received according to contractual terms.
Risks related to the recoverability of loan balances include declines in the estimated cash flows from underlying property leases, declines in the fair value of collateral, and creditworthiness of tenants of credit tenant loan properties, where lease payments directly service the loan. As of September 30, 2011, 17% of the carrying value of mortgage loans related to credit tenant loans. The Company identifies loans for evaluation of impairment primarily based on the collection experience of each loan. As of September 30, 2011, there were no loans past due or in non-accrual status, and no valuation allowance was recorded.
Investment Commitments
As of September 30, 2011, the Company had committed approximately $157 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 settlements are made. As of September 30, 2011, the Company had commitments to purchase $110 million and sell $51 million of such investments.
As of September 30, 2011, the Company had mortgage loan commitments of $31 million representing signed loan applications received and accepted. The mortgage loans are recorded once funded.

20
Table of Contents

Note D. Derivative Financial Instruments
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 Company's 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 Company's 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 obligor's 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 Company's 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 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.

21
Table of Contents

The tables below summarize open CDS contracts where the Company sold credit protection as of September 30, 2011 and December 31, 2010. 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
September 30, 2011
Fair Value of
Credit Default
Swaps
 
Maximum Amount of
Future Payments under Credit Default Swaps
 
Weighted
Average Years
to Maturity
(In millions)
 
 
BB rated
$
—

 
$
5

 
1.7

B rated
—

 
3

 
0.7

Total
$
—

 
$
8

 
1.4

Credit Ratings of Underlying Reference Obligations
December 31, 2010
Fair Value of
Credit Default
Swaps
 
Maximum Amount of
Future Payments under Credit Default Swaps
 
Weighted
Average Years
to Maturity
(In millions)
 
 
BB rated
$
1

 
$
5

 
2.5

B rated
—

 
3

 
1.5

Total
$
1

 
$
8

 
2.1

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 Condensed 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 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 $1 million and $2 million at September 30, 2011 and December 31, 2010. The fair value of cash collateral received from counterparties was $1 million at September 30, 2011 and December 31, 2010.
Derivative securities are recorded at fair value. See Note E 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 Condensed Consolidated Statements of Operations. Changes in the fair value of derivatives held for trading purposes are reported in Net investment income on the Condensed Consolidated Statements of Operations.
A summary of the recognized gains (losses) related to derivative financial instruments follows.
Recognized Gains (Losses)
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Without hedge designation
 
 
 
 
 
 
 
Credit default swaps - purchased protection
$
—

 
$
(1
)
 
$
—

 
$
(1
)
Currency forwards
—

 
—

 
(1
)
 
—

Forward commitments for mortgage-backed securities
1

 
—

 
1

 
—

Total without hedge designation
1

 
(1
)
 
—

 
(1
)
Trading activities
 
 
 
 
 
 
 
Futures sold, not yet purchased
—

 
(4
)
 
—

 
(3
)
Total
$
1

 
$
(5
)
 
$
—

 
$
(4
)

22
Table of Contents

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 Condensed 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
September 30, 2011
Contractual/
Notional
Amount
 
Estimated Fair Value
(In millions)
 
Asset
 
(Liability)
Without hedge designation
 
 
 
 
 
Credit default swaps - purchased protection
$
20

 
$
—

 
$
(2
)
Credit default swaps - sold protection
8

 
—

 
—

Forward commitments for mortgage-backed securities
62

 
1

 
—

Equity warrants
—

 
1

 
—

Options written
1

 
—

 
—

Total without hedge designation
91

 
2

 
(2
)
Trading activities
 
 
 
 
 
Futures sold, not yet purchased
13

 
—

 
—

Total
$
104

 
$
2

 
$
(2
)
Derivative Financial Instruments
December 31, 2010
Contractual/
Notional
Amount
 
Estimated Fair Value
(In millions)
 
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
)
During the three and nine months ended September 30, 2011, new derivative transactions entered into totaled approximately $229 million and $728 million in notional value while derivative termination activity totaled approximately $166 million and $673 million. This activity was primarily attributable to interest rate futures, forward commitments for mortgage-backed securities, and foreign currency forwards. During the three and nine months ended September 30, 2010, new derivative transactions entered into totaled approximately $0.9 billion and $2.1 billion in notional value while derivative termination activity totaled approximately $0.9 billion and $2.3 billion. This activity was primarily attributable to interest rate futures and forward commitments for mortgage-backed securities.

23
Table of Contents

Note E. 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 Company's 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 Company's valuation process, the Company samples past fair value estimates and compares the valuations to actual transactions executed in the market on similar dates.

24
Table of Contents

Assets and Liabilities Measured at Fair Value
Assets and liabilities measured at fair value on a recurring basis are summarized below.
September 30, 2011
 
 
 
 
 
 
Total
Assets/(Liabilities)
at Fair Value
(In millions)
Level 1
 
Level 2
 
Level 3
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate and other bonds
$
—

 
$
20,289

 
$
619

 
$
20,908

States, municipalities and political subdivisions
—

 
9,355

 
182

 
9,537

Asset-backed:
 
 
 
 
 
 
 
Residential mortgage-backed
—

 
5,219

 
631

 
5,850

Commercial mortgage-backed
—

 
1,090

 
159

 
1,249

Other asset-backed
—

 
607

 
429

 
1,036

Total asset-backed
—

 
6,916

 
1,219

 
8,135

U.S. Treasury and obligations of government-sponsored enterprises
176

 
61

 
—

 
237

Foreign government
92

 
490

 
—

 
582

Redeemable preferred stock
3

 
54

 
—

 
57

Total fixed maturity securities
271

 
37,165

 
2,020

 
39,456

Equity securities
179

 
116

 
32

 
327

Derivative and other financial instruments, included in Other invested assets
—

 
6

 
11

 
17

Short term investments
1,158

 
566

 
6

 
1,730

Life settlement contracts, included in Other assets
—

 
—

 
125

 
125

Separate account business
23

 
360

 
35

 
418

Total assets
$
1,631

 
$
38,213

 
$
2,229

 
$
42,073

Liabilities
 
 
 
 
 
 
 
Derivative financial instruments, included in Other liabilities
$
—

 
$
—

 
$
(2
)
 
$
(2
)
Total liabilities
$
—

 
$
—

 
$
(2
)
 
$
(2
)

25
Table of Contents

December 31, 2010
 
 
 
 
 
 
Total
Assets/(Liabilities)
at Fair Value
(In millions)
Level 1
 
Level 2
 
Level 3
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate and other bonds
$
—

 
$
20,407

 
$
624

 
$
21,031

States, municipalities and political subdivisions
—

 
7,623

 
266

 
7,889

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

U.S. Treasury and obligations of government-sponsored enterprises
76

 
61

 
—

 
137

Foreign government
115

 
505

 
—

 
620

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

Total assets
$
1,735

 
$
36,832

 
$
2,342

 
$
40,909

Liabilities
 
 
 
 
 
 
 
Derivative financial instruments, included in Other liabilities
$
—

 
$
—

 
$
(2
)
 
$
(2
)
Total liabilities
$
—

 
$
—

 
$
(2
)
 
$
(2
)


26
Table of Contents

The tables below present a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended September 30, 2011 and 2010.
Level 3
(In millions)
Balance at
July 1,
2011
 
Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) included in net income (loss)*
 
Net change in unrealized appreciation (depreciation) included in other comprehensive income (loss)
 
Purchases
 
Sales
 
Settlements
 
Transfers into
Level 3
 
Transfers out
of Level 3
 
Balance at
September 30,
2011

 
Unrealized gains (losses) on Level 3 assets and liabilities held at September 30, 2011 recognized in net income (loss)*
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
812

 
$
(7
)
 
$
(3
)
 
$
113

 
$
(107
)
 
$
(47
)
 
$
12

 
$
(154
)
 
$
619

 
$
(10
)
States, municipalities and political subdivisions
179

 
—

 
—

 
3

 
—

 
—

 
—

 
—

 
182

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
687

 
1

 
(5
)
 
73

 
(81
)
 
(13
)
 
—

 
(31
)
 
631

 
—

Commercial mortgage-backed
95

 
—

 
(7
)
 
76

 
—

 
—

 
—

 
(5
)
 
159

 
—

Other asset-backed
491

 
(5
)
 
(6
)
 
114

 
(105
)
 
(25
)
 
2

 
(37
)
 
429

 
(4
)
Total asset-backed
1,273

 
(4
)
 
(18
)
 
263

 
(186
)
 
(38
)
 
2

 
(73
)
 
1,219

 
(4
)
Total fixed maturity securities
2,264

 
(11
)
 
(21
)
 
379

 
(293
)
 
(85
)
 
14

 
(227
)
 
2,020

 
(14
)
Equity securities
36

 
—

 
—

 
—

 
(1
)
 
—

 
—

 
(3
)
 
32

 
—

Derivative and other financial instruments, net
9

 
(1
)
 
—

 
1

 
—

 
—

 
—

 
—

 
9

 
—

Short term investments
6

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
6

 
—

Life settlement contracts
129

 
11

 
—

 
—

 
—

 
(15
)
 
—

 
—

 
125

 
(1
)
Separate account business
37

 
—

 
—

 
—

 
(2
)
 
—

 
—

 
—

 
35

 
—

Total
$
2,481

 
$
(1
)
 
$
(21
)
 
$
380

 
$
(296
)
 
$
(100
)
 
$
14

 
$
(230
)
 
$
2,227

 
$
(15
)

27
Table of Contents

Level 3
(In millions)
Balance at
July 1,
2010
 
Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) included in net income (loss)*
 
Net change in unrealized appreciation (depreciation) included in other comprehensive income (loss)
 
Purchases,
sales,
issuances
and
settlements
 
Transfers into
Level 3
 
Transfers out
of Level 3
 
Balance at
September 30,
2010
 
Unrealized gains (losses) on Level 3 assets and liabilities held at September 30, 2010 recognized in net income (loss)*
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
718

 
$
1

 
$
18

 
$
(83
)
 
$
—

 
$
(54
)
 
$
600

 
$
(1
)
States, municipalities and political subdivisions
539

 
—

 
3

 
(84
)
 
—

 
—

 
458

 
—

Asset-backed:
 
 

 
 
 
 
 

 

 
 
 

Residential mortgage-backed
659

 
1

 
(9
)
 
(5
)
 
—

 
—

 
646

 
—

Commercial mortgage-backed
95

 
—

 
3

 
—

 
—

 
(20
)
 
78

 
—

Other asset-backed
306

 
(1
)
 
7

 
(66
)
 
—

 
—

 
246

 
—

Total asset-backed
1,060

 
—

 
1

 
(71
)
 
—

 
(20
)
 
970

 
—

Redeemable preferred stock
1

 
—

 
—

 
—

 
—

 
—

 
1

 
—

Total fixed maturity securities
2,318

 
1

 
22

 
(238
)
 
—

 
(74
)
 
2,029

 
(1
)
Equity securities
4

 
(3
)
 
—

 
15

 
6

 
—

 
22

 
(4
)
Derivative financial instruments, net
(2
)
 
2

 
—

 
25

 
—

 
—

 
25

 
2

Short term investments
11

 
—

 
—

 
2

 
—

 
(11
)
 
2

 
—

Life settlement contracts
134

 
8

 
—

 
(6
)
 
—

 
—

 
136

 
4

Separate account business
37

 
—

 
—

 
4

 
—

 
—

 
41

 
—

Total
$
2,502

 
$
8

 
$
22

 
$
(198
)
 
$
6

 
$
(85
)
 
$
2,255

 
$
1


28
Table of Contents

The tables below present a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2011 and 2010.
Level 3
(In millions)
Balance at
January 1,
2011
 
Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) included in net income (loss)*
 
Net change in unrealized appreciation (depreciation) included in other comprehensive income (loss)
 
Purchases
 
Sales
 
Settlements
 
Transfers into
Level 3
 
Transfers out
of Level 3
 
Balance at
September 30,
2011
 
Unrealized gains (losses) on Level 3 assets and liabilities held at September 30, 2011 recognized in net income (loss)*
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
624

 
$
(5
)
 
$
(6
)
 
$
459

 
$
(157
)
 
$
(144
)
 
$
52

 
$
(204
)
 
$
619

 
$
(11
)
States, municipalities and political subdivisions
266

 
—

 
—

 
3

 
—

 
(87
)
 
—

 
—

 
182

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
767

 
(11
)
 
9

 
170

 
(164
)
 
(54
)
 
—

 
(86
)
 
631

 
(15
)
Commercial mortgage-backed
73

 
3

 
11

 
81

 
(4
)
 
—

 
—

 
(5
)
 
159

 
—

Other asset-backed
359

 
—

 
(6
)
 
441

 
(236
)
 
(80
)
 
2

 
(51
)
 
429

 
(4
)
Total asset-backed
1,199

 
(8
)
 
14

 
692

 
(404
)
 
(134
)
 
2

 
(142
)
 
1,219

 
(19
)
Redeemable preferred stock
3

 
3

 
(3
)
 
—

 
(3
)
 
—

 
—

 
—

 
—

 
—

Total fixed maturity securities
2,092

 
(10
)
 
5

 
1,154

 
(564
)
 
(365
)
 
54

 
(346
)
 
2,020

 
(30
)
Equity securities
26

 
(2
)
 
(1
)
 
19

 
(12
)
 
—

 
5

 
(3
)
 
32

 
(3
)
Derivative and other financial instruments, net
25

 
2

 
—

 
1

 
(19
)
 
—

 
—

 
—

 
9

 
1

Short term investments
27

 
—

 
—

 
12

 
—

 
(23
)
 
—

 
(10
)
 
6

 
—

Life settlement contracts
129

 
20

 
—

 
—

 
—

 
(24
)
 
—

 
—

 
125

 
2

Separate account business
41

 
—

 
—

 
—

 
(6
)
 
—

 
—

 
—

 
35

 
—

Total
$
2,340

 
$
10

 
$
4

 
$
1,186

 
$
(601
)
 
$
(412
)
 
$
59

 
$
(359
)
 
$
2,227

 
$
(30
)

29
Table of Contents

Level 3
(In millions)
Balance at
January 1,
2010
 
Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) included in net income (loss)*
 
Net change in unrealized appreciation (depreciation) included in other comprehensive income (loss)
 
Purchases,
sales,
issuances
and
settlements
 
Transfers into
Level 3
 
Transfers out
of Level 3
 
Balance at
September 30,
2010
 
Unrealized gains (losses) on Level 3 assets and liabilities held at September 30, 2010 recognized in net income (loss)*
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
609

 
$
10

 
$
56

 
$
29

 
$
23

 
$
(127
)
 
$
600

 
$
(2
)
States, municipalities and political subdivisions
756

 
—

 
9

 
(307
)
 
—

 
—

 
458

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
629

 
(7
)
 
20

 
50

 
—

 
(46
)
 
646

 
(10
)
Commercial mortgage-backed
123

 
(1
)
 
1

 
6

 
7

 
(58
)
 
78

 
(2
)
Other asset-backed
348

 
3

 
29

 
(89
)
 
—

 
(45
)
 
246

 
(1
)
Total asset-backed
1,100

 
(5
)
 
50

 
(33
)
 
7

 
(149
)
 
970

 
(13
)
Redeemable preferred stock
2

 
6

 
—

 
(7
)
 
—

 
—

 
1

 
—

Total fixed maturity securities
2,467

 
11

 
115

 
(318
)
 
30

 
(276
)
 
2,029

 
(15
)
Equity securities
11

 
(4
)
 
—

 
14

 
8

 
(7
)
 
22

 
(5
)
Derivative financial instruments, net
(11
)
 
1

 
—

 
35

 
—

 
—

 
25

 
2

Short term investments
—

 
—

 
—

 
12

 
1

 
(11
)
 
2

 
—

Life settlement contracts
130

 
25

 
—

 
(19
)
 
—

 
—

 
136

 
11

Discontinued operations investments
16

 
—

 
1

 
(2
)
 
—

 
(15
)
 
—

 
—

Separate account business
38

 
—

 
—

 
3

 
—

 
—

 
41

 
—

Total
$
2,651

 
$
33

 
$
116

 
$
(275
)
 
$
39

 
$
(309
)
 
$
2,255

 
$
(7
)


30
Table of Contents

* Net realized and unrealized gains and losses shown above are reported in Net income (loss) as follows:
Major Category of Assets and Liabilities
 
Condensed Consolidated Statements of Operations Line Items
Fixed maturity securities available-for-sale
 
Net realized investment gains (losses)
Fixed maturity securities trading
 
Net investment income
Equity securities
 
Net realized investment gains (losses)
Derivative financial instruments held in a trading portfolio
 
Net investment income
Derivative financial instruments not held in a trading portfolio and fair value option financial instruments
 
Net realized investment gains (losses)
Life settlement contracts
 
Other revenues
Securities shown in the Level 3 tables on the previous pages may be transferred in or out of Level 3 based on the availability of observable market information used to verify pricing sources or used in pricing models. The availability of observable market information varies based on market conditions and trading volume and may cause securities to move in and out of Level 3 from reporting period to reporting period. There were no significant transfers between Level 1 and Level 2 during the three or nine months ended September 30, 2011. The Company's policy is to recognize transfers between levels at the beginning of quarterly reporting periods.
The following section describes the valuation methodologies used to measure different financial instruments at fair value, including an indication of the level in the fair value hierarchy in which the instruments are generally classified.
Fixed Maturity Securities
Level 1 securities include highly liquid U.S. and foreign government bonds, and redeemable preferred stock, valued using quoted market prices. The remaining fixed maturity securities are valued using pricing for similar securities, recently executed transactions, cash flow models with yield curves, broker/dealer quotes and other pricing models utilizing observable inputs. The valuation for most fixed maturity securities is classified as Level 2. Level 2 securities may also include securities that have firm sale commitments and prices that are not recorded until the settlement date. Securities are generally assigned to Level 3 in cases where broker/dealer quotes are significant inputs to the valuation and there is a lack of transparency as to whether these quotes are based on information that is observable in the marketplace. Level 3 securities also include tax-exempt and taxable auction rate certificates. Fair value of auction rate securities is determined utilizing a pricing model with three primary inputs. The interest rate and spread inputs are observable from like instruments while the maturity date assumption is unobservable due to the uncertain nature of the principal prepayments prior to maturity.
Equity Securities
Level 1 securities include publicly traded securities valued using quoted market prices. Level 2 securities are primarily non-redeemable preferred stocks and common stocks valued using pricing for similar securities, recently executed transactions, broker/dealer quotes and other pricing models utilizing observable inputs. Level 3 securities are priced using internal models with inputs that are not market observable.
Derivative and Other Financial Instruments
Exchange traded derivatives, primarily futures, are valued using quoted market prices and are classified within Level 1 of the fair value hierarchy. Level 2 derivatives primarily include currency forwards valued using observable market forward rates. Over-the-counter derivatives, principally interest rate swaps, total return swaps, credit default swaps, equity warrants and options, are valued using inputs including broker/dealer quotes and are classified within Level 3 of the valuation hierarchy due to a lack of transparency as to whether these quotes are based on information that is observable in the marketplace. Other financial instruments consist of Level 3 securities which contain embedded derivatives for which the fair value option has been elected and are priced using either broker/dealer quotes or internal models with inputs that are not market observable.

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Short Term Investments
The valuation of securities that are actively traded or have quoted prices are classified as Level 1. These securities include money market funds and treasury bills. Level 2 primarily includes commercial paper, for which all inputs are observable. Level 3 securities include fixed maturity securities purchased within one year of maturity where broker/dealer quotes are significant inputs to the valuation and there is a lack of transparency to the market inputs used.
Life Settlement Contracts
The fair values of life settlement contracts are determined as the present value of the anticipated death benefits less anticipated premium payments based on contract terms that are distinct for each insured, as well as the Company's own assumptions for mortality, premium expense, and the rate of return that a buyer would require on the contracts, as no comparable market pricing data is available.
Separate Account Business
Separate account business includes fixed maturity securities, equities and short term investments. The valuation methodologies for these asset types have been described above.
Financial Assets and Liabilities Not Measured at Fair Value
The carrying amount and estimated fair value of the Company's financial instrument assets and liabilities which are not measured at fair value on the Condensed Consolidated Balance Sheets are listed in the table below.
 
September 30, 2011
 
December 31, 2010
(In millions)
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
Financial assets
 
 
 
 
 
 
 
Notes receivable for the issuance of common stock
$
22

 
$
20

 
$
26

 
$
26

Mortgage loans
204

 
214

 
87

 
86

Financial liabilities
 
 
 
 
 
 
 
Premium deposits and annuity contracts
$
108

 
$
110

 
$
104

 
$
105

Short term debt
100

 
104

 
400

 
411

Long term debt
2,538

 
2,690

 
2,251

 
2,376

The following methods and assumptions were used to estimate the fair value of these financial assets and liabilities.
The fair values of notes receivable for the issuance of common stock were estimated using discounted cash flows utilizing interest rates currently offered for obligations securitized with similar collateral.
The fair values of mortgage loans were based on the present value of the expected future cash flows discounted at the current interest rate for origination of similar quality loans.
Premium deposits and annuity contracts were valued based on cash surrender values, estimated fair values or policyholder liabilities, net of amounts ceded related to sold business.
The Company's senior notes and debentures were valued based on observable quoted market prices. The fair value for other debt was estimated using discounted cash flows based on current incremental borrowing rates for similar borrowing arrangements.
The carrying amounts reported on the Condensed Consolidated Balance Sheets for Cash, Accrued investment income and certain other assets and other liabilities approximate fair value due to the short term nature of these items. These assets and liabilities are not listed in the table above.

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Note F. Claim and Claim Adjustment Expense Reserves
The Company's property and casualty insurance claim and claim adjustment expense reserves represent the estimated amounts necessary to resolve all outstanding claims, including claims that are incurred but not reported (IBNR) as of the reporting date. The Company's reserve projections are based primarily on detailed analysis of the facts in each case, the Company's experience with similar cases and various historical development patterns. Consideration is given to such historical patterns as field reserving trends and claims settlement practices, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions including inflation, and public attitudes. All of these factors can affect the estimation of claim and claim adjustment expense reserves.
Establishing claim and claim adjustment expense reserves, including claim and claim adjustment expense reserves for catastrophic events that have occurred, is an estimation process. Many factors can ultimately affect the final settlement of a claim and, therefore, the necessary reserve. Changes in the law, results of litigation, medical costs, the cost of repair materials and labor rates can all affect ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably estimable than long-tail claims, such as workers' compensation, general liability and professional liability claims. Adjustments to prior year reserve estimates, if necessary, are reflected in the results of operations in the period that the need for such adjustments is determined. There can be no assurance that the Company's ultimate cost for insurance losses will not exceed current estimates.
Catastrophes are an inherent risk of the property and casualty insurance business and have contributed to material period-to-period fluctuations in the Company's results of operations and/or equity. The Company reported catastrophe losses, net of reinsurance, of $50 million and $205 million for the three and nine months ended September 30, 2011. Catastrophe losses in 2011 related primarily to domestic storms, Hurricane Irene and the Japanese event. The Company reported catastrophe losses, net of reinsurance, of $12 million and $100 million for the three and nine months ended September 30, 2010 for events occurring in those periods.

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A&EP Reserves
On August 31, 2010, CCC together with several of the Company's insurance subsidiaries completed a transaction with National Indemnity Company (NICO), a subsidiary of Berkshire Hathaway Inc., under which substantially all of the Company's legacy A&EP liabilities were ceded to NICO.
Under the terms of the NICO transaction, effective January 1, 2010 the Company ceded approximately $1.6 billion of net A&EP claim and allocated claim adjustment expense reserves to NICO under a retroactive reinsurance agreement with an aggregate limit of $4 billion (Loss Portfolio Transfer). Included in the $1.6 billion of net A&EP claim and allocated claim adjustment expense reserves was approximately $90 million of net claim and allocated claim adjustment expense reserves relating to the Company's discontinued operations. The $1.6 billion of claim and allocated claim adjustment expense reserves ceded to NICO was net of $1.2 billion of ceded claim and allocated claim adjustment expense reserves under existing third party reinsurance contracts. The NICO aggregate reinsurance limit also covers credit risk on the existing third party reinsurance related to these liabilities.
The Company paid NICO a reinsurance premium of $2 billion and transferred to NICO billed third party reinsurance receivables related to A&EP claims with a net book value of $215 million (net of an allowance of $100 million for uncollectible reinsurance receivables on billed third party reinsurance receivables, as discussed further below). As of August 31, 2010, NICO deposited approximately $2.2 billion in a collateral trust account as security for its obligations to the Company. This $2.2 billion will be reduced by the amount of net A&EP claim and allocated claim adjustment expense payments. In addition, Berkshire Hathaway Inc. guaranteed the payment obligations of NICO up to the full aggregate reinsurance limit as well as certain of NICO's performance obligations under the trust agreement. NICO is responsible for claims handling and billing and collection from third party reinsurers related to the Company's A&EP claims.
The following table displays the impact of the Loss Portfolio Transfer on the Condensed Consolidated Statement of Operations.
Impact on Condensed Consolidated Statement of Operations
(In millions)
2010
Other operating expenses
$
529

Income tax benefit
185

Loss from continuing operations, included in the Corporate & Other Non-Core segment
(344
)
Loss from discontinued operations
(21
)
Net loss attributable to CNA
$
(365
)
In connection with the transfer of billed third party reinsurance receivables related to A&EP claims and the coverage of credit risk afforded under the terms of the Loss Portfolio Transfer, the Company reduced its allowance for uncollectible reinsurance receivables on billed third party reinsurance receivables and ceded claim and allocated claim adjustment expense reserves by $200 million. This reduction is reflected in Other operating expenses presented above.

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Net Prior Year Development
The following tables and discussion include the net prior year development recorded for CNA Specialty, CNA Commercial and Corporate & Other Non-Core.
Net Prior Year Development
Three months ended September 30, 2011
 
 
 
 
 
 
 
(In millions)
CNA
Specialty
 
CNA Commercial
 
Corporate
& Other
Non-Core
 
Total
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development
$
(5
)
 
$
(42
)
 
$
11

 
$
(36
)
Pretax (favorable) unfavorable premium development
(26
)
 
(11
)
 
1

 
(36
)
Total pretax (favorable) unfavorable net prior year development
$
(31
)
 
$
(53
)
 
$
12

 
$
(72
)
Net Prior Year Development
Three months ended September 30, 2010
 
 
 
 
 
 
 
(In millions)
CNA
Specialty
 
CNA Commercial
 
Corporate
& Other
Non-Core
 
Total
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development
$
(65
)
 
$
(26
)
 
$
2

 
$
(89
)
Pretax (favorable) unfavorable premium development
(2
)
 
(2
)
 
—

 
(4
)
Total pretax (favorable) unfavorable net prior year development
$
(67
)
 
$
(28
)
 
$
2

 
$
(93
)
Net Prior Year Development
Nine months ended September 30, 2011
 
 
 
 
 
 
 
(In millions)
CNA
Specialty
 
CNA Commercial
 
Corporate
& Other
Non-Core
 
Total
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development
$
(72
)
 
$
(99
)
 
$
5

 
$
(166
)
Pretax (favorable) unfavorable premium development
(34
)
 
21

 
—

 
(13
)
Total pretax (favorable) unfavorable net prior year development
$
(106
)
 
$
(78
)
 
$
5

 
$
(179
)
Net Prior Year Development
Nine months ended September 30, 2010
 
 
 
 
 
 
 
(In millions)
CNA
Specialty
 
CNA Commercial
 
Corporate
& Other
Non-Core
 
Total
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development
$
(215
)
 
$
(229
)
 
$
5

 
$
(439
)
Pretax (favorable) unfavorable premium development
(5
)
 
54

 
(3
)
 
46

Total pretax (favorable) unfavorable net prior year development
$
(220
)
 
$
(175
)
 
$
2

 
$
(393
)
For the three and nine months ended September 30, 2011, favorable premium development was recorded for CNA Specialty primarily due to changes in estimates of exposures in medical professional liability tail coverages.
For the nine months ended September 30, 2011, unfavorable premium development for CNA Commercial was recorded due to a further reduction of ultimate premium estimates relating to retrospectively rated policies, partially offset by premium adjustments on auditable policies due to increased exposures.
For the nine months ended September 30, 2010, unfavorable premium development for CNA Commercial was recorded due to a change in ultimate premium estimates relating to retrospectively rated policies and return premium on auditable policies due to reduced exposures.

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CNA Specialty
The following table provides further detail of the net prior year claim and allocated claim adjustment expense reserve development (development) recorded for the CNA Specialty segment for the three and nine months ended September 30, 2011 and 2010.
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development:
 
 
 
 
 
 
 
Medical Professional Liability
$
(18
)
 
$
4

 
$
(52
)
 
$
(44
)
Other Professional Liability
1

 
(28
)
 
(20
)
 
(116
)
Surety
1

 
(38
)
 
(2
)
 
(49
)
Warranty
—

 
—

 
(12
)
 
—

Other
11

 
(3
)
 
14

 
(6
)
Total pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development
$
(5
)
 
$
(65
)
 
$
(72
)
 
$
(215
)
Three Month Comparison
2011
Favorable development for medical professional liability was primarily due to favorable case incurred emergence in nurses and physicians in accident years 2008 and prior.
Other includes standard property and casualty coverages provided to CNA Specialty customers. Unfavorable development for other coverages was primarily due to increased frequency of large claims in auto and workers' compensation coverages in accident years 2009 and 2010.
2010
Favorable development for other professional liability was recorded in errors & omissions and directors & officers' coverages primarily due to reviews of large claims in accident years 2007 and prior.
Favorable development for surety coverages was primarily due to a decrease in the estimated loss on a large national contractor in accident year 2005 and lower than expected claim emergence in accident years 2007 and prior.
Nine Month Comparison
2011
Favorable development for medical professional liability was primarily due to favorable case incurred emergence in nurses, physicians, and primary institutions in accident years 2008 and prior.
Favorable development for other professional liability was driven by better than expected loss emergence in the life agents coverages.
Favorable development in warranty was driven by favorable policy year experience on an aggregate stop loss policy covering the Company's non-insurance warranty subsidiary.
Other includes standard property and casualty coverages provided to CNA Specialty customers. Unfavorable development for other coverages was primarily due to increased frequency of large claims in auto and workers' compensation coverages in accident years 2009 and 2010.

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Table of Contents

2010
Overall, favorable development for medical professional liability was primarily due to lower than expected frequency of large losses, primarily in accident years 2007 and prior. Additionally, unfavorable development in accident years 2008 and 2009 was due to increased frequency of large losses related to medical products.
Overall, favorable development for other professional liability was recorded primarily in accident years 2007 and prior in errors & omissions and directors & officers' coverages due to several factors, including reduced frequency of large claims and the result of reviews of large claims. Additionally, unfavorable development for other professional liability was recorded in accident years 2008 and 2009 in employment practices liability and errors & omissions coverages, driven by the economic recession and higher unemployment.
Favorable development for surety coverages was primarily due to a decrease in the estimated loss on a large national contractor in accident year 2005 and lower than expected claim emergence in accident years 2007 and prior.

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CNA Commercial
The following table provides further detail of the development recorded for the CNA Commercial segment for the three and nine months ended September 30, 2011 and 2010.
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development:
 
 
 
 
 
 
 
Commercial Auto
$
(2
)
 
$
(1
)
 
$
(36
)
 
$
(71
)
General Liability
4

 
(29
)
 
26

 
(71
)
Workers Compensation
3

 
39

 
39

 
39

Property and Other
(47
)
 
(35
)
 
(128
)
 
(126
)
Total pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development
$
(42
)
 
$
(26
)
 
$
(99
)
 
$
(229
)
Three Month Comparison
2011
Overall, unfavorable development for workers' compensation was related to increased medical severity and higher adjusting and other payments in accident years 2008 and subsequent. Additionally, favorable development for workers' compensation was due to reduced indemnity severity in accident years 2002 and prior.
Favorable development for property and other coverages was due to decreased frequency of large losses in accident year 2010 and favorable loss emergence related to non-catastrophe claims in accident years 2010 and prior.
2010
Overall, favorable development for general liability coverages was primarily due to better than expected loss emergence in accident years 2006 and prior in the small and middle markets business. Additionally, unfavorable development for other liability coverages was primarily due to increased frequency in accident years 2004 and prior in excess workers' compensation.
Unfavorable development for workers' compensation was related to increased severity of indemnity losses relative to expectations on claims related to Defense Base Act contractors, primarily in accident years 2008 and prior.
Favorable development was recorded for property and other coverages. Favorable property and marine development primarily reflects decreased claim frequency in accident years 2008 and 2009, and lower than expected severity for marine excess liability in accident years 2005 and prior.
Nine Month Comparison
2011
Favorable development for commercial auto coverages was due to lower than expected severity on bodily injury claims in accident years 2006 and prior.
The unfavorable development in the general liability coverages was primarily due to two large claim outcomes on umbrella claims in accident year 2001.
Unfavorable development for workers' compensation was related to increased medical severity and higher adjusting and other payments in accident years 2008 and subsequent.
Favorable development for property and other coverages was due to decreased frequency of large losses in commercial multi-peril coverages primarily in accident year 2010, a favorable settlement on an individual equipment breakdown claim in accident year 2003, favorable loss emergence related to catastrophe claims in accident year 2008 and favorable loss emergence related to non-catastrophe claims in accident years 2010 and prior.

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Table of Contents

2010
Favorable development for commercial auto coverages was primarily due to decreased frequency and severity trends in accident years 2009 and prior.
Overall, favorable development for general liability and umbrella coverages was primarily due to better than expected loss emergence in accident years 2006 and prior. Additionally, unfavorable development was primarily driven by increased claim frequency in accident years 2004 and prior for excess workers' compensation and in accident years 2008 and 2009 for a portion of the Company's primary casualty surplus lines coverages.
Unfavorable development for workers' compensation was related to increased severity of indemnity losses relative to expectations on claims related to Defense Base Act contractors primarily in accident years 2008 and prior.
Favorable development was recorded for property and other coverages. Favorable catastrophe development was due to favorable incurred loss emergence, primarily in accident years 2008 and 2009. Favorable non-catastrophe development was due to lower than expected severity in accident years 2009 and prior. Favorable marine development primarily reflects decreased claim frequency in accident years 2008 and 2009, and lower than expected severity for marine excess liability in accident years 2005 and prior.

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Table of Contents

Note G. Legal Proceedings and Contingent Liabilities
Insurance Brokerage Antitrust Litigation
In August 2005, CNAF and certain insurance subsidiaries were joined as defendants, along with other insurers and brokers, in multidistrict litigation pending in the United States District Court for the District of New Jersey, In re Insurance Brokerage Antitrust Litigation, Civil No. 04-5184 (GEB). The plaintiffs' consolidated class action complaint alleged bid rigging and improprieties in the payment of contingent commissions in connection with the sale of insurance. After various motions and preliminary court rulings providing for further proceedings, all parties executed final settlement documents and the plaintiffs filed a motion for preliminary approval of the settlement in May 2011. In June 2011, the Court entered an order preliminarily approving the settlement. A fairness hearing was held in September 2011 to determine final approval of the settlement. The Court took the matter under advisement and will issue a ruling in due course. As currently structured, the settlement will not have a material impact on the Company's results of operations. In addition, the Company does not believe it has any material ongoing exposure relating to this matter.
Other Litigation
The Company is also a party to routine litigation incidental to its business, which, based on the facts and circumstances currently known, is not material to the operations or financial condition of the Company.

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Note H. Benefit Plans
The components of net periodic cost (benefit) are presented in the following table.
Net Periodic Cost (Benefit)
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Pension cost
 
 
 
 
 
 
 
Service cost
$
3

 
$
5

 
$
10

 
$
13

Interest cost on projected benefit obligation
37

 
38

 
110

 
112

Expected return on plan assets
(44
)
 
(41
)
 
(130
)
 
(122
)
Amortization of net actuarial loss
7

 
6

 
19

 
18

Net periodic pension cost
$
3

 
$
8

 
$
9

 
$
21

 
 
 
 
 
 
 
 
Postretirement benefit
 
 
 
 
 
 
 
Service cost
$
—

 
$
—

 
$
—

 
$
1

Interest cost on projected benefit obligation
1

 
2

 
3

 
6

Amortization of prior service credit
(5
)
 
(4
)
 
(14
)
 
(12
)
Amortization of net actuarial loss
—

 
—

 
—

 
1

Net periodic postretirement benefit
$
(4
)
 
$
(2
)
 
$
(11
)
 
$
(4
)

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Table of Contents

Note I. Commitments, Contingencies, and Guarantees
Commitments and Contingencies
The Company holds an investment in a real estate joint venture. In the normal course of business, the Company, on a joint and several basis with other unrelated insurance company shareholders, has committed to continue funding the operating deficits of this joint venture. Additionally, the Company and the other unrelated shareholders, on a joint and several basis, have guaranteed an operating lease for an office building, which expires in 2016. The guarantee of the operating lease is a parallel guarantee to the commitment to fund operating deficits; consequently, the separate guarantee to the lessor is not expected to be triggered as long as the joint venture continues to be funded by its shareholders which provide liquidity to make its annual lease payments.
In the event that the other parties to the joint venture are unable to meet their commitments in funding the operations of this joint venture, the Company would be required to assume the obligation for the entire office building operating lease. The Company does not believe it is likely that it will be required to do so.  However, the maximum potential future lease payments and other related costs at September 30, 2011 that the Company could be required to pay under this guarantee, in excess of amounts already recorded, were approximately $142 million. If the Company were required to assume the entire lease obligation, the Company would have the right to pursue reimbursement from the other shareholders and the right to all sublease revenues.
The Company has entered into a limited number of contracts with minimum payments, primarily related to outsourced services and software. Estimated future minimum payments under these contracts, which amounted to approximately $35 million at September 30, 2011, were $24 million in 2011, $3 million in 2012, and $8 million thereafter.
Guarantees
In the course of selling business entities and assets to third parties, the Company has agreed to indemnify purchasers for losses arising out of breaches of representation and warranties with respect to the business entities or assets being sold, including, in certain cases, losses arising from undisclosed liabilities or certain named litigation. Such indemnification provisions generally survive for periods ranging from nine months following the applicable closing date to the expiration of the relevant statutes of limitation. As of September 30, 2011, the aggregate amount of quantifiable indemnification agreements in effect for sales of business entities, assets and third party loans was $719 million.
In addition, the Company has agreed to provide indemnification to third party purchasers for certain losses associated with sold business entities or assets that are not limited by a contractual monetary amount. As of September 30, 2011, the Company had outstanding unlimited indemnifications in connection with the sales of certain of its business entities or assets that included tax liabilities arising prior to a purchaser's ownership of an entity or asset, defects in title at the time of sale, employee claims arising prior to closing and in some cases losses arising from certain litigation and undisclosed liabilities. These indemnification agreements survive until the applicable statutes of limitation expire, or until the agreed upon contract terms expire.
As of September 30, 2011 and December 31, 2010, the Company had recorded liabilities of approximately $16 million related to indemnification agreements and management believes that it is not likely that any future indemnity claims will be significantly greater than the amounts recorded.

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Table of Contents

Note J. Business Segments
 
The Company's core property and casualty commercial insurance operations are reported in two business segments: CNA Specialty and CNA Commercial. The Company's non-core operations are managed in two segments: Life & Group Non-Core and Corporate & Other Non-Core.
The accounting policies of the segments are the same as those described in Note A of the Consolidated Financial Statements within CNAF's Annual Report on Form 10-K for the year ended December 31, 2010. The Company manages most of its assets on a legal entity basis, while segment operations are conducted across legal entities. As such, only insurance and reinsurance receivables, insurance reserves and deferred acquisition costs are readily identifiable by individual segment. Distinct investment portfolios are not maintained for each individual segment; accordingly, allocation of assets to each segment is not performed. Therefore, net investment income and realized investment gains or losses are allocated primarily based on each segment's net carried insurance reserves, as adjusted. All significant intrasegment income and expense has been eliminated. Income taxes have been allocated on the basis of the taxable income of the segments.
In the following tables, certain financial measures are presented to provide information used by management to monitor the Company's operating performance. Management utilizes these financial measures to monitor the Company's insurance operations and investment portfolio. Net operating income, which is derived from certain income statement amounts, is used by management to monitor performance of the Company's insurance operations. The Company's investment portfolio is monitored by management through analysis of various factors including unrealized gains and losses on securities, portfolio duration and exposure to interest rate, market and credit risk. Based on such analyses, the Company may recognize an OTTI loss on an investment security in accordance with its policy, or sell a security, which may produce realized gains and losses.
Net operating income (loss) 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. The calculation of net operating income excludes net realized investment gains or losses because net realized investment gains or losses are largely discretionary, except for some losses related to OTTI, and are generally driven by economic factors that are not necessarily consistent with key drivers of underwriting performance, and are therefore not considered an indication of trends in insurance operations.
The significant components of the Company's continuing operations and selected balance sheet items are presented in the following tables.


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Table of Contents

Three months ended
 
 
 
 
 
 
 
 
 
 
 
September 30, 2011
CNA
Specialty
 
CNA
Commercial
 
Life &
Group
Non-Core
 
Corporate
& Other
Non-Core
 
 
 
 
(In millions)
 
 
 
 
Eliminations
 
Total
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
Net earned premiums
$
741

 
$
848

 
$
142

 
$
2

 
$
(1
)
 
$
1,732

Net investment income
85

 
115

 
190

 
4

 
—

 
394

Other revenues
56

 
14

 
6

 
—

 
—

 
76

Total operating revenues
882

 
977

 
338

 
6

 
(1
)
 
2,202

Claims, Benefits and Expenses
 
 
 
 
 
 
 
 
 
 
 
Net incurred claims and benefits
485

 
583

 
332

 
(1
)
 
—

 
1,399

Policyholders’ dividends
(4
)
 
3

 
2

 
—

 
—

 
1

Amortization of deferred acquisition costs
170

 
181

 
5

 
—


—

 
356

Other insurance related expenses
51

 
106

 
36

 
1

 
(1
)
 
193

Other expenses
48

 
10

 
2

 
42

 
—

 
102

Total claims, benefits and expenses
750

 
883

 
377

 
42

 
(1
)
 
2,051

Operating income (loss) from continuing operations before income tax
132

 
94

 
(39
)
 
(36
)
 
—

 
151

Income tax (expense) benefit on operating income (loss)
(48
)
 
(47
)
 
25

 
11

 
—

 
(59
)
Net operating (income) loss, after-tax, attributable to noncontrolling interests
—

 
(1
)
 
—

 
—

 
—

 
(1
)
Net operating income (loss) from continuing operations attributable to CNA
84

 
46

 
(14
)
 
(25
)
 
—

 
91

Net realized investment losses, net of participating policyholders’ interests
(8
)
 
(15
)
 
(4
)
 
—

 
—

 
(27
)
Income tax benefit on net realized investment losses
3

 
5

 
1

 
1

 
—

 
10

Net realized investment (gains) losses, after-tax, attributable to noncontrolling interests
—

 
1

 
—

 
—

 
—

 
1

Net realized investment gains (losses) attributable to CNA
(5
)
 
(9
)
 
(3
)
 
1

 
—

 
(16
)
Net income (loss) from continuing operations attributable to CNA
$
79

 
$
37

 
$
(17
)
 
$
(24
)
 
$
—

 
$
75


44
Table of Contents

Three months ended
 
 
 
 
 
 
 
 
 
 
 
September 30, 2010
CNA
Specialty
 
CNA
Commercial
 
Life &
Group
Non-Core
 
Corporate
& Other
Non-Core
 
 
 
 
(In millions)
 
 
 
 
Eliminations
 
Total
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
Net earned premiums
$
679

 
$
819

 
$
145

 
$
3

 
$
(1
)
 
$
1,645

Net investment income
148

 
216

 
182

 
35

 
—

 
581

Other revenues
57

 
15

 
4

 
(1
)
 
—

 
75

Total operating revenues
884

 
1,050

 
331

 
37

 
(1
)
 
2,301

Claims, Benefits and Expenses
 
 
 
 
 
 
 
 
 
 
 
Net incurred claims and benefits
393

 
578

 
354

 
12

 
—

 
1,337

Policyholders’ dividends
2

 
4

 
1

 
—

 
—

 
7

Amortization of deferred acquisition costs
162

 
183

 
6

 
—

 
—

 
351

Other insurance related expenses
45

 
104

 
41

 
9

 
(1
)
 
198

Other expenses
47

 
14

 
7

 
569

 
—

 
637

Total claims, benefits and expenses
649

 
883

 
409

 
590

 
(1
)
 
2,530

Operating income (loss) from continuing operations before income tax
235

 
167

 
(78
)
 
(553
)
 
—

 
(229
)
Income tax (expense) benefit on operating income (loss)
(80
)
 
(54
)
 
23

 
198

 
—

 
87

Net operating (income) loss, after-tax, attributable to noncontrolling interests
(11
)
 
(5
)
 
—

 
—

 
—

 
(16
)
Net operating income (loss) from continuing operations attributable to CNA
144

 
108

 
(55
)
 
(355
)
 
—

 
(158
)
Net realized investment gains, net of participating policyholders’ interests
15

 
21

 
20

 
6

 
—

 
62

Income tax expense on net realized investment gains
(6
)
 
(8
)
 
(7
)
 
(2
)
 
—

 
(23
)
Net realized investment (gains) losses, after-tax, attributable to noncontrolling interests
—

 
1

 
—

 
—

 
—

 
1

Net realized investment gains attributable to CNA
9

 
14

 
13

 
4

 
—

 
40

Net income (loss) from continuing operations attributable to CNA
$
153

 
$
122

 
$
(42
)
 
$
(351
)
 
$
—

 
$
(118
)

45
Table of Contents

Nine months ended
 
 
 
 
 
 
 
 
 
 
 
September 30, 2011
CNA
Specialty
 
CNA
Commercial
 
Life &
Group
Non-Core
 
Corporate
& Other
Non-Core
 
 
 
 
(In millions)
 
 
 
 
Eliminations
 
Total
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
Net earned premiums
$
2,098

 
$
2,418

 
$
427

 
$
1

 
$
(2
)
 
$
4,942

Net investment income
371

 
569

 
567

 
24

 
—

 
1,531

Other revenues
164

 
40

 
6

 
4

 
—

 
214

Total operating revenues
2,633

 
3,027

 
1,000

 
29

 
(2
)
 
6,687

Claims, Benefits and Expenses
 
 
 
 
 
 
 
 
 
 
 
Net incurred claims and benefits
1,333

 
1,807

 
985

 
—

 
—

 
4,125

Policyholders’ dividends
(4
)
 
5

 
5

 
—

 
—

 
6

Amortization of deferred acquisition costs
495

 
539

 
17

 
—

 
—

 
1,051

Other insurance related expenses
147

 
291

 
108

 
4

 
(2
)
 
548

Other expenses
140

 
37

 
14

 
129

 
—

 
320

Total claims, benefits and expenses
2,111

 
2,679

 
1,129

 
133

 
(2
)
 
6,050

Operating income (loss) from continuing operations before income tax
522

 
348

 
(129
)
 
(104
)
 
—

 
637

Income tax (expense) benefit on operating income (loss)
(182
)
 
(129
)
 
78

 
34

 
—

 
(199
)
Net operating (income) loss, after-tax, attributable to noncontrolling interests
(12
)
 
(3
)
 
—

 
—

 
—

 
(15
)
Net operating income (loss) from continuing operations attributable to CNA
328

 
216

 
(51
)
 
(70
)
 
—

 
423

Net realized investment gains (losses), net of participating policyholders’ interests
7

 
13

 
(7
)
 
(12
)
 
—

 
1

Income tax (expense) benefit on net realized investment gains (losses)
(2
)
 
(4
)
 
2

 
5

 
—

 
1

Net realized investment (gains) losses, after-tax, attributable to noncontrolling interests
—

 
—

 
—

 
—

 
—

 
—

Net realized investment gains (losses) attributable to CNA
5

 
9

 
(5
)
 
(7
)
 
—

 
2

Net income (loss) from continuing operations attributable to CNA
$
333

 
$
225

 
$
(56
)
 
$
(77
)
 
$
—

 
$
425

September 30, 2011
 
 
 
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
 
 
 
 
 
 
Reinsurance receivables
$
874

 
$
1,850

 
$
1,411

 
$
2,687

 
$
—

 
$
6,822

Insurance receivables
$
650

 
$
1,161

 
$
8

 
$
9

 
$
—

 
$
1,828

Deferred acquisition costs
$
351

 
$
338

 
$
94

 
$
—

 
$
—

 
$
783

Insurance reserves
 
 
 
 
 
 
 
 
 
 
 
Claim and claim adjustment expenses
$
7,000

 
$
12,116

 
$
2,748

 
$
3,167

 
$
—

 
$
25,031

Unearned premiums
1,639

 
1,604

 
144

 
—

 
(1
)
 
3,386

Future policy benefits
—

 
—

 
9,258

 
—

 
—

 
9,258

Policyholders’ funds
16

 
10

 
150

 
—

 
—

 
176


46
Table of Contents

Nine months ended
 
 
 
 
 
 
 
 
 
 
 
September 30, 2010
CNA
Specialty
 
CNA
Commercial
 
Life &
Group
Non-Core
 
Corporate
& Other
Non-Core
 
 
 
 
(In millions)
 
 
 
 
Eliminations
 
Total
Operating revenues
 
 
 
 
 
 
 
 
 
 
 
Net earned premiums
$
1,998

 
$
2,432

 
$
436

 
$
5

 
$
(3
)
 
$
4,868

Net investment income
420

 
621

 
531

 
120

 
—

 
1,692

Other revenues
162

 
49

 
10

 
5

 
—

 
226

Total operating revenues
2,580

 
3,102

 
977

 
130

 
(3
)
 
6,786

Claims, Benefits and Expenses
 
 
 
 
 
 
 
 
 
 
 
Net incurred claims and benefits
1,115

 
1,668

 
949

 
48

 
—

 
3,780

Policyholders’ dividends
6

 
11

 
2

 
—

 
—

 
19

Amortization of deferred acquisition costs
471

 
552

 
15

 
—

 
—

 
1,038

Other insurance related expenses
139

 
318

 
137

 
10

 
(3
)
 
601

Other expenses
141

 
42

 
13

 
641

 
—

 
837

Total claims, benefits and expenses
1,872

 
2,591

 
1,116

 
699

 
(3
)
 
6,275

Operating income (loss) from continuing operations before income tax
708

 
511

 
(139
)
 
(569
)
 
—

 
511

Income tax (expense) benefit on operating income (loss)
(238
)
 
(165
)
 
67

 
204

 
—

 
(132
)
Net operating (income) loss, after-tax, attributable to noncontrolling interests
(30
)
 
(15
)
 
—

 
—

 
—

 
(45
)
Net operating income (loss) from continuing operations attributable to CNA
440

 
331

 
(72
)
 
(365
)
 
—

 
334

Net realized investment gains, net of participating policyholders’ interests
60

 
30

 
15

 
20

 
—

 
125

Income tax expense on net realized investment gains
(21
)
 
(17
)
 
(7
)
 
(6
)
 
—

 
(51
)
Net realized investment (gains) losses, after-tax, attributable to noncontrolling interests
—

 
1

 
—

 
—

 
—

 
1

Net realized investment gains attributable to CNA
39

 
14

 
8

 
14

 
—

 
75

Net income (loss) from continuing operations attributable to CNA
$
479

 
$
345

 
$
(64
)
 
$
(351
)
 
$
—

 
$
409

December 31, 2010
 
 
 
 
 
 
 
 
 
 
 
(In millions)
 
 
 
 
 
 
 
 
 
 
 
Reinsurance receivables
$
906

 
$
1,973

 
$
1,502

 
$
2,823

 
$
—

 
$
7,204

Insurance receivables
$
654

 
$
1,050

 
$
9

 
$
4

 
$
—

 
$
1,717

Deferred acquisition costs
$
330

 
$
315

 
$
434

 
$
—

 
$
—

 
$
1,079

Insurance reserves

 

 

 

 

 
 
Claim and claim adjustment expenses
$
6,793

 
$
12,522

 
$
2,739

 
$
3,442

 
$
—

 
$
25,496

Unearned premiums
1,543

 
1,526

 
132

 
2

 
—

 
3,203

Future policy benefits
—

 
—

 
8,718

 
—

 
—

 
8,718

Policyholders’ funds
16

 
13

 
144

 
—

 
—

 
173



47
Table of Contents

The following table provides revenue by line of business for each reportable segment. Revenues are comprised of operating revenues and net realized investment gains and losses, net of participating policyholders’ interests.
Revenues by Line of Business
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
CNA Specialty
 
 
 
 
 
 
 
International
$
54

 
$
51

 
$
159

 
$
150

Professional & Management Liability
623

 
650

 
1,909

 
1,915

Surety
123

 
124

 
353

 
357

Warranty & Alternative Risks
74

 
74

 
219

 
218

CNA Specialty revenues
874

 
899

 
2,640

 
2,640

CNA Commercial
 
 
 
 
 
 
 
CNA Select Risk
65

 
69

 
203

 
195

Commercial Insurance
622

 
737

 
2,015

 
2,147

International
133

 
123

 
390

 
367

Small Business
142

 
142

 
432

 
423

CNA Commercial revenues
962

 
1,071

 
3,040

 
3,132

Life & Group Non-Core
 
 
 
 
 
 
 
Health
274

 
276

 
818

 
796

Life & Annuity
55

 
69

 
170

 
185

Other
5

 
6

 
5

 
11

Life & Group Non-Core revenues
334

 
351

 
993

 
992

Corporate & Other Non-Core revenues
6

 
43

 
17

 
150

Eliminations
(1
)
 
(1
)
 
(2
)
 
(3
)
Total revenues
$
2,175

 
$
2,363

 
$
6,688

 
$
6,911


48
Table of Contents

CNA Financial Corporation
Item 2. Management’s Discussion and Analysis (MD&A) of Financial Condition and Results of Operations
Overview
The following discussion highlights significant factors impacting the Company. References to “we,” “our,” “us” or like terms refer to the business of CNA. Based on 2010 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 of America. 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.
The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements included under Part I, Item 1 of this Form 10-Q and Item 1A Risk Factors and Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations, which are included in our Annual Report on Form 10-K filed with the SEC for the year ended December 31, 2010.
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 J of the Condensed Consolidated Financial Statements included under Part I, Item 1. 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 of the Condensed Consolidated Financial Statements included under Part I, Item 1.
Agreement to Cede Asbestos and Environmental Pollution (A&EP) Liabilities to National Indemnity Company (NICO)
As further discussed in Note F of the Condensed Consolidated Financial Statements included under Part I, Item 1, 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). We recognized an after-tax net loss of $365 million in the third quarter of 2010, of which $344 million related to our continuing operations and $21 million related to our discontinued operations.

49
Table of Contents

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.
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Operating Revenues
 
 
 
 
 
 
 
Net earned premiums
$
1,732

 
$
1,645

 
$
4,942

 
$
4,868

Net investment income
394

 
581

 
1,531

 
1,692

Other revenues
76

 
75

 
214

 
226

Total operating revenues
2,202

 
2,301

 
6,687

 
6,786

Claims, Benefits and Expenses
 
 
 
 
 
 
 
Net incurred claims and benefits
1,399

 
1,337

 
4,125

 
3,780

Policyholders’ dividends
1

 
7

 
6

 
19

Amortization of deferred acquisition costs
356

 
351

 
1,051

 
1,038

Other insurance related expenses
193

 
198

 
548

 
601

Other expenses
102

 
637

 
320

 
837

Total claims, benefits and expenses
2,051

 
2,530

 
6,050

 
6,275

Operating income (loss) from continuing operations before income tax
151

 
(229
)
 
637

 
511

Income tax (expense) benefit on operating income (loss)
(59
)
 
87

 
(199
)
 
(132
)
Net operating (income) loss, after-tax, attributable to noncontrolling interests
(1
)
 
(16
)
 
(15
)
 
(45
)
Net operating income (loss) from continuing operations attributable to CNA
91

 
(158
)
 
423

 
334

Net realized investment gains (losses), net of participating policyholders’ interests
(27
)
 
62

 
1

 
125

Income tax (expense) benefit on net realized investment gains (losses)
10

 
(23
)
 
1

 
(51
)
Net realized investment (gains) losses, after-tax, attributable to noncontrolling interests
1

 
1

 
—

 
1

Net realized investment gains (losses) attributable to CNA
(16
)
 
40

 
2

 
75

Income (loss) from continuing operations attributable to CNA
75

 
(118
)
 
425

 
409

Income (loss) from discontinued operations attributable to CNA
—

 
(22
)
 
(1
)
 
(21
)
Net income (loss) attributable to CNA
$
75

 
$
(140
)
 
$
424

 
$
388

Three Month Comparison
Net results increased $215 million for the three months ended September 30, 2011 as compared with the same period in 2010, due primarily to a loss in 2010 associated with the Loss Portfolio Transfer. Excluding the loss associated with the Loss Portfolio Transfer, net income decreased $150 million for the three months ended September 30, 2011 as compared with the same period in 2010. This decrease was primarily driven by significantly unfavorable limited partnership results. On a pretax basis, limited partnerships produced a loss of $93 million for the three months ended September 30, 2011, as compared to income of $68 million for the three months ended September 30, 2010.
Net realized investment results decreased $56 million for the three months ended September 30, 2011 as compared with the same period in 2010. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.

50
Table of Contents

Net operating results increased $249 million for the three months ended September 30, 2011 as compared with the same period in 2010. Excluding the loss associated with the Loss Portfolio Transfer, net operating income decreased $95 million for the three months ended September 30, 2011 as compared with the same period in 2010. Net operating income decreased $122 million for our core segments, CNA Specialty and CNA Commercial. This decrease was due to decreased net investment income, reflecting the unfavorable results from limited partnerships as discussed above, and higher catastrophe losses. Catastrophe losses were $32 million after-tax for the three months ended September 30, 2011 as compared to $8 million after-tax for the same period in 2010. Net operating results improved $27 million for our non-core segments, primarily due to the favorable period over period impact of a $39 million pretax and after-tax increase to payout annuity benefit reserves recorded in 2010.
Favorable net prior year development of $72 million and $93 million was recorded for the three months ended September 30, 2011 and 2010 related to our CNA Specialty, CNA Commercial and Corporate & Other Non-Core segments. Further information on net prior year development for the three months ended September 30, 2011 and 2010 is included in Note F to the Condensed Consolidated Financial Statements included under Part I, Item 1.
Net loss from discontinued operations for the three months ended September 30, 2010 was primarily due to the loss associated with the Loss Portfolio Transfer.
Nine Month Comparison
Net income increased $36 million for the nine months ended September 30, 2011 as compared with the same period in 2010. Excluding the loss associated with the Loss Portfolio Transfer, net income decreased $329 million for the nine months ended September 30, 2011 as compared with the same period in 2010, due to lower net operating income and decreased net realized investment gains.
Net realized investment gains decreased $73 million for the nine months ended September 30, 2011 as compared with the same period in 2010. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.
Net operating income increased $89 million for the nine months ended September 30, 2011 as compared with the same period in 2010. Excluding the loss associated with the Loss Portfolio Transfer, net operating income decreased $255 million for the nine months ended September 30, 2011 as compared with the same period in 2010. Net operating income decreased $227 million for our core segments, CNA Specialty and CNA Commercial, primarily due to the same reasons as discussed above in the three month comparison, as well as a lower level of favorable net prior year development. Catastrophe losses were $133 million after-tax for the nine months ended September 30, 2011 as compared to $65 million after-tax for the same period in 2010. Expenses in 2010 were unfavorably impacted by costs associated with our Information Technology (IT) Transformation as discussed below. Net operating results decreased $28 million for our non-core segments, as further discussed in the Life & Group Non-Core and Corporate & Other Non-Core sections in this MD&A.
In 2010 we commenced a program to significantly transform our IT organization and delivery model. A key initiative was moving to a managed services model which involved outsourcing our infrastructure and application development functions to selected vendors that possess proven skills and scale. The IT Transformation is expected to improve both the efficiency and effectiveness of IT delivery in support of our businesses. Total costs of the program were $37 million, of which $36 million were incurred in 2010. The costs by reportable segment for the nine months ended September 30, 2010 were as follows.
IT Transformation Costs by Segment
Nine months ended September 30
 
(In millions)
2010
CNA Specialty
$
7

CNA Commercial
15

Life & Group Non-Core
9

Corporate & Other Non-Core
3

Total IT Transformation Costs
$
34


51
Table of Contents

The savings resulting from this program are being reinvested in IT and other property and casualty underwriting areas necessary to support our business strategies.
Favorable net prior year development of $179 million and $393 million was recorded for the nine months ended September 30, 2011 and 2010 related to our CNA Specialty, CNA Commercial and Corporate & Other Non-Core segments. Further information on net prior year development for the nine months ended September 30, 2011 and 2010 is included in Note F to the Condensed Consolidated Financial Statements included under Part I, Item 1.
Net loss from discontinued operations for the nine months ended September 30, 2010 was primarily due to the loss associated with the Loss Portfolio Transfer.

52
Table of Contents

Critical Accounting Estimates
The preparation of the Condensed Consolidated Financial Statements (Unaudited) in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the Condensed Consolidated Financial Statements and the amounts of revenues and expenses reported during the period. Actual results may differ from those estimates.
Our Condensed Consolidated Financial Statements and accompanying notes have been prepared in accordance with GAAP applied on a consistent basis. We continually evaluate the accounting policies and estimates used to prepare the Condensed Consolidated Financial Statements. In general, our estimates are based on historical experience, evaluation of current trends, information from third party professionals and various other assumptions that are believed to be reasonable under the known facts and circumstances.
The accounting estimates below are considered by us to be critical to an understanding of our Condensed Consolidated Financial Statements as their application places the most significant demands on our judgment.
•
Insurance Reserves
•
Reinsurance and Insurance Receivables
•
Valuation of Investments and Impairment of Securities
•
Long Term Care Products and Payout Annuity Contracts
•
Pension and Postretirement Benefit Obligations
•
Income Taxes
Due to the inherent uncertainties involved with these types of judgments, actual results could differ significantly from estimates and may have a material adverse impact on our results of operations or equity. See the Critical Accounting Estimates section of our Management's Discussion and Analysis of Financial Condition and Results of Operations included under Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2010 for further information.

53
Table of Contents

SEGMENT RESULTS
The following discusses the results of continuing operations for our operating segments.
CNA SPECIALTY
The following table details the results of operations for CNA Specialty.
Results of Operations
Periods ended September 30
Three Months
 
Nine Months
(In millions, except ratios)
2011
 
2010
 
2011
 
2010
Net written premiums
$
750

 
$
706

 
$
2,172

 
$
2,009

Net earned premiums
741

 
679

 
2,098

 
1,998

Net investment income
85

 
148

 
371

 
420

Net operating income
84

 
144

 
328

 
440

Net realized investment gains (losses), after-tax
(5
)
 
9

 
5

 
39

Net income
79

 
153

 
333

 
479

Ratios
 
 
 
 
 
 
 
Loss and loss adjustment expense
65.5
 %
 
57.8
%
 
63.6
 %
 
55.8
%
Expense
29.8

 
30.4

 
30.5

 
30.5

Dividend
(0.6
)
 
0.3

 
(0.2
)
 
0.3

Combined
94.7
 %
 
88.5
%
 
93.9
 %
 
86.6
%
Three Month Comparison
Net written premiums for CNA Specialty increased $44 million for the three months ended September 30, 2011 as compared with the same period in 2010, primarily driven by new business. Net earned premiums increased $62 million as compared to the same period in 2010, consistent with increases in net written premiums in recent quarters and favorable premium development in 2011.
CNA Specialty's average rate was flat for the three months ended September 30, 2011, as compared to a decrease of 3% for the three months ended September 30, 2010 for the policies that renewed in each period. Retention of 86% was achieved in each period.
Net income decreased $74 million for the three months ended September 30, 2011 as compared with the same period in 2010. This decrease was due to lower net operating income and decreased net realized investment results.
Net operating income decreased $60 million for the three months ended September 30, 2011 as compared with the same period in 2010, primarily due to decreased net investment income and a lower level of favorable net prior year development.
The combined ratio increased 6.2 points for the three months ended September 30, 2011 as compared with the same period in 2010. The loss ratio increased 7.7 points, primarily due to a lower level of favorable net prior year development as well as the impact of a higher current accident year loss ratio. The 2011 current accident year loss ratio was unfavorably affected by the loss cost trend that exceeded earned rate levels. The expense ratio improved 0.6 points, due to the favorable impact of the higher net earned premium base.
Favorable net prior year development of $31 million and $67 million was recorded for the three months ended September 30, 2011 and 2010. Further information on CNA Specialty's net prior year development for the three months ended September 30, 2011 and 2010 is included in Note F to the Condensed Consolidated Financial Statements included under Part I, Item 1.

54
Table of Contents

Nine Month Comparison
Net written premiums for CNA Specialty increased $163 million and net earned premiums increased $100 million for the nine months ended September 30, 2011 as compared with the same period in 2010, primarily due to the same reasons discussed above in the three month comparison.
CNA Specialty's average rate was flat for the nine months ended September 30, 2011, as compared to a decrease of 2% for the nine months ended September 30, 2010 for the policies that renewed in each period. Retention of 86% was achieved in each period.
Net income decreased $146 million and net operating income decreased $112 million for the nine months ended September 30, 2011 as compared with the same period in 2010, primarily due to the same reasons discussed above in the three month comparison.
The combined ratio increased 7.3 points for the nine months ended September 30, 2011 as compared with the same period in 2010. The loss ratio increased 7.8 points, primarily due to a lower level of favorable net prior year development as well as the impact of a higher current accident year loss ratio. The 2011 current accident year loss ratio was unfavorably affected by the loss cost trend that exceeded earned rate levels.
Favorable net prior year development of $106 million and $220 million was recorded for the nine months ended September 30, 2011 and 2010. Further information on CNA Specialty's net prior year development for the nine months ended September 30, 2011 and 2010 is included in Note F to the Condensed Consolidated Financial Statements included under Part I, Item 1.
The following table summarizes the gross and net carried reserves as of September 30, 2011 and December 31, 2010 for CNA Specialty.
Gross and Net Carried Claim and Claim Adjustment Expense Reserves
(In millions)
September 30,
2011
 
December 31,
2010
Gross Case Reserves
$
2,472

 
$
2,341

Gross IBNR Reserves
4,528

 
4,452

Total Gross Carried Claim and Claim Adjustment Expense Reserves
$
7,000

 
$
6,793

Net Case Reserves
$
2,110

 
$
1,992

Net IBNR Reserves
4,039

 
3,926

Total Net Carried Claim and Claim Adjustment Expense Reserves
$
6,149

 
$
5,918


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CNA COMMERCIAL
The following table details the results of operations for CNA Commercial.
Results of Operations
Periods ended September 30
Three Months
 
Nine Months
(In millions, except ratios)
2011
 
2010
 
2011
 
2010
Net written premiums
$
836

 
$
763

 
$
2,544

 
$
2,430

Net earned premiums
848

 
819

 
2,418

 
2,432

Net investment income
115

 
216

 
569

 
621

Net operating income
46

 
108

 
216

 
331

Net realized investment gains (losses), after-tax
(9
)
 
14

 
9

 
14

Net income
37

 
122

 
225

 
345

Ratios
 
 
 
 
 
 
 
Loss and loss adjustment expense
68.7
%
 
70.3
%
 
74.7
%
 
68.5
%
Expense
33.9

 
35.1

 
34.4

 
35.8

Dividend
0.4

 
0.4

 
0.2

 
0.4

Combined
103.0
%
 
105.8
%
 
109.3
%
 
104.7
%
Three Month Comparison
Net written premiums for CNA Commercial increased $73 million for the three months ended September 30, 2011 as compared with the same period in 2010. This increase was driven by continued positive rate achievement, improved economic conditions reflected in insured exposures, as well as improved reinsurance costs and new business levels in certain business lines. Net earned premiums increased $29 million for the three months ended September 30, 2011 as compared with the same period in 2010, consistent with modest increases in net written premiums in recent quarters.
CNA Commercial's average rate increased 2% for the three months ended September 30, 2011, and was flat for the three months ended September 30, 2010 for the policies that renewed in each period. Retention of 79% and 81% were achieved in each period.
Net income decreased $85 million for the three months ended September 30, 2011 as compared with the same period in 2010. This decrease was due to lower net operating income and decreased net realized investment results.
Net operating income decreased $62 million for the three months ended September 30, 2011 as compared with the same period in 2010. This decrease was primarily due to lower net investment income and higher catastrophe losses, partially offset by improved non-catastrophe current accident year underwriting results and increased favorable net prior year development. Additionally, income tax expense of $22 million was recorded due to an increase in the tax rate applicable to the undistributed earnings of a 50% owned subsidiary now under contract for sale. Previously, it was anticipated that a dividend rate would be applicable to these undistributed earnings. A modest realized gain will be recognized in the fourth quarter upon closing of the sale.
The combined ratio improved 2.8 points for the three months ended September 30, 2011 as compared with the same period in 2010. The loss ratio improved 1.6 points, primarily due to increased favorable net prior year development and an improved current accident year non-catastrophe loss ratio, partially offset by higher catastrophe losses. Catastrophe losses were $46 million, or 5.5 points of the loss ratio, for the three months ended September 30, 2011, as compared to $11 million, or 1.4 points of the loss ratio, for the same period in 2010. The expense ratio improved 1.2 points, primarily due to the favorable period over period impact of changes in estimates for insurance-related assessments recorded in 2010.
Favorable net prior year development of $53 million and $28 million was recorded for the three months ended September 30, 2011 and 2010. Further information on CNA Commercial net prior year development for the three months ended September 30, 2011 and 2010 is included in Note F to the Condensed Consolidated Financial Statements included under Part I, Item 1.

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Table of Contents

Nine Month Comparison
Net written premiums for CNA Commercial increased $114 million for the nine months ended September 30, 2011, primarily due to the same reasons discussed above in the three month comparison.
CNA Commercial's average rate increased 2% for the nine months ended September 30, 2011, as compared with an increase of 1% for the nine months ended September 30, 2010 for the policies that renewed in each period. Retention of 79% was achieved in each period.
Net income decreased $120 million for the nine months ended September 30, 2011 as compared with the same period in 2010, due to the same reasons discussed above in the three month comparison.
Net operating income decreased $115 million for the nine months ended September 30, 2011 as compared with the same period in 2010, primarily due to higher catastrophe losses, a lower level of favorable net prior year development, lower net investment income, as well as the tax expense item discussed above in the three month comparison. These unfavorable impacts were partially offset by improved non-catastrophe current accident year underwriting results, including lower expenses. In 2010, expenses were unfavorably impacted by IT transformation costs.
The combined ratio increased 4.6 points for the nine months ended September 30, 2011 as compared with the same period in 2010. The loss ratio increased 6.2 points, due to a lower level of favorable net prior year development and higher catastrophe losses, partially offset by an improved current accident year non-catastrophe loss ratio. Catastrophe losses were $195 million, or 8.1 points of the loss ratio, for the nine months ended September 30, 2011, as compared to $94 million, or 3.9 points of the loss ratio, for the same period in 2010.
The expense ratio improved 1.4 points for the nine months ended September 30, 2011 as compared with the same period in 2010, primarily due to the favorable impact of recoveries in 2011 on insurance receivables written off in prior years and the impact of IT Transformation costs incurred in the first quarter of 2010.
Favorable net prior year development of $78 million and $175 million was recorded for the nine months ended September 30, 2011 and 2010. Further information on CNA Commercial net prior year development for the nine months ended September 30, 2011 and 2010 is included in Note F to the Condensed Consolidated Financial Statements included under Part I, Item 1.
The following table summarizes the gross and net carried reserves as of September 30, 2011 and December 31, 2010 for CNA Commercial.
Gross and Net Carried Claim and Claim Adjustment Expense Reserves
(In millions)
September 30,
2011
 
December 31,
2010
Gross Case Reserves
$
6,381

 
$
6,390

Gross IBNR Reserves
5,735

 
6,132

Total Gross Carried Claim and Claim Adjustment Expense Reserves
$
12,116

 
$
12,522

Net Case Reserves
$
5,445

 
$
5,349

Net IBNR Reserves
4,948

 
5,292

Total Net Carried Claim and Claim Adjustment Expense Reserves
$
10,393

 
$
10,641


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Table of Contents

LIFE & GROUP NON-CORE
The following table summarizes the results of operations for Life & Group Non-Core.
Results of Operations
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Net earned premiums
$
142

 
$
145

 
$
427

 
$
436

Net investment income
190

 
182

 
567

 
531

Net operating loss
(14
)
 
(55
)
 
(51
)
 
(72
)
Net realized investment gains (losses), after-tax
(3
)
 
13

 
(5
)
 
8

Net loss
(17
)
 
(42
)
 
(56
)
 
(64
)
Three Month Comparison
Net earned premiums for Life & Group Non-Core decreased $3 million for the three months ended September 30, 2011 as compared with the same period in 2010. Net earned premiums relate primarily to the individual and group long term care businesses.
Net loss decreased $25 million for the three months ended September 30, 2011 as compared with the same period in 2010. This improvement was primarily due to a $39 million pretax and after-tax increase to payout annuity benefit reserves recognized during the third quarter of 2010, resulting from unlocking assumptions due to loss recognition. Lower expenses also contributed to this improvement. These favorable impacts were partially offset by unfavorable realized investment results and unfavorable performance on our remaining 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 may record an additional pretax liability in Policyholders' funds based on the results of the investments supporting this business. During the third quarter of 2011, we increased this pretax liability by $6 million. During the third quarter of 2010, we decreased this pretax liability by $7 million.
Nine Month Comparison
Net earned premiums for Life & Group Non-Core decreased $9 million for the nine months ended September 30, 2011 as compared with the same period in 2010.
Net loss decreased $8 million for the nine months ended September 30, 2011 as compared with the same period in 2010, primarily due to the same reasons discussed above in the three month comparison. In 2010, expenses were unfavorably impacted by IT transformation costs. These impacts were partially offset by a $15 million after-tax favorable impact in 2010 of reserve development arising from a commutation of an assumed reinsurance agreement.
We increased the pretax liability related to our pension deposit business, as discussed above, by $4 million during the nine months ended September 30, 2011 and decreased this pretax liability by $26 million during the nine months ended September 30, 2010. As of September 30, 2011, the remaining additional liability in Policyholders' funds for these separate account investment contracts was $6 million.

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Table of Contents

CORPORATE & OTHER NON-CORE
The following table summarizes the results of operations for the Corporate & Other Non-Core segment, including asbestos and environmental pollution (A&EP) and intrasegment eliminations.
Results of Operations
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Net investment income
$
4

 
$
35

 
$
24

 
$
120

Net operating loss
(25
)
 
(355
)
 
(70
)
 
(365
)
Net realized investment gains (losses), after-tax
1

 
4

 
(7
)
 
14

Net loss
(24
)
 
(351
)
 
(77
)
 
(351
)
Three Month Comparison
Net loss decreased $327 million for the three months ended September 30, 2011 as compared with the same period in 2010, primarily driven by the after-tax net loss of $344 million as a result of the Loss Portfolio Transfer consummated in the third quarter of 2010, as previously discussed in Note F to the Condensed Consolidated Financial Statements included under Part I, Item 1. As a result of that transaction, the investment income allocated to the Corporate & Other Non-Core segment decreased because of the lower net reserve base and associated risk capital. Claim adjustment expenses are lower because the counterparty to the Loss Portfolio Transfer is responsible for A&EP claim handling.
Additionally, the decrease in net loss was driven by a $15 million pretax release of a previously established allowance for uncollectible reinsurance receivables arising from a change in estimate. This was partially offset by decreased net realized investment results and higher interest expense. The increase in interest expense primarily relates to the use of debt to fund a portion of the 2010 redemption of our preferred stock.
Unfavorable net prior year development of $12 million was recorded for the three months ended September 30, 2011, compared to unfavorable net prior year development of $2 million for the same period of 2010.
Nine Month Comparison
Net loss decreased $274 million for the nine months ended September 30, 2011 as compared with the same period in 2010, primarily due to the same reasons discussed above in the three month comparison.
Unfavorable net prior year development of $5 million was recorded for the nine months ended September 30, 2011, compared to unfavorable net prior year development of $2 million for the same period of 2010.
The following table summarizes the gross and net carried reserves as of September 30, 2011 and December 31, 2010 for Corporate & Other Non-Core.
Gross and Net Carried Claim and Claim Adjustment Expense Reserves
(In millions)
September 30,
2011
 
December 31,
2010
Gross Case Reserves
$
1,337

 
$
1,430

Gross IBNR Reserves
1,830

 
2,012

Total Gross Carried Claim and Claim Adjustment Expense Reserves
$
3,167

 
$
3,442

Net Case Reserves
$
356

 
$
461

Net IBNR Reserves
265

 
257

Total Net Carried Claim and Claim Adjustment Expense Reserves
$
621

 
$
718


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Table of Contents

INVESTMENTS
Net Investment Income
The significant components of pretax net investment income are presented in the following table.
Net Investment Income
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Fixed maturity securities
$
494

 
$
511

 
$
1,505

 
$
1,540

Short term investments
2

 
2

 
6

 
13

Limited partnership investments
(93
)
 
68

 
32

 
136

Equity securities
4

 
7

 
16

 
26

Mortgage loans
2

 
1

 
6

 
1

Trading portfolio
(1
)
 
4

 
5

 
10

Other
1

 
2

 
6

 
7

Gross investment income
409

 
595

 
1,576

 
1,733

Investment expense
(15
)
 
(14
)
 
(45
)
 
(41
)
Net investment income
$
394

 
$
581

 
$
1,531

 
$
1,692

Net investment income for the three months ended September 30, 2011 decreased $187 million as compared with the same period in 2010. The decrease was primarily driven by a significant decrease in limited partnership results as well as lower fixed maturity security income. Limited partnership results were adversely impacted by negative equity market returns, widening credit spreads and overall capital market volatility. Limited partnership investments generally present greater volatility, higher illiquidity and greater risk than fixed income investments. The decrease in fixed maturity security income was driven primarily by a decline in the effective income yield of the portfolio.
Net investment income for the nine months ended September 30, 2011 decreased $161 million as compared with the same period in 2010. The decrease was primarily due to the same reasons discussed above in the three month comparison.
The fixed maturity investment portfolio provided a pretax effective income yield of 5.5% and 5.6% for the nine months ended September 30, 2011 and 2010. Tax-exempt municipal bonds generated $60 million and $174 million of net investment income for the three and nine months ended September 30, 2011, compared with $61 million and $207 million of net investment income for the same periods in 2010.

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Table of Contents

Net Realized Investment Gains (Losses)
The components of net realized investment results are presented in the following table.
Net Realized Investment Gains (Losses)
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2011
 
2010
 
2011
 
2010
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate and other bonds
$
(28
)
 
$
47

 
$
63

 
$
110

States, municipalities and political subdivisions
13

 
7

 
3

 
15

Asset-backed
(15
)
 
22

 
(62
)
 
32

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

 
—

 
1

 
4

Foreign government
1

 
—

 
3

 
1

Redeemable preferred stock
—

 
—

 
3

 
7

Total fixed maturity securities
(29
)
 
76

 
11

 
169

Equity securities
(1
)
 
(17
)
 
(3
)
 
(42
)
Derivative securities
1

 
(1
)
 
—

 
(1
)
Short term investments and other
2

 
4

 
(7
)
 
(1
)
Net realized investment gains (losses), net of participating policyholders’ interests
(27
)
 
62

 
1

 
125

Income tax (expense) benefit on net realized investment gains (losses)
10

 
(23
)
 
1

 
(51
)
Net realized investment (gains) losses, after-tax, attributable to noncontrolling interests
1

 
1

 
—

 
1

Net realized investment gains (losses) attributable to CNA
$
(16
)
 
$
40

 
$
2

 
$
75

Net realized investment results decreased $56 million and $73 million for the three and nine months ended September 30, 2011 compared with the same periods in 2010. Results for the nine months ended September 30, 2011 include a $6 million after-tax loss on the early extinguishment of debt. Further information on our realized gains and losses, including our OTTI losses and impairment decision process, is set forth in Note C to the Condensed Consolidated Financial Statements included under Part I, Item 1.
Portfolio Quality
Our fixed maturity portfolio consists primarily of high quality bonds, 92% and 91% of which were rated as investment grade (rated BBB- or higher) at September 30, 2011 and December 31, 2010. 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 Moody's, 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.
The following table summarizes the ratings of our fixed maturity portfolio at fair value.
Fixed Maturity Ratings
(In millions)
September 30,
2011
 
%
 
December 31,
2010
 
%
U.S. Government, Government agencies and Government-sponsored enterprises
$
4,427

 
11
%
 
$
4,003

 
11
%
AAA rated
3,795

 
10

 
3,950

 
10

AA and A rated
17,663

 
45

 
15,665

 
42

BBB rated
10,213

 
26

 
10,425

 
28

Non-investment grade
3,358

 
8

 
3,534

 
9

Total
$
39,456

 
100
%
 
$
37,577

 
100
%

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Table of Contents

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 $3,402 million and $3,490 million at September 30, 2011 and December 31, 2010. The following table summarizes the ratings of this portfolio at fair value.
Non-investment Grade
(In millions)
September 30,
2011
 
%
 
December 31,
2010
 
%
BB
$
1,491

 
44
%
 
$
1,492

 
42
%
B
958

 
29

 
1,163

 
33

CCC — C
803

 
24

 
801

 
23

D
106

 
3

 
78

 
2

Total
$
3,358

 
100
%
 
$
3,534

 
100
%
At September 30, 2011 and December 31, 2010, approximately 98% of the fixed maturity portfolio was issued or guaranteed by the U.S. Government, Government agencies or Government-sponsored enterprises or was rated by S&P or Moody's. The remaining bonds were rated by other rating agencies or internally.
The fair value of fixed maturity and equity securities that trade in illiquid private placement markets at September 30, 2011 was $280 million, which represents approximately 0.6% of our total investment portfolio. These securities were in a net unrealized gain position of $8 million at September 30, 2011.
The gross unrealized loss on available-for-sale fixed maturity securities was $546 million at September 30, 2011. 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
Fair Value
 
Percent of
Unrealized Loss
Due in one year or less
7
%
 
4
%
Due after one year through five years
34

 
23

Due after five years through ten years
30

 
31

Due after ten years
29

 
42

Total
100
%
 
100
%
Select Asset Class Discussion
Our fixed maturity portfolio includes exposure to sub-prime residential mortgages (sub-prime) and Alternative A residential mortgages that have lower than normal standards of loan documentation (Alt-A), as measured by the original deal structure. As of September 30, 2011, the fair value of sub-prime securities was $368 million with associated net unrealized losses of $39 million, 65% of which were rated investment grade. As of September 30, 2011, the fair value of Alt-A securities was $553 million with associated net unrealized losses of $15 million, 71% of which were rated investment grade. Pretax OTTI losses of $42 million for securities with sub-prime and Alt-A exposure were included in the $99 million of pretax OTTI losses related to asset-backed securities recognized in earnings on the Condensed Consolidated Statement of Operations for the nine months ended September 30, 2011. If additional deterioration in the underlying collateral occurs beyond our current expectations, additional OTTI losses may be recognized in earnings. See Note C to the Condensed Consolidated Financial Statements included under Part I, Item 1 for additional information related to unrealized losses on asset-backed securities.

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Table of Contents

Our fixed maturity portfolio also includes European exposure. The following table summarizes European exposure included within fixed maturity holdings.
European Exposure
September 30, 2011
Corporate
 
Sovereign
 
Total
(In millions)
Financial Sector
 
Other Sectors
 
 
 
 
AAA
$
233

 
$
—

 
$
172

 
$
405

AA
295

 
161

 
13

 
469

A
851

 
697

 
—

 
1,548

BBB
105

 
1,019

 
—

 
1,124

Non-investment grade
5

 
171

 
—

 
176

Total fair value
$
1,489

 
2,048

 
$
185

 
$
3,722

Total amortized cost
$
1,502

 
$
1,858

 
$
181

 
$
3,541

European exposure is based on application of a country of risk methodology. Country of risk is derived from the issuing entity's management location, country of primary listing, revenue and reporting currency. As of September 30, 2011, 81% of our European exposure is denominated in U.S. dollars and approximately 68% relates to securities for which the country of risk is the United Kingdom, France, Germany or the Netherlands. European exposure includes investments in Greece, Ireland, Italy, Portugal and Spain with a fair value and amortized cost of $439 million and $437 million as of September 30, 2011, of which $12 million and $13 million relates to sovereign securities.
Duration
A primary objective in the management of the investment portfolio 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 and to meet future liquidity needs, minimize interest rate risk and maintain a level of income sufficient to support the underlying insurance liabilities. For portfolios where future liability cash flows are determinable and typically long term in nature, we segregate investments for asset/liability management purposes. The segregated investments support the liabilities 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 accounts payable and receivable amounts for securities purchased and sold, but not yet settled.
Effective Durations
 
September 30, 2011
 
December 31, 2010
(In millions)
Fair Value
 
Effective
Duration
(In years)
 
Fair Value
 
Effective
Duration
(In years)
Investments supporting Life & Group Non-Core
$
13,283

 
11.4

 
$
11,825

 
11.0

Other interest sensitive investments
27,993

 
4.0

 
28,096

 
4.5

Total
$
41,276

 
6.4

 
$
39,921

 
6.4


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Table of Contents

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 the Quantitative and Qualitative Disclosures About Market Risk in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2010.
Short Term Investments
The carrying value of the components of the short term investment portfolio is presented in the following table.
Short Term Investments
 
September 30,
2011
 
December 31,
2010
(In millions)
 
Short term investments:
 
 
 
Commercial paper
$
507

 
$
686

U.S. Treasury securities
877

 
903

Money market funds
88

 
94

Other
258

 
532

Total short term investments
$
1,730

 
$
2,215


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Table of Contents

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. Additionally, cash may be paid or received for income taxes.
For the nine months ended September 30, 2011, net cash provided by operating activities was $813 million as compared with net cash used by operating activities of $673 million for the same period in 2010. In 2010, we completed a transaction whereby substantially all of our legacy A&EP liabilities were ceded to National Indemnity Company (NICO). As a result of this transaction, operating cash flows were reduced for the initial net cash settlement with NICO.
Additionally, we received a federal income tax refund of $10 million in 2011 compared to $328 million in 2010. Further, because cash receipts and cash payments resulting from purchases and sales of trading securities are reported as cash flows related to operating activities, during 2010 operating cash flows were increased by $125 million related to net cash inflows primarily from sales of trading securities as compared to a decrease of $8 million during 2011 related to net trading cash outflows. Excluding the items above, net cash generated by our business operations was approximately $811 million for 2011 and $775 million for 2010.
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 resale.
For the nine months ended September 30, 2011, net cash used by investing activities was $217 million as compared with net cash provided by investing activities of $860 million for the same period in 2010. Investing cash flows related principally to purchases and sales of fixed maturity securities and short term investments. The cash flow from investing activities is impacted by various factors such as the anticipated payment of claims, financing activity, asset/liability management and individual security buy and sell decisions made in the normal course of portfolio management. Net cash provided by investing activities in 2010 primarily related to the sale of short term investments which was used to fund the $1.9 billion initial net cash settlement with NICO as discussed above.
Cash flows from financing activities include proceeds from the issuance of debt and equity securities, outflows for stockholder dividends or repayment of debt and outlays to reacquire equity instruments.
For the nine months ended September 30, 2011, net cash used by financing activities was $588 million as compared with $245 million for the same period in 2010. During 2011, we purchased the noncontrolling interest of CNA Surety. Additionally, during 2011 we issued $400 million of 5.75% senior notes due August 15, 2021 and used the net proceeds of the offering, together with cash on hand, to redeem the outstanding $400 million aggregate principal amount of 6.00% senior notes due August 15, 2011, plus accrued and unpaid interest thereon, along with a call premium.
Dividends
On August 31, 2011, we paid a quarterly dividend of $0.10 per share to stockholders of record on August 15, 2011. On October 28, 2011, we declared a quarterly dividend of $0.10 per share, payable November 30, 2011 to stockholders of record on November 14, 2011. The declaration and payment of future dividends to holders of our common stock will be at the discretion of our Board of Directors and will depend on many factors, including our earnings, financial condition, business needs, and regulatory constraints.
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. There are currently no amounts outstanding under our revolving credit facility, which provides for a total commitment of up to $250 million.

65
Table of Contents

We have an effective automatic shelf registration statement under which we may issue debt, equity or hybrid securities.
Surplus Note
In 2011, CCC repaid $250 million of the $1.0 billion surplus note originally issued in 2008, leaving an outstanding balance of $250 million as of September 30, 2011.
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 Condensed Consolidated Financial Statements included under Part I, Item 1.

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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 of our Annual Report on Form 10-K, including the sufficiency of the reserves and the possibility for future increases, which would be reflected in the results of operations in the period that the need for such adjustment is determined;
•
the risk that the other parties to the transaction in which, subject to certain limitations, we ceded our legacy A&EP liabilities will not fully perform their obligations to CNA, the uncertainty in estimating loss reserves for A&EP liabilities and the possible continued exposure of CNA to liabilities for A&EP claims that are not covered under the terms of the transaction;
•
the performance of reinsurance companies under reinsurance contracts with us; and
•
the 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.
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;

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•
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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CNA Financial Corporation
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There were no material changes in our market risk components for the nine months ended September 30, 2011. See the Quantitative and Qualitative Disclosures About Market Risk included in Item 7A on our Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2010 for further information. Additional information related to portfolio duration is discussed in the Investments section of our Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Part I, Item 2.

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CNA Financial Corporation
Item 4. Controls and Procedures
The Company maintains a system of disclosure controls and procedures which are designed to ensure that information required to be disclosed by the Company in reports that it files or submits to the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the Exchange Act), including this report, is recorded, processed, summarized and reported on a timely basis. These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed under the Exchange Act is accumulated and communicated to the Company’s management on a timely basis to allow decisions regarding required disclosure.
As of September 30, 2011, the Company’s management, including the Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO), conducted an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on this evaluation, the CEO and CFO have concluded that the Company’s disclosure controls and procedures are effective as of September 30, 2011.
There has been no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15 (f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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CNA Financial Corporation
Part II. Other Information

Item 1. Legal Proceedings
Information on our legal proceedings is set forth in Note G of the Condensed Consolidated Financial Statements included under Part I, Item 1.

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Item 6. Exhibits
See Exhibit Index.

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CNA Financial Corporation
Part II. Other Information
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
CNA Financial Corporation
 
 
Dated:
November 1, 2011
By  
/s/ D. Craig Mense  
 
 
 
 
D. Craig Mense 
 
 
 
 
Executive Vice President and
Chief Financial Officer 
 


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EXHIBIT INDEX
 
 
 
Description of Exhibit
Exhibit Number
 
 
 
Certification of Chief Executive Officer
 
 
 
 
Certification of Chief Financial Officer
 
 
 
 
Written Statement of the Chief Executive Officer of CNA Financial Corporation Pursuant to 18 U.S.C. Section 1350 (As adopted by Section 906 of the Sarbanes-Oxley Act of 2002)
 
 
 
 
Written Statement of the Chief Financial Officer of CNA Financial Corporation Pursuant to 18 U.S.C. Section 1350 (As adopted by Section 906 of the Sarbanes-Oxley Act of 2002)
 
 
 
 
XBRL Instance Document
 
101.INS
 
 
 
XBRL Taxonomy Extension Schema
 
101.SCH
 
 
 
XBRL Taxonomy Extension Calculation Linkbase
 
101.CAL
 
 
 
XBRL Taxonomy Extension Definition Linkbase
 
101.DEF
 
 
 
XBRL Taxonomy Label Linkbase
 
101.LAB
 
 
 
XBRL Taxonomy Extension Presentation Linkbase
 
101.PRE