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CNA FINANCIAL CORP - Quarter Report: 2013 June (Form 10-Q)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2013
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number 1-5823
 
CNA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
 
36-6169860
(I.R.S. Employer
Identification No.)
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 [x] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [x] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 [x]
 
Accelerated filer [ ]
 
Non-accelerated filer [ ] (Do not check if a smaller reporting company)
 
Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [x]
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class
 
Outstanding at July 26, 2013
Common Stock, Par value $2.50
 
269,698,289



Item Number
PART I. Financial Information
Page
Number
1.
 





 
2.
3.
4.
 
PART II. Other Information
 
1.
4.
6.


2

Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements
CNA Financial Corporation
Condensed Consolidated Statements of Operations (Unaudited)
Periods ended June 30
Three Months
 
Six Months
(In millions, except per share data)
2013
 
2012
 
2013
 
2012
Revenues
 
 
 
 
 
 
 
Net earned premiums
$
1,800

 
$
1,668

 
$
3,564

 
$
3,317

Net investment income
578

 
470

 
1,211

 
1,118

Net realized investment gains (losses):
 
 
 
 
 
 
 
Other-than-temporary impairment losses
(16
)
 
(12
)
 
(34
)
 
(27
)
Portion of other-than-temporary impairments recognized in Other comprehensive income (loss)
—

 
(11
)
 
—

 
(23
)
Net other-than-temporary impairment losses recognized in earnings
(16
)
 
(23
)
 
(34
)
 
(50
)
Other net realized investment gains
2

 
45

 
48

 
108

Net realized investment gains (losses)
(14
)
 
22

 
14

 
58

Other revenues
129

 
86

 
207

 
154

Total revenues
2,493

 
2,246

 
4,996

 
4,647

Claims, Benefits and Expenses
 
 
 
 
 
 
 
Insurance claims and policyholders’ benefits
1,521

 
1,348

 
2,950

 
2,729

Amortization of deferred acquisition costs
335

 
309

 
663

 
604

Other operating expenses
320

 
316

 
661

 
635

Interest
41

 
43

 
83

 
85

Total claims, benefits and expenses
2,217

 
2,016

 
4,357

 
4,053

Income before income tax
276

 
230

 
639

 
594

Income tax expense
(82
)
 
(64
)
 
(195
)
 
(178
)
Net income
$
194

 
$
166

 
$
444

 
$
416

 
 
 
 
 
 
 
 
Basic earnings per share
$
0.72

 
$
0.62

 
$
1.65

 
$
1.55

 
 
 
 
 
 
 
 
Diluted earnings per share
$
0.72

 
$
0.62

 
$
1.64

 
$
1.54

 
 
 
 
 
 
 
 
Dividends per share
$
0.20

 
$
0.15

 
$
0.40

 
$
0.30

 
 
 
 
 
 
 
 
Weighted Average Outstanding Common Stock and Common Stock Equivalents
 
 
 
 
 
 
 
Basic
269.7

 
269.4

 
269.6

 
269.4

Diluted
270.1

 
269.8

 
270.0

 
269.7

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


3

CNA Financial Corporation
Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
Periods ended June 30
Three Months
 
Six Months
(In millions)
2013
 
2012
 
2013
 
2012
Other Comprehensive Income (Loss), Net of Tax
 
 
 
 
 
 
 
Changes in:
 
 
 
 
 
 
 
Net unrealized gains (losses) on investments with other-than-temporary impairments
$
(8
)
 
$
(3
)
 
$
6

 
$
37

Net unrealized gains (losses) on other investments
(585
)
 
120

 
(647
)
 
337

Net unrealized gains (losses) on investments
(593
)
 
117

 
(641
)
 
374

Foreign currency translation adjustment
(13
)
 
(17
)
 
(74
)
 
4

Pension and postretirement benefits
5

 
3

 
10

 
9

Other comprehensive income (loss), net of tax
(601
)
 
103

 
(705
)
 
387

Net income
194

 
166

 
444

 
416

Total comprehensive income (loss)
$
(407
)
 
$
269

 
$
(261
)
 
$
803

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

4

CNA Financial Corporation
Condensed Consolidated Balance Sheets (Unaudited)
 
June 30,
2013
 
December 31,
2012
(In millions, except share data)
 
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities at fair value (amortized cost of $38,928 and $38,170)
$
41,431

 
$
42,633

Equity securities at fair value (cost of $185 and $228)
199

 
249

Limited partnership investments
2,665

 
2,462

Other invested assets
36

 
59

Mortgage loans
437

 
401

Short term investments
1,531

 
1,832

Total investments
46,299

 
47,636

Cash
121

 
156

Reinsurance receivables (less allowance for uncollectible receivables of $71 and $73)
5,970

 
6,158

Insurance receivables (less allowance for uncollectible receivables of $94 and $101)
2,133

 
1,882

Accrued investment income
446

 
434

Deferred acquisition costs
650

 
598

Deferred income taxes
315

 
93

Property and equipment at cost (less accumulated depreciation of $379 and $404)
327

 
326

Goodwill
152

 
154

Other assets (includes $0 and $4 due from Loews Corporation)
907

 
773

Separate account business
247

 
312

Total assets
$
57,567

 
$
58,522

Liabilities
 

 
 

Insurance reserves:
 

 
 

Claim and claim adjustment expenses
$
24,339

 
$
24,763

Unearned premiums
3,869

 
3,610

Future policy benefits
10,787

 
11,475

Policyholders’ funds
133

 
157

Short term debt
13

 
13

Long term debt
2,558

 
2,557

Other liabilities (includes $65 and $0 due to Loews Corporation)
3,677

 
3,321

Separate account business
247

 
312

Total liabilities
45,623

 
46,208

Commitments and contingencies (Notes C, G and J)


 


Stockholders' Equity
 

 
 

Common stock ($2.50 par value; 500,000,000 shares authorized; 273,040,243 shares issued; 269,697,889 and 269,399,390 shares outstanding)
683

 
683

Additional paid-in capital
2,140

 
2,146

Retained earnings
9,110

 
8,774

Accumulated other comprehensive income
126

 
831

Treasury stock (3,342,354 and 3,640,853 shares), at cost
(91
)
 
(99
)
Notes receivable for the issuance of common stock
(24
)
 
(21
)
Total stockholders’ equity
11,944

 
12,314

Total liabilities and stockholders' equity
$
57,567

 
$
58,522

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

5

CNA Financial Corporation
Condensed Consolidated Statements of Cash Flows (Unaudited)
Six months ended June 30
 
 
 
(In millions)
2013
 
2012
Cash Flows from Operating Activities
 
 
 
Net income
$
444

 
$
416

Adjustments to reconcile net income to net cash flows provided by operating activities:
 
 
 
Loss on disposal of property and equipment
—

 
1

Deferred income tax expense
122

 
81

Trading portfolio activity
(7
)
 
(44
)
Net realized investment gains
(14
)
 
(58
)
Equity method investees
(151
)
 
(8
)
Amortization of investments
(14
)
 
(33
)
Depreciation and amortization
58

 
39

Changes in:
 
 
 
Receivables, net
(83
)
 
70

Accrued investment income
(12
)
 
(10
)
Deferred acquisition costs
(43
)
 
(17
)
Insurance reserves
198

 
121

Other assets
(69
)
 
43

Other liabilities
134

 
12

Other, net
6

 
5

Total adjustments
125

 
202

Net cash flows provided by operating activities
$
569

 
$
618

Cash Flows from Investing Activities
 
 
 

Dispositions:
 
 
 
Fixed maturity securities - sales
$
3,143

 
$
3,303

Fixed maturity securities - maturities, calls and redemptions
1,820

 
1,566

Equity securities
60

 
61

Limited partnerships
77

 
64

Mortgage loans
18

 
5

Purchases:
 
 
 
Fixed maturity securities
(5,656
)
 
(5,169
)
Equity securities
(33
)
 
(27
)
Limited partnerships
(103
)
 
(53
)
Mortgage loans
(54
)
 
(109
)
Change in other investments
—

 
2

Change in short term investments
293

 
(123
)
Purchases of property and equipment
(42
)
 
(42
)
Other, net
6

 
12

Net cash flows used by investing activities
$
(471
)
 
$
(510
)
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).

6

Six months ended June 30
 
 
 
(In millions)
2013
 
2012
Cash Flows from Financing Activities
 
 
 
Dividends paid to common stockholders
$
(108
)
 
$
(81
)
Stock options exercised
1

 
1

Other, net
(20
)
 
(3
)
Net cash flows used by financing activities
$
(127
)
 
$
(83
)
Effect of foreign exchange rate changes on cash
$
(6
)
 
$
—

Net change in cash
$
(35
)
 
$
25

Cash, beginning of year
156

 
75

Cash, end of period
$
121

 
$
100

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


7

CNA Financial Corporation
Condensed Consolidated Statements of Stockholders' Equity (Unaudited)
Six months ended June 30
 
 
 
(In millions)
2013
 
2012
Common Stock
 
 
 
Balance, beginning of period
$
683

 
$
683

Balance, end of period
683

 
683

Additional Paid-in Capital
 
 
 
Balance, beginning of period
2,146

 
2,141

Stock-based compensation
(6
)
 
—

Balance, end of period
2,140

 
2,141

Retained Earnings
 
 
 
Balance, beginning of period
8,774

 
8,308

Dividends paid to common stockholders
(108
)
 
(81
)
Net income
444

 
416

Balance, end of period
9,110

 
8,643

Accumulated Other Comprehensive Income
 
 
 
Balance, beginning of period
831

 
480

Other comprehensive income (loss)
(705
)
 
387

Balance, end of period
126

 
867

Treasury Stock
 
 
 
Balance, beginning of period
(99
)
 
(102
)
Stock-based compensation
8

 
3

Balance, end of period
(91
)
 
(99
)
Notes Receivable for the Issuance of Common Stock
 
 
 
Balance, beginning of period
(21
)
 
(22
)
(Increase) decrease in notes receivable for the issuance of common stock
(3
)
 
1

Balance, end of period
(24
)
 
(21
)
Total Stockholders' Equity
$
11,944

 
$
12,214

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


8

CNA Financial Corporation
Notes to Condensed Consolidated Financial Statements
Note A. General
Basis of Presentation
The Condensed Consolidated Financial Statements (Unaudited) include the accounts of CNA Financial Corporation (CNAF) and its subsidiaries. Collectively, CNAF and its subsidiaries are referred to as CNA or the Company. The Company acquired Hardy Underwriting Bermuda Limited and its subsidiaries on July 2, 2012. Loews Corporation (Loews) owned approximately 90% of the outstanding common stock of CNAF as of June 30, 2013.
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 for the year ended December 31, 2012, 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 June 30, 2013 and for the three and six months ended June 30, 2013 and 2012 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.
Note B. Earnings Per Share
Earnings per share is based on the weighted average number of outstanding common shares. Basic earnings (loss) per share excludes the impact of dilutive securities and is computed by dividing Net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
For the three and six months ended June 30, 2013, approximately 407 thousand and 446 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 114 thousand and 478 thousand 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 and six months ended June 30, 2012, approximately 410 thousand and 368 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 622 thousand and 735 thousand 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.

9

Note C. Investments
The significant components of net investment income are presented in the following table.
Net Investment Income
Periods ended June 30
Three Months
 
Six Months
(In millions)
2013
 
2012
 
2013
 
2012
Fixed maturity securities
$
498

 
$
505

 
$
997

 
$
1,021

Short term investments
1

 
2

 
2

 
3

Limited partnership investments
79

 
(35
)
 
210

 
95

Equity securities
3

 
2

 
6

 
6

Mortgage loans
6

 
5

 
11

 
8

Trading portfolio (a)
5

 
4

 
10

 
11

Other
—

 
2

 
1

 
3

Gross investment income
592

 
485

 
1,237

 
1,147

Investment expense
(14
)
 
(15
)
 
(26
)
 
(29
)
Net investment income
$
578

 
$
470

 
$
1,211

 
$
1,118

___________________
(a)
There were no net unrealized gains (losses) related to changes in fair value of trading securities still held included in net investment income for the three or six months ended June 30, 2013 or 2012.
Net realized investment gains (losses) are presented in the following table.
Net Realized Investment Gains (Losses)
Periods ended June 30
Three Months
 
Six Months
(In millions)
2013
 
2012
 
2013
 
2012
Net realized investment gains (losses):
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Gross realized gains
$
37

 
$
49

 
$
81

 
$
118

Gross realized losses
(42
)
 
(32
)
 
(54
)
 
(71
)
Net realized investment gains (losses) on fixed maturity securities
(5
)
 
17

 
27

 
47

Equity securities:
 
 
 
 
 
 
 

Gross realized gains
5

 
2

 
7

 
5

Gross realized losses
(7
)
 
(2
)
 
(22
)
 
(4
)
Net realized investment gains (losses) on equity securities
(2
)
 
—

 
(15
)
 
1

Derivatives
(5
)
 
1

 
(3
)
 
—

Short term investments and other
(2
)
 
4

 
5

 
10

Net realized investment gains (losses)
$
(14
)
 
$
22

 
$
14

 
$
58


10

The components of net other-than-temporary impairment (OTTI) losses recognized in earnings by asset type are summarized in the following table.
Periods ended June 30
Three Months
 
Six Months
(In millions)
2013
 
2012
 
2013
 
2012
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
Corporate and other bonds
$
5

 
$
6

 
$
8

 
$
16

Asset-backed:
 
 
 
 
 
 
 
Residential mortgage-backed
3

 
15

 
3

 
29

Other asset-backed
1

 
—

 
1

 
—

Total asset-backed
4

 
15

 
4

 
29

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

 
—

 
—

 
1

Total fixed maturity securities available-for-sale
9

 
21

 
12

 
46

Equity securities available-for-sale:
 
 
 
 
 
 
 
Common stock
2

 
2

 
2

 
4

Preferred stock
5

 
—

 
20

 
—

Total equity securities available-for-sale
7

 
2

 
22

 
4

Net OTTI losses recognized in earnings
$
16

 
$
23

 
$
34

 
$
50

The following tables provide a summary of fixed maturity and equity securities.
Summary of Fixed Maturity and Equity Securities
June 30, 2013
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
$
20,079

 
$
1,826

 
$
147

 
$
21,758

 
$
—

States, municipalities and political subdivisions
10,098

 
814

 
173

 
10,739

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
5,031

 
153

 
88

 
5,096

 
(37
)
Commercial mortgage-backed
1,941

 
95

 
27

 
2,009

 
(3
)
Other asset-backed
933

 
16

 
2

 
947

 
—

Total asset-backed
7,905

 
264

 
117

 
8,052

 
(40
)
U.S. Treasury and obligations of government-sponsored enterprises
167

 
9

 
—

 
176

 
—

Foreign government
528

 
17

 
1

 
544

 
—

Redeemable preferred stock
121

 
13

 
2

 
132

 
—

Total fixed maturity securities available-for-sale
38,898

 
2,943

 
440

 
41,401

 
$
(40
)
Total fixed maturity securities trading
30

 
—

 
—

 
30

 
 
Equity securities available-for-sale:
 
 
 
 
 
 
 
 
 
Common stock
47

 
10

 
—

 
57

 
 
Preferred stock
138

 
4

 
—

 
142

 
 
Total equity securities available-for-sale
185

 
14

 
—

 
199

 
 
Total
$
39,113

 
$
2,957

 
$
440

 
$
41,630

 
 

11

December 31, 2012
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
$
19,530

 
$
2,698

 
$
21

 
$
22,207

 
$
—

States, municipalities and political subdivisions
9,372

 
1,455

 
44

 
10,783

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
5,745

 
246

 
71

 
5,920

 
(28
)
Commercial mortgage-backed
1,692

 
147

 
17

 
1,822

 
(3
)
Other asset-backed
929

 
23

 
—

 
952

 
—

Total asset-backed
8,366

 
416

 
88

 
8,694

 
(31
)
U.S. Treasury and obligations of government-sponsored enterprises
172

 
11

 
1

 
182

 
—

Foreign government
588

 
25

 
—

 
613

 
—

Redeemable preferred stock
113

 
13

 
1

 
125

 
—

Total fixed maturity securities available-for-sale
38,141

 
4,618

 
155

 
42,604

 
$
(31
)
Total fixed maturity securities trading
29

 
—

 
—

 
29

 
 
Equity securities available-for-sale:
 
 
 
 
 
 
 
 
 
Common stock
38

 
14

 
—

 
52

 
 
Preferred stock
190

 
7

 
—

 
197

 
 
Total equity securities available-for-sale
228

 
21

 
—

 
249

 
 
Total
$
38,398

 
$
4,639

 
$
155

 
$
42,882

 
 
The net unrealized gains on investments included in the tables above are recorded as a component of Accumulated other comprehensive income (AOCI). When presented in AOCI, these amounts are net of tax and any required Shadow Adjustments. At June 30, 2013 and December 31, 2012, the net unrealized gains on investments included in AOCI were net of after-tax Shadow Adjustments of $883 million and $1,511 million. To the extent that unrealized gains on fixed income securities supporting certain products within the Life & Group Non-Core segment would result in a premium deficiency if realized, a related decrease in Deferred acquisition costs and/or increase in Insurance reserves are recorded, net of tax, as a reduction of net unrealized gains through Other comprehensive income (loss) (Shadow Adjustments).

12

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
 
12 Months or Longer
 
Total
June 30, 2013
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
$
3,478

 
$
143

 
$
33

 
$
4

 
$
3,511

 
$
147

States, municipalities and political subdivisions
2,075

 
130

 
119

 
43

 
2,194

 
173

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
1,462

 
33

 
321

 
55

 
1,783

 
88

Commercial mortgage-backed
593

 
23

 
79

 
4

 
672

 
27

Other asset-backed
235

 
2

 
—

 
—

 
235

 
2

Total asset-backed
2,290

 
58

 
400

 
59

 
2,690

 
117

Foreign government
65

 
1

 
—

 
—

 
65

 
1

Redeemable preferred stock
39

 
2

 
—

 
—

 
39

 
2

Total
$
7,947

 
$
334

 
$
552

 
$
106

 
$
8,499

 
$
440

 
Less than 12 Months
 
12 Months or Longer
 
Total
December 31, 2012
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
$
846

 
$
13

 
$
108

 
$
8

 
$
954

 
$
21

States, municipalities and political subdivisions
254

 
5

 
165

 
39

 
419

 
44

Asset-backed:
 
 
 
 
 
 
 
 
 

 
 

Residential mortgage-backed
583

 
5

 
452

 
66

 
1,035

 
71

Commercial mortgage-backed
85

 
2

 
141

 
15

 
226

 
17

Total asset-backed
668

 
7

 
593

 
81

 
1,261

 
88

U.S. Treasury and obligations of government-sponsored enterprises
23

 
1

 
—

 
—

 
23

 
1

Redeemable preferred stock
28

 
1

 
—

 
—

 
28

 
1

Total
$
1,819

 
$
27

 
$
866

 
$
128

 
$
2,685

 
$
155

The amount of pretax net realized losses on available-for-sale securities reclassified out of AOCI into earnings was $7 million for the three months ended June 30, 2013, and the amount of pretax net realized gains on available-for-sale securities reclassified out of AOCI into earnings was $12 million for the six months ended June 30, 2013. The amount of pretax net realized gains on available-for-sale securities reclassified out of AOCI into earnings was $15 million and $47 million for the three and six months ended June 30, 2012.
Based on current facts and circumstances, the Company believes the unrealized losses presented in the June 30, 2013 Securities in a Gross Unrealized Loss Position table above, are primarily attributable to broader economic conditions, changes in interest rates and credit spreads, market illiquidity and other market factors, but are not indicative of the ultimate collectibility of the current amortized cost of the securities. The investments with longer duration, primarily included within the states, municipalities and political subdivision asset category, were more significantly impacted by changes in market interest rates. 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 June 30, 2013.

13

The following table summarizes the activity for the three and six months ended June 30, 2013 and 2012 related to the pretax credit loss component reflected in Retained earnings on fixed maturity securities still held at June 30, 2013 and 2012 for which a portion of an OTTI loss was recognized in Other comprehensive income (loss).
Periods ended June 30
Three Months
 
Six Months
(In millions)
2013
 
2012
 
2013
 
2012
Beginning balance of credit losses on fixed maturity securities
$
92

 
$
100

 
$
95

 
$
92

Additional credit losses for securities for which an OTTI loss was previously recognized
1

 
10

 
1

 
21

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

 
1

 
—

 
2

Reductions for securities sold during the period
(4
)
 
(4
)
 
(7
)
 
(8
)
Reductions for securities the Company intends to sell or more likely than not will be required to sell
—

 
(8
)
 
—

 
(8
)
Ending balance of credit losses on fixed maturity securities
$
89

 
$
99

 
$
89

 
$
99

Contractual Maturity
The following table summarizes available-for-sale fixed maturity securities by contractual maturity at June 30, 2013 and December 31, 2012. 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
 
June 30, 2013
 
December 31, 2012
(In millions)
Cost or
Amortized
Cost
 
Estimated
Fair
Value
 
Cost or
Amortized
Cost
 
Estimated
Fair
Value
Due in one year or less
$
2,105

 
$
2,153

 
$
1,648

 
$
1,665

Due after one year through five years
11,450

 
12,078

 
13,603

 
14,442

Due after five years through ten years
10,613

 
10,981

 
8,726

 
9,555

Due after ten years
14,730

 
16,189

 
14,164

 
16,942

Total
$
38,898

 
$
41,401

 
$
38,141

 
$
42,604

Investment Commitments
As of June 30, 2013, the Company had committed approximately $372 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, sales and funding. As of June 30, 2013, the Company had commitments to purchase or fund additional amounts of $160 million and sell $150 million under the terms of such securities.


14

Note D. Derivative Financial Instruments
Gross estimated fair values of derivative positions are presented in Other invested assets and Other liabilities on the Condensed Consolidated Balance Sheets. There would be no significant difference in the balance included in such accounts if the estimated fair values were presented net for the periods ended June 30, 2013 and December 31, 2012. 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
June 30, 2013
Contractual/
Notional
Amount
 
Estimated Fair Value
(In millions)
 
Asset
 
(Liability)
Without hedge designation
 
 
 
 
 
Credit default swaps - purchased protection
$
20

 
$
—

 
$
—

Currency forwards
41

 
—

 
—

Equity warrants
5

 
—

 
—

Total
$
66

 
$
—

 
$
—

December 31, 2012
Contractual/
Notional
Amount
 
Estimated Fair Value
(In millions)
 
Asset
 
(Liability)
Without hedge designation
 
 
 
 
 
Credit default swaps - purchased protection
$
20

 
$
—

 
$
(1
)
Currency forwards
59

 
—

 
(2
)
Equity warrants
5

 
—

 
—

Total
$
84

 
$
—

 
$
(3
)
During the three and six months ended June 30, 2013, new derivative transactions entered into totaled $1,443 million and $2,047 million in notional value while derivative termination activity totaled $1,523 million and $2,065 million. This activity was attributable to forward commitments for mortgage-backed securities, interest rate futures and foreign currency forwards. During the three and six months ended June 30, 2012, new derivative transactions entered into totaled $447 million and $779 million in notional value while derivative termination activity totaled $391 million and $712 million. This activity was primarily attributable to interest rate futures and forward commitments for mortgage-backed securities.

15

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.
Prices may fall within Level 1, 2 or 3 depending upon the methodologies and inputs used to estimate fair value for each specific security. Prices are determined by a dedicated group who ultimately report to the Company's CFO. This group is responsible for valuation policies and procedures. In general the Company seeks to price securities using third-party pricing services. Securities not priced by pricing services are submitted to independent brokers for valuation and, if those are not available, internally developed pricing models are used to value assets using methodologies and inputs the Company believes market participants would use to value the assets. Prices obtained from third-party pricing services or brokers are not adjusted by the Company.
The Company performs control procedures over information obtained from pricing services and brokers to ensure prices received represent a reasonable estimate of fair value and to confirm representations regarding whether inputs are observable or unobservable. Procedures include i) the review of pricing service or broker pricing methodologies, ii) back-testing, where past fair value estimates are compared to actual transactions executed in the market on similar dates, iii) exception reporting, where changes in price, period-over-period, are reviewed and challenged with the pricing service or broker based on exception criteria, iv) deep dives, where the Company independently validates detailed information regarding inputs and assumptions for individual securities and v) pricing validation, where prices received are compared to prices independently estimated by the Company.

16

Assets and Liabilities Measured at Fair Value
Assets and liabilities measured at fair value on a recurring basis are summarized below.
June 30, 2013
 
 
 
 
 
 
Total
Assets/(Liabilities)
at Fair Value
(In millions)
Level 1
 
Level 2
 
Level 3
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate and other bonds
$
30

 
$
21,556

 
$
202

 
$
21,788

States, municipalities and political subdivisions
—

 
10,599

 
140

 
10,739

Asset-backed:
 
 
 
 
 
 
 
Residential mortgage-backed
—

 
4,668

 
428

 
5,096

Commercial mortgage-backed
—

 
1,844

 
165

 
2,009

Other asset-backed
—

 
560

 
387

 
947

Total asset-backed
—

 
7,072

 
980

 
8,052

U.S. Treasury and obligations of government-sponsored enterprises
147

 
29

 
—

 
176

Foreign government
98

 
446

 
—

 
544

Redeemable preferred stock
49

 
58

 
25

 
132

Total fixed maturity securities
324

 
39,760

 
1,347

 
41,431

Equity securities
134

 
52

 
13

 
199

Other invested assets
—

 
36

 
—

 
36

Short term investments
1,057

 
423

 
—

 
1,480

Life settlement contracts, included in Other assets
—

 
—

 
91

 
91

Separate account business
6

 
239

 
2

 
247

Total assets
$
1,521

 
$
40,510

 
$
1,453

 
$
43,484

Liabilities
 
 
 
 
 

 
 

Derivative financial instruments, included in Other liabilities
$
—

 
$
—

 
$
—

 
$
—

Total liabilities
$
—

 
$
—

 
$
—

 
$
—


17

December 31, 2012
 
 
 
 
 
 
Total
Assets/(Liabilities)
at Fair Value
(In millions)
Level 1
 
Level 2
 
Level 3
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate and other bonds
$
6

 
$
22,011

 
$
219

 
$
22,236

States, municipalities and political subdivisions
—

 
10,687

 
96

 
10,783

Asset-backed:
 
 
 
 
 
 
 

Residential mortgage-backed
—

 
5,507

 
413

 
5,920

Commercial mortgage-backed
—

 
1,693

 
129

 
1,822

Other asset-backed
—

 
584

 
368

 
952

Total asset-backed
—

 
7,784

 
910

 
8,694

U.S. Treasury and obligations of government-sponsored enterprises
158

 
24

 
—

 
182

Foreign government
140

 
473

 
—

 
613

Redeemable preferred stock
40

 
59

 
26

 
125

Total fixed maturity securities
344

 
41,038

 
1,251

 
42,633

Equity securities
117

 
98

 
34

 
249

Other invested assets
—

 
58

 
1

 
59

Short term investments
987

 
799

 
6

 
1,792

Life settlement contracts, included in Other assets
—

 
—

 
100

 
100

Separate account business
4

 
306

 
2

 
312

Total assets
$
1,452

 
$
42,299

 
$
1,394

 
$
45,145

Liabilities
 

 
 

 
 

 
 

Derivative financial instruments, included in Other liabilities
$
—

 
$
(2
)
 
$
(1
)
 
$
(3
)
Total liabilities
$
—

 
$
(2
)
 
$
(1
)
 
$
(3
)

18

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 June 30, 2013 and 2012.
Level 3
(In millions)
Balance at
April 1,
2013
 
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
June 30,
2013
 
Unrealized gains (losses) on Level 3 assets and liabilities held at June 30, 2013 recognized in net income (loss)*
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
302

 
$
1

 
$
(3
)
 
$
13

 
$
(73
)
 
$
(6
)
 
$
—

 
$
(32
)
 
$
202

 
$
(1
)
States, municipalities and political subdivisions
129

 
—

 
4

 
37

 
(32
)
 
(3
)
 
5

 
—

 
140

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
Residential mortgage-backed
450

 
(1
)
 
(1
)
 
50

 
(10
)
 
(21
)
 
4

 
(43
)
 
428

 
(2
)
Commercial mortgage-backed
177

 
—

 
4

 
5

 
—

 
(2
)
 
21

 
(40
)
 
165

 
—

Other asset-backed
396

 
—

 
(3
)
 
38

 
(33
)
 
(11
)
 
—

 
—

 
387

 
(1
)
Total asset-backed
1,023

 
(1
)
 
—

 
93

 
(43
)
 
(34
)
 
25

 
(83
)
 
980

 
(3
)
Redeemable preferred stock
26

 
—

 
(1
)
 
—

 
—

 
—

 
—

 
—

 
25

 
—

Total fixed maturity securities
1,480

 
—

 
—

 
143

 
(148
)
 
(43
)
 
30

 
(115
)
 
1,347

 
(4
)
Equity securities
19

 
(5
)
 
(1
)
 
—

 
—

 
—

 
—

 
—

 
13

 
(5
)
Other invested assets, including derivatives, net
(1
)
 
—

 
—

 
—

 
—

 
1

 
—

 
—

 
—

 
—

Short term investments
5

 
—

 
—

 
—

 
(5
)
 
—

 
—

 
—

 
—

 
—

Life settlement contracts
95

 
4

 
—

 
—

 
—

 
(8
)
 
—

 
—

 
91

 
(1
)
Separate account business
2

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
2

 
—

Total
$
1,600

 
$
(1
)
 
$
(1
)
 
$
143

 
$
(153
)
 
$
(50
)
 
$
30

 
$
(115
)
 
$
1,453

 
$
(10
)

19

Level 3
(In millions)
Balance at
April 1,
2012
 
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
June 30,
2012
 
Unrealized gains (losses) on Level 3 assets and liabilities held at June 30, 2012 recognized in net income (loss)*
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
486

 
$
3

 
$
2

 
$
68

 
$
(27
)
 
$
(13
)
 
$
9

 
$
(40
)
 
$
488

 
$
—

States, municipalities and political subdivisions
173

 
—

 
1

 
—

 
—

 
(85
)
 
—

 
—

 
89

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
447

 
1

 
(18
)
 
22

 
—

 
(9
)
 
—

 
—

 
443

 
—

Commercial mortgage-backed
105

 
2

 
4

 
87

 
(12
)
 
(4
)
 
—

 
(16
)
 
166

 
—

Other asset-backed
384

 
2

 
(1
)
 
182

 
(99
)
 
(34
)
 
—

 
—

 
434

 
—

Total asset-backed
936

 
5

 
(15
)
 
291

 
(111
)
 
(47
)
 
—

 
(16
)
 
1,043

 
—

Redeemable preferred stock
53

 
—

 
—

 
—

 
(26
)
 
—

 
—

 
—

 
27

 
—

Total fixed maturity securities
1,648

 
8

 
(12
)
 
359

 
(164
)
 
(145
)
 
9

 
(56
)
 
1,647

 
—

Equity securities
74

 
—

 
19

 
15

 
(15
)
 
—

 
—

 
—

 
93

 
(1
)
Other invested assets, including derivatives, net
10

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
10

 
—

Short term investments
—

 
—

 
—

 
4

 
—

 
—

 
—

 
—

 
4

 
—

Life settlement contracts
115

 
20

 
—

 
—

 
—

 
(19
)
 
—

 
—

 
116

 
3

Separate account business
4

 
—

 
—

 
—

 
(1
)
 
—

 
—

 
—

 
3

 
—

Total
$
1,851

 
$
28

 
$
7

 
$
378

 
$
(180
)
 
$
(164
)
 
$
9

 
$
(56
)
 
$
1,873

 
$
2


20

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 six months ended June 30, 2013 and 2012.

Level 3
(In millions)
Balance at
January 1,
2013
 
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
June 30,
2013
 
Unrealized gains (losses) on Level 3 assets and liabilities held at June 30, 2013 recognized in net income (loss)*
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
219

 
$
1

 
$
(1
)
 
$
123

 
$
(90
)
 
$
(26
)
 
$
26

 
$
(50
)
 
$
202

 
$
(2
)
States, municipalities and political subdivisions
96

 
(3
)
 
4

 
122

 
(79
)
 
(5
)
 
5

 
—

 
140

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
Residential mortgage-backed
413

 
2

 
(1
)
 
111

 
(10
)
 
(32
)
 
4

 
(59
)
 
428

 
(2
)
Commercial mortgage-backed
129

 
1

 
9

 
78

 
—

 
(9
)
 
21

 
(64
)
 
165

 
—

Other asset-backed
368

 
3

 
(2
)
 
174

 
(132
)
 
(24
)
 
—

 
—

 
387

 
(1
)
Total asset-backed
910

 
6

 
6

 
363

 
(142
)
 
(65
)
 
25

 
(123
)
 
980

 
(3
)
Redeemable preferred stock
26

 
—

 
(1
)
 
—

 
—

 
—

 
—

 
—

 
25

 
—

Total fixed maturity securities
1,251

 
4

 
8

 
608

 
(311
)
 
(96
)
 
56

 
(173
)
 
1,347

 
(5
)
Equity securities
34

 
(20
)
 
—

 
—

 
—

 
—

 
—

 
(1
)
 
13

 
(20
)
Other invested assets, including derivatives, net
—

 
—

 
—

 
—

 
(1
)
 
1

 
—

 
—

 
—

 
—

Short term investments
6

 
—

 
—

 
—

 
(6
)
 
—

 
—

 
—

 
—

 
—

Life settlement contracts
100

 
11

 
—

 
—

 
—

 
(20
)
 
—

 
—

 
91

 
(1
)
Separate account business
2

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
2

 
—

Total
$
1,393

 
$
(5
)
 
$
8

 
$
608

 
$
(318
)
 
$
(115
)
 
$
56

 
$
(174
)
 
$
1,453

 
$
(26
)

21

Level 3
(In millions)
Balance at
January 1,
2012
 
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
June 30,
2012
 
Unrealized gains (losses) on Level 3 assets and liabilities held at June 30, 2012 recognized in net income (loss)*
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
482

 
$
6

 
$
6

 
$
147

 
$
(113
)
 
$
(32
)
 
$
42

 
$
(50
)
 
$
488

 
$
—

States, municipalities and political subdivisions
171

 
—

 
3

 
—

 
—

 
(85
)
 
—

 
—

 
89

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
452

 
2

 
(22
)
 
60

 
—

 
(16
)
 
—

 
(33
)
 
443

 
—

Commercial mortgage-backed
59

 
2

 
8

 
129

 
(12
)
 
(4
)
 
—

 
(16
)
 
166

 
—

Other asset-backed
343

 
6

 
3

 
358

 
(176
)
 
(59
)
 
—

 
(41
)
 
434

 
—

Total asset-backed
854

 
10

 
(11
)
 
547

 
(188
)
 
(79
)
 
—

 
(90
)
 
1,043

 
—

Redeemable preferred stock
—

 
—

 
—

 
53

 
(26
)
 
—

 
—

 
—

 
27

 
—

Total fixed maturity securities
1,507

 
16

 
(2
)
 
747

 
(327
)
 
(196
)
 
42

 
(140
)
 
1,647

 
—

Equity securities
67

 
—

 
16

 
26

 
(16
)
 
—

 
—

 
—

 
93

 
(3
)
Other invested assets, including derivatives, net
10

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
10

 
—

Short term investments
27

 
—

 
—

 
16

 
—

 
(39
)
 
—

 
—

 
4

 
—

Life settlement contracts
117

 
23

 
—

 
—

 
—

 
(24
)
 
—

 
—

 
116

 
3

Separate account business
23

 
—

 
—

 
—

 
(20
)
 
—

 
—

 
—

 
3

 
—

Total
$
1,751

 
$
39

 
$
14

 
$
789

 
$
(363
)
 
$
(259
)
 
$
42

 
$
(140
)
 
$
1,873

 
$
—



22
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)
Other invested assets - Derivative financial instruments held in a trading portfolio
 
Net investment income
Other invested assets - Derivative financial instruments not held in a trading portfolio
 
Net realized investment gains (losses)
Other invested assets - Overseas deposits
 
Net investment income
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 determine the fair value of the security. 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 transfers between Level 1 and Level 2 during the three or six months ended June 30, 2013 or 2012. The Company's policy is to recognize transfers between levels at the beginning of quarterly reporting periods.
Valuation Methodologies and Inputs
The following section describes the valuation methodologies and relevant inputs 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
Fixed maturity securities are valued using methodologies that model information generated by market transactions involving identical or comparable assets, as well as discounted cash flow methodologies. Common inputs include: prices from recently executed transactions of similar securities, broker/dealer quotes, benchmark yields, spreads off benchmark yields, interest rates, and U.S. Treasury or swap curves. Specifically for asset-backed securities, key inputs include prepayment and default projections based on past performance of the underlying collateral and current market data.
Level 1 securities include exchange traded bonds, highly liquid U.S. and foreign government bonds, and redeemable preferred stock, valued using quoted market prices. Level 2 securities include most other fixed maturity securities as the significant inputs are observable in the marketplace. 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 auction rate certificates and private placement debt securities. 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 expected call date assumption is unobservable due to the uncertain nature of principal prepayments prior to maturity and the credit spread adjustment that is security specific. Fair value of certain private placement debt securities is determined using internal models with inputs that are not market observable.
Equity Securities
Level 1 equity 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 market observable inputs. Level 3 securities are priced using internal models with inputs that are not market observable.

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Table of Contents

Other Invested Assets
Level 1 securities include exchange traded derivatives, primarily futures, valued using quoted market prices. Level 2 securities include overseas deposits, which can be redeemed at net asset value in 90 days or less, and derivatives, primarily 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.
Short Term Investments
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 market observable. Fixed maturity securities purchased within one year of maturity are classified consistent with fixed maturity securities discussed above. Short term investments as presented in the tables above differ from the amounts presented on the Condensed Consolidated Balance Sheets because certain short term investments, such as time deposits, are not measured at fair value.
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 and inputs for these asset types have been described above.
Significant Unobservable Inputs
The table below presents quantitative information about the significant unobservable inputs utilized by the Company in the fair value measurements of Level 3 assets. Valuations for assets and liabilities not presented in the table below are primarily based on broker/dealer quotes for which there is a lack of transparency as to inputs used to develop the valuations. The quantitative detail of these unobservable inputs is neither provided nor reasonably available to the Company.
Assets
(In millions)
Fair Value at June 30, 2013
 
Valuation Technique(s)
 
Unobservable Input(s)
 
Range
 (Weighted Average)
Fixed maturity securities
$
106

 
Discounted cash flow
 
Expected call date
 
1.6 - 3.5 years (3.1 years)
 
 
 
 
 
Credit spread
 
1.95% - 7.95% (2.67%)
 
$
83

 
Market approach
 
Private offering price
 
$36.32 - $113.76 ($101.70)
Equity securities
$
13

 
Market approach
 
Private offering price
 
$33.73 - $4,017.00 per share
($936.89 per share)
Life settlement contracts
$
91

 
Discounted cash flow
 
Discount rate risk premium
 
9%
 
 
 
 
 
Mortality assumption
 
69% - 883% (209.2%)

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Table of Contents

Assets
(In millions)
Fair Value at December 31, 2012
 
Valuation Technique(s)
 
Unobservable Input(s)
 
Range
 (Weighted Average)
Fixed maturity securities
$
121

 
Discounted cash flow
 
Expected call date
 
3.3 - 5.3 years (4.3 years)
 
 
 
 
 
Credit spread adjustment
 
0.02% - 0.48% (0.17%)
 
$
72

 
Market approach
 
Private offering price
 
$42.39 - $102.32 ($100.11)
Equity securities
$
34

 
Market approach
 
Private offering price
 
$4.54 - $3,842.00 per share
($571.17 per share)
Life settlement contracts
$
100

 
Discounted cash flow
 
Discount rate risk premium
 
9%
 
 
 
 
 
Mortality assumption
 
69% - 883% (208.9%)
For fixed maturity securities, an increase to the expected call date assumption and credit spread adjustment or decrease in the private offering price would result in a lower fair value measurement. For equity securities, an increase in the private offering price would result in a higher fair value measurement. For life settlement contracts, an increase in the discount rate risk premium or decrease in the mortality assumption would result in a lower fair value measurement.
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 tables below.
June 30, 2013
Carrying
Amount
 
Estimated Fair Value
(In millions)
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial assets
 
 
 
 
 
 
 
 
 
Notes receivable for the issuance of common stock
$
24

 
$
—

 
$
—

 
$
24

 
$
24

Mortgage loans
437

 
—

 
—

 
449

 
449

Financial liabilities
 
 
 
 
 
 
 
 
 
Premium deposits and annuity contracts
$
75

 
$
—

 
$
—

 
$
76

 
$
76

Short term debt
13

 
—

 
13

 
—

 
13

Long term debt
2,558

 
—

 
2,912

 
—

 
2,912

December 31, 2012
Carrying
Amount
 
Estimated Fair Value
(In millions)
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial assets
 
 
 
 
 
 
 
 
 
Notes receivable for the issuance of common stock
$
21

 
$
—

 
$
—

 
$
21

 
$
21

Mortgage loans
401

 
—

 
—

 
418

 
418

Financial liabilities
 
 
 
 
 
 
 
 
 
Premium deposits and annuity contracts
$
100

 
$
—

 
$
—

 
$
104

 
$
104

Short term debt
13

 
—

 
13

 
—

 
13

Long term debt
2,557

 
—

 
3,016

 
—

 
3,016

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, adjusted for specific note receivable risk.
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, adjusted for specific loan risk.
Premium deposits and annuity contracts were valued based on cash surrender values or estimated fair values of policyholder liabilities, net of amounts ceded related to sold business.

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Table of Contents

The Company's senior notes and debentures were valued based on observable 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, Short term investments not carried at fair value, 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 tables above.


26

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 IBNR claims 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 $65 million and $104 million for the three and six months ended June 30, 2013. Catastrophe losses in 2013 related primarily to U.S. storms. The Company reported catastrophe losses, net of reinsurance, of $68 million and $96 million for the three and six months ended June 30, 2012.

27

Net Prior Year Development
The following tables and discussion include the net prior year development recorded for CNA Specialty, CNA Commercial, Hardy and Corporate & Other Non-Core segments.
Net Prior Year Development
Three months ended June 30, 2013
 
 
 
 
 
 
 
 
 
(In millions)
CNA Specialty
 
CNA Commercial
 
Hardy
 
Corporate
& Other
Non-Core
 
Total
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development
$
(41
)
 
$
27

 
$
12

 
$
(3
)
 
$
(5
)
Pretax (favorable) unfavorable premium development
(5
)
 
(5
)
 
2

 
—

 
(8
)
Total pretax (favorable) unfavorable net prior year development
$
(46
)
 
$
22

 
$
14

 
$
(3
)
 
$
(13
)