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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549    FORM 10-Q þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended September 30, 2004 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  Delaware
(State or other jurisdiction of
incorporation or organization)
    
    36-6169860
(I.R.S. Employer
Identification No.)
 CNA Center
Chicago, Illinois
(Address of principal executive offices)
    
    60685
(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     þ
    
    No     o
 Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes     þ
    
    No     o
 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 25, 2004Common Stock, Par value $2.50
    
    255,953,958




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CNA FINANCIAL CORPORATION
INDEX Item
    
    
    
    PageNumber
    
    
    
    NumberPART I. Financial Information1.
    
    Condensed Consolidated Financial Statements (Unaudited):Condensed Consolidated Balance Sheets at September 30,
2004 and at December 31, 2003
    
    
    3Condensed Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 2004 and
2003
    
    
    4Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2004 and
2003
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    62.
    
    Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    493.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    1154.
    
    Disclosure Controls and Procedures
    
    
    121PART II. Other Information1.
    
    Item 1. Legal Proceedings
    
    
    1226.
    
    Exhibits
    
    
    122Signatures
    
    
    123Certifications
    
    
    124302 Certification of Chief Executive Officer302 Certification of Chief Financial Officer906 Certification of Chief Executive Officer906 Certification of Chief Financial Officer




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CNA FINANCIAL CORPORATION PART I. FINANCIAL INFORMATION
 
 ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 September 30,
    
    December 31,2004
    
    2003(In millions, except share data)AssetsInvestments:Fixed maturity securities at fair value (amortized cost of $30,667 and $27,564)
    
    $
    31,720
    
    
    $
    28,678Equity securities at fair value (cost of $253 and $293)
    
    
    343
    
    
    
    527Mortgage loans and real estate (less accumulated depreciation of $11 and $10)
    
    
    24
    
    
    
    25Limited partnership investments
    
    
    1,715
    
    
    
    1,117Other invested assets
    
    
    6
    
    
    
    215Short-term investments, at cost which approximates fair value
    
    
    4,142
    
    
    
    7,538Total investments
    
    
    37,950
    
    
    
    38,100Cash
    
    
    71
    
    
    
    139Reinsurance receivables (less allowance for uncollectible receivables of $531 and $573)
    
    
    15,381
    
    
    
    15,681Insurance receivables (less allowance for doubtful accounts of $486 and $375)
    
    
    2,184
    
    
    
    2,707Accrued investment income
    
    
    341
    
    
    
    323Receivables for securities sold
    
    
    634
    
    
    
    836Deferred acquisition costs
    
    
    1,312
    
    
    
    2,533Prepaid reinsurance premiums
    
    
    921
    
    
    
    1,252Federal income taxes recoverable (includes $130 and $594 due from Loews Corporation)
    
    
    126
    
    
    
    607Deferred income taxes
    
    
    726
    
    
    
    600Property and equipment at cost (less accumulated depreciation of $687 and $727)
    
    
    261
    
    
    
    314Goodwill and other intangible assets
    
    
    162
    
    
    
    162Other assets
    
    
    785
    
    
    
    1,571Separate account business
    
    
    567
    
    
    
    3,678Total assets
    
    $
    61,421
    
    
    $
    68,503Liabilities and Stockholders EquityLiabilities:Insurance reserves:Claim and claim adjustment expense
    
    $
    31,495
    
    
    $
    31,730Unearned premiums
    
    
    4,381
    
    
    
    4,891Future policy benefits
    
    
    5,743
    
    
    
    8,161Policyholders funds
    
    
    1,768
    
    
    
    601Collateral on loaned securities and derivatives
    
    
    116
    
    
    
    442Payables for securities purchased
    
    
    1,183
    
    
    
    1,902Participating policyholders funds
    
    
    66
    
    
    
    118Short term debt
    
    
    531
    
    
    
    263Long term debt ($46 and $0 of surplus notes due to Loews Corporation)
    
    
    1,182
    
    
    
    1,641Reinsurance balances payable
    
    
    3,103
    
    
    
    3,432Other liabilities
    
    
    2,114
    
    
    
    2,436Separate account business
    
    
    567
    
    
    
    3,678Total liabilities
    
    
    52,249
    
    
    
    59,295Commitments and contingencies (Notes F, G, I and K)Minority interest
    
    
    270
    
    
    
    256Stockholders equity:Preferred stock (12,500,000 shares authorized)Series H Issue (no par value; $100,000 stated value; 7,500 shares issued; held by Loews Corporation)
    
    
    750
    
    
    
    750Series I Issue (no par value; $23,200 stated value; 32,327 shares issued; held by Loews Corporation)
    
    
    
    
    
    
    750Common stock ($2.50 par value; 500,000,000 shares authorized; 258,177,285 and 225,850,270 shares
issued; and 255,953,958 and 223,617,337 shares outstanding)
    
    
    645
    
    
    
    565Additional paid-in capital
    
    
    1,701
    
    
    
    1,031Retained earnings
    
    
    5,296
    
    
    
    5,160Accumulated other comprehensive income
    
    
    652
    
    
    
    841Treasury stock (2,223,327 and 2,232,933 shares), at cost
    
    
    (69
    )
    
    
    (69
    )8,975
    
    
    
    9,028Notes receivable for the issuance of common stock
    
    
    (73
    )
    
    
    (76
    )Total stockholders equity
    
    
    8,902
    
    
    
    8,952Total liabilities and stockholders equity
    
    $
    61,421
    
    
    $
    68,503
 The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited). 3




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CNA FINANCIAL CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions, except per share data)RevenuesNet earned premiums
    
    $
    1,947
    
    
    $
    2,126
    
    
    $
    6,221
    
    
    $
    6,704Net investment income
    
    
    359
    
    
    
    352
    
    
    
    1,212
    
    
    
    1,211Realized investment gains (losses), net of
participating policyholders and minority
interests
    
    
    (62
    )
    
    
    164
    
    
    
    (415
    )
    
    
    466Other revenues
    
    
    73
    
    
    
    83
    
    
    
    227
    
    
    
    288Total revenues
    
    
    2,317
    
    
    
    2,725
    
    
    
    7,245
    
    
    
    8,669Claims, Benefits and ExpensesInsurance claims and policyholders benefits
    
    
    1,596
    
    
    
    4,342
    
    
    
    4,859
    
    
    
    8,320Amortization of deferred acquisition costs
    
    
    374
    
    
    
    495
    
    
    
    1,114
    
    
    
    1,434Other operating expenses
    
    
    393
    
    
    
    635
    
    
    
    1,100
    
    
    
    1,414Interest
    
    
    28
    
    
    
    33
    
    
    
    94
    
    
    
    100Total claims, benefits and expenses
    
    
    2,391
    
    
    
    5,505
    
    
    
    7,167
    
    
    
    11,268Income (loss) before income tax and minority interest
    
    
    (74
    )
    
    
    (2,780
    )
    
    
    78
    
    
    
    (2,599
    )Income tax benefit
    
    
    52
    
    
    
    1,006
    
    
    
    77
    
    
    
    983Minority interest
    
    
    (6
    )
    
    
    14
    
    
    
    (19
    )
    
    
    9Net income (loss)
    
    $
    (28
    )
    
    $
    (1,760
    )
    
    $
    136
    
    
    $
    (1,607
    )Basic and Diluted Earnings (Loss) Per ShareBasic and diluted earnings (loss) per share
available to common stockholders
    
    $
    (0.17
    )
    
    $
    (7.94
    )
    
    $
    0.35
    
    
    $
    (7.39
    )Weighted average outstanding common stock and common
stock equivalents
    
    
    256.0
    
    
    
    223.6
    
    
    
    256.0
    
    
    
    223.6
 The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited). 4




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CNA FINANCIAL CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 Nine months ended September 30
    
    2004
    
    2003(In millions)Cash Flows from Operating ActivitiesNet income (loss)
    
    $
    136
    
    
    $
    (1,607
    )Adjustments to reconcile net income (loss) to net cash flows provided by operating activities:Change in bad debt provision for insurance and reinsurance receivables
    
    
    70
    
    
    
    596Minority interest
    
    
    19
    
    
    
    (9
    )Loss on disposal of property and equipment
    
    
    19
    
    
    
    30Deferred income tax provision
    
    
    (42
    )
    
    
    Realized investment gains (losses), net of participating policyholders and minority interests
    
    
    415
    
    
    
    (466
    )Equity method income
    
    
    (134
    )
    
    
    (157
    )Accretion/Amortization of bond discount
    
    
    (1
    )
    
    
    (47
    )Depreciation
    
    
    58
    
    
    
    66Changes in:Receivables
    
    
    (471
    )
    
    
    (2,424
    )Deferred acquisition costs
    
    
    150
    
    
    
    (128
    )Accrued investment income
    
    
    (56
    )
    
    
    (64
    )Federal income taxes payable/recoverable
    
    
    472
    
    
    
    (751
    )Prepaid reinsurance premiums
    
    
    331
    
    
    
    (43
    )Reinsurance balances payable
    
    
    (295
    )
    
    
    523Insurance reserves
    
    
    598
    
    
    
    5,880Other, net
    
    
    (8
    )
    
    
    83Net purchases of trading securities
    
    
    (2
    )
    
    
    Total adjustments
    
    
    1,123
    
    
    
    3,089Net cash flows provided by operating activities
    
    
    1,259
    
    
    
    1,482Cash Flows from Investing ActivitiesPurchases of fixed maturity securities
    
    
    (44,581
    )
    
    
    (48,158
    )Proceeds from fixed maturity securities:Sales
    
    
    35,641
    
    
    
    41,330Maturities, calls and redemptions
    
    
    3,756
    
    
    
    5,011Purchases of equity securities
    
    
    (365
    )
    
    
    (229
    )Proceeds from sales of equity securities
    
    
    528
    
    
    
    416Change in short-term investments
    
    
    3,689
    
    
    
    17Change in collateral on loaned securities and derivatives
    
    
    (326
    )
    
    
    328Change in other investments
    
    
    (79
    )
    
    
    111Purchases of property and equipment
    
    
    (32
    )
    
    
    (68
    )Dispositions
    
    
    647
    
    
    
    (46
    )Other, net
    
    
    (27
    )
    
    
    18Net cash flows used by investing activities
    
    
    (1,149
    )
    
    
    (1,270
    )Net Cash Flows from Financing ActivitiesPrincipal payments on debt
    
    
    (537
    )
    
    
    (138
    )Proceeds from issuance of surplus notes
    
    
    346
    
    
    
    Returns and deposits of policyholder account balances on investment contracts
    
    
    10
    
    
    
    (18
    )Other
    
    
    3
    
    
    
    (4
    )Net cash flows used by financing activities
    
    
    (178
    )
    
    
    (160
    )Net change in cash
    
    
    (68
    )
    
    
    52Cash, beginning of period
    
    
    139
    
    
    
    126Cash, end of period
    
    $
    71
    
    
    $
    178Supplemental Disclosures of Cash Flow Information:Cash paid:Interest
    
    $
    162
    
    
    $
    133Federal income taxes
    
    
    (534
    )
    
    
    (248
    )Non-cash transactions:Notes receivable for the issuance of common stock
    
    
    
    
    
    
    3
 The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited). 5




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CNA FINANCIAL CORPORATION 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (UNAUDITED)
 Note A. 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 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 (CIC), and Continental Assurance Company (CAC). Loews
Corporation (Loews) owned approximately 91% of the outstanding common stock and
100% of the preferred stock of CNAF as of September 30, 2004. The Companys individual life insurance business, including its previously
wholly owned subsidiary Valley Forge Life Insurance Company (VFL), was sold on
April 30, 2004 to Swiss Re Life & Health America Inc. (Swiss Re). The results
of the individual life insurance business sold through the date of sale are
included in the Condensed Consolidated Statement of Operations for the nine
months ended September 30, 2004 and the three and nine months ended September
30, 2003. See Note N for further information. CNA Group Life Assurance Company (CNAGLA) was sold to Hartford Financial
Services Group, Inc. (Hartford) on December 31, 2003. The results of the group
benefits business sold are included in the Condensed Consolidated Statement of
Operations for the three and nine months ended September 30, 2003. See Note N
for further information. The accompanying Condensed Consolidated Financial Statements (Unaudited) 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 footnotes, 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 Form 10-K filed with the Securities and
Exchange Commission (SEC) for the year ended December 31, 2003. The interim financial data as of September 30, 2004 and for the three and nine
months ended September 30, 2004 and 2003 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. All
significant intercompany amounts have been eliminated. In the second quarter of 2004, the expenses incurred related to uncollectible
reinsurance receivables were reclassified from Other operating expenses to
Insurance claims and policyholders benefits on the Condensed Consolidated
Statements of Operations. Prior period amounts have been reclassified to
conform to the current year presentation. This reclassification had no impact
on net income (loss) in any period. 6




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 Note B. Accounting Pronouncements In January of 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 46, Consolidation of Variable Interest Entities, an
interpretation of ARB No. 51 (FIN 46). In December of 2003, the FASB issued
FIN 46 (revised December 2003), Consolidation of Variable Interest Entities, an
interpretation of ARB No. 51 (FIN 46R) which replaces FIN 46 and clarifies the
application of Accounting Research Bulletin No. 51 Consolidated Financial
Statements (ARB 51). As per ARB 51, a general rule for preparation of
consolidated financial statements of a parent and its subsidiary is ownership
by the parent, either directly or indirectly, of over fifty percent of the
outstanding voting shares of a subsidiary. However, application of the
majority voting interest requirement of ARB 51 to certain types of entities may
not identify the party with a controlling financial interest because the
controlling financial interest may be achieved through arrangements that do not
involve voting interest. FIN 46R clarifies applicability of ARB 51 to entities
in which the equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support. FIN
46R requires an entity to consolidate a variable interest entity even though
the entity does not, either directly or indirectly, own over fifty percent of
the outstanding voting shares. FIN 46R is applicable for financial statements issued for reporting periods
that end after March 15, 2004. The adoption of FIN 46R did not have a
significant impact on the results of operations or equity of the Company. In December of 2003, the FASB revised SFAS No.132, Employers Disclosures about
Pensions and Other Postretirement Benefits (SFAS 132) to require additional
disclosures related to pensions and post retirement benefits. While retaining
the existing disclosure requirements for pensions and postretirement benefits,
additional disclosures are required related to pension plan assets,
obligations, contributions and net benefit costs, beginning with fiscal years
ending after December 15, 2003. Additional disclosures pertaining to benefit
payments are required for fiscal years ending after June 30, 2004. The SFAS
132 revisions also include additional disclosure requirements for interim
financial reports beginning after December 15, 2003. CNA has implemented the
revised interim disclosures in these financial statements and will implement
the annual benefit payment disclosures in subsequent annual financial
statements. In July of 2003, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 03-01,
Accounting and Reporting by Insurance Enterprises for Certain Nontraditional
Long-Duration Contracts and for Separate Accounts (SOP 03-01). SOP 03-01
provides guidance on accounting and reporting by insurance enterprises for
certain nontraditional long-duration contracts and for separate accounts. SOP
03-01 is effective for financial statements for fiscal years beginning after
December 15, 2003. SOP 03-01 may not be applied retroactively to prior years
financial statements, and initial application should be as of the beginning of
an entitys fiscal year, therefore prior year amounts have not been conformed
to the current year presentation. CNA adopted SOP 03-01 as of January 1, 2004. The assets and liabilities of
certain guaranteed investment contracts and indexed group annuity contracts
that were previously segregated and reported as separate accounts no longer
qualify for separate account presentation. Prior to the adoption of SOP 03-01,
the asset and liability presentation of these affected contracts were
categorized as separate account assets and liabilities in the Condensed
Consolidated Balance Sheet. The results of operations from separate account
business were primarily classified as other revenue
in the Condensed Consolidated 7




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 Statements of Operations. In accordance with the provisions of SOP 03-01, the
classification and presentation of certain balance sheet and income statement
items have been modified within these financial statements. Accordingly, the
investment securities previously classified as separate account assets have now
been reclassified to the general account and will be reported based on their
investment classification whether available-for-sale or trading securities.
The investment portfolio supporting indexed group annuity contracts is
classified as held for trading purposes and is carried at fair value, with both
the net realized and unrealized gains (losses) included within net investment
income in the Condensed Consolidated Statement of Operations. The following table provides the balance sheet presentation of assets and
liabilities for certain guaranteed investment contracts and indexed group
annuity contracts upon adoption of SOP 03-01, including the classification of
the indexed group annuity contract investments as trading securities. September 30,2004
    
    January 1,2004 (a)(In millions)AssetsInvestments:Fixed maturity securities, available-for-sale
    
    $
    894
    
    
    $
    1,220Fixed maturity securities, trading
    
    
    317
    
    
    
    304Equity securities
    
    
    4
    
    
    
    4Limited partnerships
    
    
    454
    
    
    
    419Short term investments, available-for-sale
    
    
    24
    
    
    
    55Short term investments, trading
    
    
    375
    
    
    
    414Total investments
    
    
    2,068
    
    
    
    2,416Accrued investment income
    
    
    10
    
    
    
    13Receivables for securities sold
    
    
    170
    
    
    
    97Other assets
    
    
    
    
    
    
    1Total assets
    
    $
    2,248
    
    
    $
    2,527LiabilitiesLiabilities:Insurance reserves:Claim and claim adjustment expense
    
    $
    
    
    
    $
    1Future policy benefits
    
    
    525
    
    
    
    617Policyholders funds
    
    
    1,210
    
    
    
    1,324Collateral on loaned securities and derivatives
    
    
    
    
    
    
    17Payables for securities purchased
    
    
    160
    
    
    
    43Other liabilities
    
    
    53
    
    
    
    47Total liabilities
    
    $
    1,948
    
    
    $
    2,049
   (a)
    
    Includes assets and liabilities of the individual life business sold
on April 30, 2004. See Note N for further information. The Company continues to have contracts that meet the criteria for separate
account presentation. The assets and liabilities of these contracts are
legally segregated and reported as assets and liabilities of the separate
account business. Substantially all assets of the separate account business
are carried at fair value. Separate account liabilities are carried at
contract values. In May of 2004, the FASB revised FASB Staff Position (FSP) 106-1, Accounting
and Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003 and issued FSP 106-2, Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003 (FSP 106-2). The FSP provides accounting guidance 8




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 to employers who sponsor postretirement health care plans that provide
prescription drug benefits and the prescription drug benefit provided by the
employer is actuarially equivalent to Medicare Part D and hence qualifies for
the subsidy under the Medicare amendment act. This FSP was effective for the
Company as of July 1, 2004, and its adoption did not have a material impact on
the Companys results of operations and/or equity. In March of 2004, the Emerging Issues Task Force (EITF) reached consensus on
the guidance provided in EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain Investments
(EITF 03-1), as applicable to debt and equity securities that are within the
scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities (SFAS 115) and equity securities that are accounted for using the
cost method specified in Accounting Principles Board Opinion No. 18, The Equity
Method of Accounting for Investments in Common Stock. Under EITF 03-1 an
investment is impaired if the fair value of the investment is less than its
cost including adjustments for amortization, accretion, foreign exchange, and
hedging. An impairment would be considered other-than-temporary unless a) the
investor has the ability and intent to hold an investment for a reasonable
period of time sufficient for the recovery of the fair value up to (or beyond)
the cost of the investment and b) evidence indicating that the cost of the
investment is recoverable within a reasonable period of time outweighs evidence
to the contrary. The investor should consider its cash or working capital
needs to assess its intent and ability to hold an investment for a reasonable
period of time for the recovery of fair value up to or beyond the cost of the
investment. Although not presumptive, a pattern of selling investments prior
to the forecasted recovery of fair value may call into question the investors
intent. In addition, the severity and duration of the impairment should also
be considered in determining whether the impairment is other-than-temporary. This new guidance for determining whether impairment is other-than-temporary
was to be effective for reporting periods beginning after June 15, 2004. In
September of 2004, the FASB issued FSP EITF Issue 03-1-1, which delayed the
effective date for the measurement and recognition guidance included in EITF
Issue 03-1 related to other-than-temporary impairment until additional
implementation guidance is provided. As a result of the delay, during the
three month period ended September 30, 2004, the Company continued to apply
existing accounting literature for determining when a decline in fair value is
other-than-temporary. The Company continues to evaluate the impact of this new accounting standard on
its process for determining other-than-temporary impairment of equity and fixed
maturity securities, including the potential impacts from any revisions to the
original guidance issued. Adoption of this standard as originally issued may
cause the Company to recognize impairment losses in the Consolidated Statements
of Operations which would not have been recognized under the current guidance
or to recognize such losses in earlier periods, especially those due to
increases in interest rates, and would likely also impact the recognition of
investment income on impaired securities. Such an impact would likely increase
earnings volatility in future periods. However, since fluctuations in the fair
value for available-for-sale securities are already recorded in Accumulated
Other Comprehensive Income, adoption of this standard is not expected to have a
significant impact on equity. Further information on the Companys investments
is provided in the Investments section below. Note C. Earnings (Loss) Per Share Earnings (loss) per share available to common stockholders is based on
weighted-average outstanding shares. Basic and diluted earnings per share is
computed by dividing income available to common stockholders by the
weighted-average number of shares of common stock or common stock equivalents
outstanding for the period. The weighted average number of shares outstanding
for computing basic and 9




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 diluted earnings per share was 256.0 million for the
three and nine months ended September 30, 2004 and 223.6 million for the three
and nine months ended September 30, 2003. Included in the outstanding shares
in 2004 is the effect of 32.3 million shares of CNAF common stock issued on
April 20, 2004 in conjunction with the conversion of the $750 million Series I
convertible preferred stock issued during the fourth quarter of 2003. The Series H Cumulative Preferred Issue (Series H Issue) is held by Loews and
accrues cumulative dividends at an initial rate of 8% per year, compounded
annually. As of September 30, 2004, the Company has $110 million of undeclared
but accumulated dividends. The Series H Issue dividend amounts for the three
and nine months ended September 30, 2004 and 2003 have been subtracted from Net
Income (Loss) to determine income (loss) available to common stockholders. Diluted earnings (loss) per share reflect 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,
2004 and 2003, approximately one million shares attributable to the exercise of
outstanding options were excluded from the calculation of diluted earnings
(loss) per share because the exercise price of these options was greater than
the average market price of CNA common stock. The computation of earnings (loss) per share was as follows. Earnings (Loss) Per Share Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions, except per share amounts)Net income (loss)
    
    $
    (28
    )
    
    $
    (1,760
    )
    
    $
    136
    
    
    $
    (1,607
    )Less: undeclared preferred stock dividend
    
    
    (16
    )
    
    
    (15
    )
    
    
    (48
    )
    
    
    (45
    )Net income (loss) available to common stockholders
    
    $
    (44
    )
    
    $
    (1,775
    )
    
    $
    88
    
    
    $
    (1,652
    )Weighted average outstanding common stock and common
stock equivalents
    
    
    256.0
    
    
    
    223.6
    
    
    
    256.0
    
    
    
    223.6Effect of dilutive securities, employee stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Adjusted weighted average outstanding common stock
and common stock equivalents assuming conversions
    
    
    256.0
    
    
    
    223.6
    
    
    
    256.0
    
    
    
    223.6Basic and diluted earnings (loss) per share
available to common stockholders
    
    $
    (0.17
    )
    
    $
    (7.94
    )
    
    $
    0.35
    
    
    $
    (7.39
    )
 The Company applies the intrinsic value method under Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and
related interpretations, in accounting for its stock-based compensation plan.
Under the recognition and measurement principles of APB 25, no stock-based
compensation cost has been recognized, as the exercise price of the granted
options equaled the market price of the underlying stock at the grant date. 10




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 The following table illustrates the pro forma effect on net income (loss) and
earnings per share, had the Company applied the fair value recognition
provisions of SFAS 123 to stock-based employee compensation under the Companys
stock-based compensation plans. Pro Forma Effect of SFAS 123 on Net Income (Loss) and Earnings (Loss) Per Share Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions, except per share amounts)Net income (loss), as reported
    
    $
    (28
    )
    
    $
    (1,760
    )
    
    $
    136
    
    
    $
    (1,607
    )Less: Total stock-based compensation cost determined under
the fair value method, net of tax
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    (1
    )Pro forma net income (loss)
    
    
    (28
    )
    
    
    (1,760
    )
    
    
    135
    
    
    
    (1,608
    )Less: undeclared preferred stock dividend
    
    
    (16
    )
    
    
    (15
    )
    
    
    (48
    )
    
    
    (45
    )Pro forma net income (loss) available to common stockholders
    
    $
    (44
    )
    
    $
    (1,775
    )
    
    $
    87
    
    
    $
    (1,653
    )Basic and diluted earnings (loss) per share, as reported
    
    $
    (0.17
    )
    
    $
    (7.94
    )
    
    $
    0.35
    
    
    $
    (7.39
    )Basic and diluted earnings (loss) per share, pro forma
    
    $
    (0.17
    )
    
    $
    (7.94
    )
    
    $
    0.35
    
    
    $
    (7.40
    )
 Note D. Investments The significant components of net investment income are presented in the
following table. Net Investment Income Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Fixed maturity securities
    
    $
    396
    
    
    $
    412
    
    
    $
    1,189
    
    
    $
    1,254Short term investments
    
    
    14
    
    
    
    14
    
    
    
    39
    
    
    
    46Limited partnerships
    
    
    26
    
    
    
    61
    
    
    
    131
    
    
    
    159Equity securities
    
    
    3
    
    
    
    4
    
    
    
    11
    
    
    
    13Income (loss) from trading portfolio (a)
    
    
    (21
    )
    
    
    
    
    
    
    13
    
    
    
    Interest on funds withheld and other deposits
    
    
    (55
    )
    
    
    (148
    )
    
    
    (161
    )
    
    
    (288
    )Other
    
    
    4
    
    
    
    20
    
    
    
    15
    
    
    
    63Gross investment income
    
    
    367
    
    
    
    363
    
    
    
    1,237
    
    
    
    1,247Investment expense
    
    
    (8
    )
    
    
    (11
    )
    
    
    (25
    )
    
    
    (36
    )Net investment income
    
    $
    359
    
    
    $
    352
    
    
    $
    1,212
    
    
    $
    1,211
   (a)
    
    The change in net unrealized gains (losses) on trading securities,
included in net investment income, was $(4) million and $(2) million for the
three and nine months ended September 30, 2004. 11




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##### Table of Contents



CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)
 The components of realized investment results from available-for-sale
securities are presented in the following table. Realized Investment Gains (Losses) Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Realized investment gains (losses):Fixed maturity securities:U.S. Government bonds
    
    $
    4
    
    
    $
    (145
    )
    
    $
    13
    
    
    $
    (70
    )Corporate and other taxable bonds
    
    
    (35
    )
    
    
    177
    
    
    
    (2
    )
    
    
    303Tax-exempt bonds
    
    
    42
    
    
    
    (16
    )
    
    
    23
    
    
    
    79Asset-backed bonds
    
    
    9
    
    
    
    17
    
    
    
    44
    
    
    
    58Redeemable preferred stock
    
    
    6
    
    
    
    (4
    )
    
    
    11
    
    
    
    (14
    )Total fixed maturity securities
    
    
    26
    
    
    
    29
    
    
    
    89
    
    
    
    356Equity securities
    
    
    10
    
    
    
    31
    
    
    
    187
    
    
    
    89Derivative securities
    
    
    (105
    )
    
    
    85
    
    
    
    (88
    )
    
    
    8Short term investments
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    13Other, including disposition of businesses net of
participating policyholders interest
    
    
    10
    
    
    
    18
    
    
    
    (594
    )
    
    
    1Realized investment gains (losses) before allocation to
participating policyholders and minority interests
    
    
    (59
    )
    
    
    166
    
    
    
    (406
    )
    
    
    467Allocated to participating policyholders and minority interest
    
    
    (3
    )
    
    
    (2
    )
    
    
    (9
    )
    
    
    (1
    )Realized investment gains (losses), net of participating
policyholders and minority interests
    
    $
    (62
    )
    
    $
    164
    
    
    $
    (415
    )
    
    $
    466
 Realized investment losses were $62 million as compared to realized investment
gains of $164 million for the three months ended September 30, 2004 and 2003.
The decline was primarily due to losses related to derivative securities held
to mitigate the effect of changes in long term interest rates on the value of
the fixed maturity portfolio. While a decrease in long term interest rates
during the third quarter of 2004 resulted in a realized loss related to these
derivatives, the fair value of the Companys fixed maturity portfolio benefited
from the interest rate movements resulting in a substantial increase in
Accumulated Other Comprehensive Income and Stockholders Equity. Realized investment losses were $415 million for the nine months ended
September 30, 2004 as compared to realized investment gains of $466 million for
the nine months ended September 30, 2003. The decrease in the pretax
investment results was primarily due to a $622 million pretax loss on the sale
of the individual life insurance business, losses related to derivative
securities and decreased realized gains on the sale of fixed maturity
securities. These decreases were partially offset by a $162 million pretax
gain on the disposition of the Companys equity holdings of Canary Wharf Group
PLC (Canary Wharf), a London-based real estate company. Realized investment gains for the three and nine months ended September 30,
2003 included $16 million and $302 million of pretax impairment losses for
other-than-temporary declines in fair values for fixed maturity and equity
securities. These impairment losses were for securities across several market
sectors, including the airline, healthcare and energy industries. Impairment
losses were $19 million pretax for other-than-temporary declines in fair value
for fixed maturity and equity securities for the three and nine months ended
September 30, 2004. 12




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##### Table of Contents



CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 Note E. Derivative Financial Instruments A summary of the recognized gains (losses) related to derivative financial
instruments follows. Derivative Financial Instruments Recognized Gains (Losses) Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)General accountSwaps
    
    $
    3
    
    
    $
    98
    
    
    $
    26
    
    
    $
    86Futures purchased
    
    
    (25
    )
    
    
    
    
    
    
    3
    
    
    
    Futures sold, not yet purchased
    
    
    (107
    )
    
    
    (20
    )
    
    
    (113
    )
    
    
    (59
    )Forwards
    
    
    (2
    )
    
    
    1
    
    
    
    (1
    )
    
    
    2Forwards sold, not yet purchased
    
    
    (1
    )
    
    
    
    
    
    
    4
    
    
    
    Commitments to purchase government and municipal securities
    
    
    
    
    
    
    1
    
    
    
    (12
    )
    
    
    (17
    )Equity warrants
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    Collateralized debt obligation liabilities
    
    
    1
    
    
    
    5
    
    
    
    5
    
    
    
    (4
    )Options written
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    Options purchased
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )
    
    
    Options embedded in convertible debt securities
    
    
    (48
    )
    
    
    
    
    
    
    (33
    )
    
    
    9Total
    
    $
    (180
    )
    
    $
    85
    
    
    $
    (119
    )
    
    $
    17Separate accountsFutures purchased
    
    $
    
    
    
    $
    21
    
    
    $
    
    
    
    $
    96Futures sold, not yet purchased
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    Options purchased
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )Options written
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1Total
    
    $
    
    
    
    $
    22
    
    
    $
    
    
    
    $
    96
 A summary of the aggregate contractual or notional amounts and estimated fair
values related to derivative financial instruments follows. Derivative Financial Instruments Contractual/
    
    Estimated
    
    EstimatedNotional
    
    Fair Value
    
    Fair ValueSeptember 30, 2004
    
    Amount
    
    Asset
    
    (Liability)(In millions)General accountSwaps
    
    $
    5,694
    
    
    $
    3
    
    
    $
    Futures purchased
    
    
    1,060
    
    
    
    
    
    
    
    Futures sold, not yet purchased
    
    
    91
    
    
    
    
    
    
    
    Forwards purchased
    
    
    82
    
    
    
    
    
    
    
    (1
    )Forwards sold, not yet purchased
    
    
    85
    
    
    
    
    
    
    
    Equity warrants
    
    
    11
    
    
    
    1
    
    
    
    Options purchased
    
    
    82
    
    
    
    
    
    
    
    Options written
    
    
    81
    
    
    
    
    
    
    
    (1
    )Commitments to purchase government and municipal securities
    
    
    919
    
    
    
    
    
    
    
    Collateralized debt obligation liabilities
    
    
    39
    
    
    
    
    
    
    
    (1
    )Options embedded in convertible debt securities
    
    
    788
    
    
    
    202
    
    
    
    Total
    
    $
    8,932
    
    
    $
    206
    
    
    $
    (3
    )Separate accountsOptions written
    
    $
    6
    
    
    $
    
    
    
    $
    Total
    
    $
    6
    
    
    $
    
    
    
    $
    
 13




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##### Table of Contents



CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)
 Derivative Financial Instruments Contractual/
    
    Estimated
    
    EstimatedNotional
    
    Fair Value
    
    Fair ValueDecember 31, 2003
    
    Amount
    
    Asset
    
    (Liability)(In millions)General accountSwaps
    
    $
    856
    
    
    $
    
    
    
    $
    (5
    )Interest rate caps
    
    
    225
    
    
    
    
    
    
    
    Futures sold, not yet purchased
    
    
    18
    
    
    
    
    
    
    
    Forwards
    
    
    16
    
    
    
    
    
    
    
    (1
    )Commitments to purchase government and municipal securities
    
    
    3,318
    
    
    
    12
    
    
    
    Equity warrants
    
    
    11
    
    
    
    
    
    
    
    Options purchased
    
    
    4
    
    
    
    
    
    
    
    Options written
    
    
    515
    
    
    
    
    
    
    
    (2
    )Collateralized debt obligation liabilities
    
    
    110
    
    
    
    
    
    
    
    (14
    )Synthetic guaranteed investment contracts
    
    
    280
    
    
    
    
    
    
    
    Options embedded in convertible debt securities
    
    
    681
    
    
    
    201
    
    
    
    Total
    
    $
    6,034
    
    
    $
    213
    
    
    $
    (22
    )Separate accountsFutures purchased
    
    $
    1,106
    
    
    $
    3
    
    
    $
    Futures sold, not yet purchased
    
    
    12
    
    
    
    
    
    
    
    Options written
    
    
    12
    
    
    
    
    
    
    
    Total
    
    $
    1,130
    
    
    $
    3
    
    
    $
    
 Options embedded in convertible debt securities are classified as fixed
maturity securities in the Condensed Consolidated Balance Sheets, consistent
with the host instruments. The change in fair value for derivatives with no hedge designation that are
associated with the indexed group annuity contracts are reflected in Net
Investment Income. Note F. Legal Proceedings and Contingent Liabilities IGI Contingency In 1997, CNA Reinsurance Company Limited (CNA Re Ltd.) entered into an
arrangement with IOA Global, Ltd. (IOA), an independent managing general agent
based in Philadelphia, Pennsylvania, to develop and manage a book of accident
and health coverages. Pursuant to this arrangement, IGI Underwriting Agencies,
Ltd. (IGI), a personal accident reinsurance managing general underwriter, was
appointed to underwrite and market the book under the supervision of IOA.
Between April 1, 1997 and December 1, 1999, IGI underwrote a number of
reinsurance arrangements with respect to personal accident insurance worldwide
(the IGI Program). Under various arrangements, CNA Re Ltd. both assumed risks
as a reinsurer and also ceded a substantial portion of those risks to other
companies, including other CNA insurance subsidiaries and ultimately to a group of
reinsurers participating in a reinsurance pool known as the Associated Accident
and Health Reinsurance Underwriters (AAHRU) Facility. CNAs group operations
business unit, now included in the Life and Group Non-Core segment,
participated as a pool member in the AAHRU Facility in varying percentages
between 1997 and 1999. CNA has determined that a portion of the premiums assumed under the IGI Program
related to United States workers compensation carve-out business. Some of
these premiums were received from John Hancock Financial Services, Inc. (John
Hancock). CNA is aware that a number of reinsurers with 14




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##### Table of Contents



CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 workers compensation
carve-out insurance exposure, including John Hancock, have disavowed their
obligations under various legal theories. If one or more such companies are
successful in avoiding or reducing their liabilities, then it is likely that
CNAs potential liability will also be reduced. Moreover, based on information
known at this time, CNA believes it has strong grounds to successfully
challenge its alleged exposure on a substantial portion of its United States
workers compensation carve-out business, including all purported exposure
derived from John Hancock, through legal action. As noted, CNA arranged substantial reinsurance protection to manage its
exposures under the IGI Program. CNA believes it has valid and enforceable
reinsurance contracts with the AAHRU Facility and other reinsurers with respect
to the IGI Program, including the United States workers compensation carve-out
business. However, certain reinsurers have disputed their liabilities to CNA,
and CNA has commenced arbitration proceedings against such reinsurers. CNA has
resolved its dispute with respect to the validity and enforceability of ceding
IGI Program losses to the AAHRU Facility, including the United States workers
compensation carve-out business; however, an arbitration is still pending with
certain members of the AAHRU Facility related to a dispute over the allocation
of such losses to pool years. As a result, the Company increased its insurance
reserves related to the IGI program by $18 million in the second quarter of
2004. An arbitration with another reinsurer is also still pending. CNA has established reserves for its estimated exposure under the IGI Program,
other than that derived from John Hancock, and an estimate for recoverables
from retrocessionaires. CNA has not established any reserve for any exposure
derived from John Hancock because, as indicated, CNA believes the contract will
be rescinded. An arbitration to determine whether rescission will be granted
is pending. The Company is pursuing a number of loss mitigation strategies with respect to
the entire IGI Program. Although the results of these various actions to date
support the recorded reserves, the estimate of ultimate losses is subject to
considerable uncertainty due to the complexities described above. As a result
of these uncertainties, the results of operations in future periods may be
adversely affected by potentially significant reserve additions. Management
does not believe that any such reserve additions would be material to the
equity of the Company, although results of operations may be adversely
affected. The Companys position in relation to the IGI Program was unaffected
by the sale of CNA Re Ltd. in 2002. California Wage and Hour Litigation Ernestine Samora, et al. v. CCC, Case No. BC 242487, Superior Court of
California, County of Los Angeles, California and Brian Wenzel v. Galway
Insurance Company, Superior Court of California, County of Orange No.
BC01CC08868 are purported class actions on behalf of present and former CNA
employees asserting they worked hours for which they should have been
compensated at a rate of one and one-half times their base hourly wage over a
four-year period. The Company has denied the material allegations of the
amended complaint and intends to vigorously contest the claims. Based on facts
and circumstances presently known, in the opinion of management, an unfavorable
outcome would not materially affect the equity of the Company, although results
of operations may be adversely affected. Voluntary Market Premium Litigation CNA, along with dozens of other insurance companies, is a defendant in twelve
cases, including eleven purported class actions, brought by large policyholders
which generally allege that the defendants, as part of an industry-wide
conspiracy, included improper charges in their retrospectively rated and other
loss-sensitive insurance programs. Among the claims asserted are violations of
state antitrust laws, breach of contract, fraud and unjust enrichment. In one
federal court case, Sandwich Chef of Texas, Inc. v. Reliance National Indemnity
Insurance Co., 202 F.R.D. 480 (S.D. Tex. 2001), revd, 319 F.3d 205 (5th 15




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##### Table of Contents



CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 Cir.
2003), cert. denied, 72 USLW 3235 (U.S. Oct 6, 2003), the United States Court
of Appeals for the Fifth Circuit reversed a decision by the District Court for
the Southern District of Texas certifying a multi-state class. The Company
intends to vigorously contest these claims. Based on facts and circumstances
presently known, in the opinion of management, an unfavorable outcome will not
materially affect the equity of the Company, although results of operations may
be adversely affected. Asbestos, Environmental Pollution and Mass Tort (APMT) Reserves CNA is also a party to litigation and claims related to APMT cases arising in
the ordinary course of business. See Note G for further discussion. Other Litigation CNA is also a party to other litigation arising in the ordinary course of
business. Based on the facts and circumstances currently known, such other
litigation will not, in the opinion of management, materially affect the
results of operations or equity of CNA. Note G. Claim and Claim Adjustment Expense Reserves CNAs property and casualty insurance claim and claim adjustment expense
reserves represent the estimated amounts necessary to settle 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, CNA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 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 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. 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 level of
catastrophe losses experienced in any period cannot be predicted and can be
material to the results of operations and/or equity of the Company. Catastrophe losses were $271 million and $132 million pretax for the nine
months ended September 30, 2004 and 2003. The catastrophe losses in 2004
related primarily to Hurricanes Charley, Frances, Ivan and Jeanne. The
catastrophe losses in 2003 related primarily to Hurricane Claudette, Hurricane
Isabel, Texas tornadoes, and Midwest rain storms. 16




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 Claim and Claim Adjustment Expense reserves are presented net of amounts due
from insureds related to losses under high deductible policies. The Company
has established a valuation allowance related to these amounts, which is
presented as a component of the allowance for doubtful accounts for insurance
receivables. APMT Reserves CNAs property and casualty insurance subsidiaries have actual and potential
exposures related to APMT claims. Establishing reserves for APMT claim and claim adjustment expenses is subject
to uncertainties that are greater than those presented by other claims.
Traditional actuarial methods and techniques employed to estimate the ultimate
cost of claims for more traditional property and casualty exposures are less
precise in estimating claim and claim adjustment expense reserves for APMT,
particularly in an environment of emerging or potential claims and coverage
issues that arise from industry practices and legal, judicial, and social
conditions. Therefore, these traditional actuarial methods and techniques are
necessarily supplemented with additional estimating techniques and
methodologies, many of which involve significant judgments that are required of
management. Accordingly, a high degree of uncertainty remains for the
Companys ultimate liability for APMT claim and claim adjustment expenses. In addition to the difficulties described above, estimating the ultimate cost
of both reported and unreported APMT claims is subject to a higher degree of
variability due to a number of additional factors, including among others: the
number and outcome of direct actions against the Company; coverage issues,
including whether certain costs are covered under the policies and whether
policy limits apply; allocation of liability among numerous parties, some of
whom may be in bankruptcy proceedings, and in particular the application of
joint and several liability to specific insurers on a risk; inconsistent
court decisions and developing legal theories; increasingly aggressive tactics
of plaintiffs lawyers; the risks and lack of predictability inherent in major
litigation; increased filings of claims in certain states; enactment of
national federal legislation to address asbestos claims; a future increase in
asbestos and environmental pollution claims which cannot now be anticipated; a
future increase in number of mass tort claims relating to silica and
silica-containing products, and the outcome of ongoing disputes as to coverage
in relation to these claims; a further increase of claims and claims payments
that may exhaust underlying umbrella and excess coverages at accelerated rates;
and future developments pertaining to the Companys ability to recover
reinsurance for asbestos and environmental pollution claims. CNA regularly performs ground up reviews of all open APMT claims to evaluate
the adequacy of the Companys APMT reserves. In performing its comprehensive
ground up analysis, the Company considers input from its professionals with
direct responsibility for the claims, inside and outside counsel with
responsibility for representation of the Company, and its actuarial staff.
These professionals review, among many factors, the policyholders present and
predicted future exposures, including such factors as claims volume, trial
conditions, prior settlement history, settlement demands and defense costs; the
impact of asbestos defendant bankruptcies on the policyholder; the policies
issued by CNA, including
such factors as aggregate or per occurrence limits, whether the policy is
primary, umbrella or excess, and the existence of policyholder retentions
and/or deductibles; the existence of other insurance; and reinsurance
arrangements. With respect to other court cases and how they might affect the Companys
reserves and reasonable possible losses, the following should be noted. State
and federal courts issue numerous decisions each year, which potentially impact
losses and reserves in both a favorable and unfavorable manner. Examples of
favorable developments include decisions to allocate defense and indemnity
payments in a manner so 17




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 as to limit carriers obligations to damages taking
place during the effective dates of their policies; decisions holding that
injuries occurring after asbestos operations are completed are subject to the
completed operations aggregate limits of the policies; and decisions ruling
that carriers loss control inspections of their insureds premises do not give
rise to a duty to warn third parties to the dangers of asbestos. Examples of
unfavorable developments include decisions limiting the application of the
absolute pollution exclusion; and decisions holding carriers liable for defense
and indemnity of asbestos and pollution claims on a joint and several basis. The Companys ultimate liability for its environmental pollution and mass tort
claims is impacted by several factors including ongoing disputes with
policyholders over scope and meaning of coverage terms and, in the area of
environmental pollution, court decisions that continue to restrict the scope
and applicability of the absolute pollution exclusion contained in policies
issued by the Company after 1989. Due to the inherent uncertainties described
above, including the inconsistency of court decisions, the number of waste
sites subject to cleanup, and in the area of environmental pollution, the
standards for cleanup and liability, the ultimate liability of CNA for
environmental pollution and mass tort claims may vary substantially from the
amount currently recorded. Due to the inherent uncertainties in estimating claim and claim adjustment
expense reserves for APMT and due to the significant uncertainties previously
described related to APMT claims, the ultimate liability for these cases, both
individually and in aggregate, may exceed the recorded reserves. Any such
potential additional liability, or any range of potential additional amounts,
cannot be reasonably estimated currently, but could be material to the
Companys business, results of operations, equity, and insurer financial
strength and debt ratings. Due to, among other things, the factors described
above, it may be necessary for the Company to record material changes in its
APMT claim and claim adjustment expense reserves in the future, should new
information become available or other developments emerge. The following table provides data related to CNAs APMT claim and claim
adjustment expense reserves. APMT Reserves September 30, 2004
    
    December 31, 2003Environmental
    
    
    
    
    
    EnvironmentalPollution and
    
    
    
    
    
    Pollution andAsbestos
    
    Mass Tort
    
    Asbestos
    
    Mass Tort(In millions)Gross reserves
    
    $
    3,221
    
    
    $
    787
    
    
    $
    3,347
    
    
    $
    839Ceded reserves
    
    
    (1,514
    )
    
    
    (279
    )
    
    
    (1,580
    )
    
    
    (262
    )Net reserves
    
    $
    1,707
    
    
    $
    508
    
    
    $
    1,767
    
    
    $
    577
 18




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)
 Asbestos CNAs property and casualty insurance subsidiaries have exposure to
asbestos-related claims. Estimation of asbestos-related claim and claim
adjustment expense reserves involves limitations such as
inconsistency of court decisions, specific policy provisions, allocation of
liability among insurers and insureds, and additional factors such as missing
policies and proof of coverage. Furthermore, estimation of asbestos-related
claims is difficult due to, among other reasons, the proliferation of
bankruptcy proceedings and attendant uncertainties, the targeting of a broader
range of businesses and entities as defendants, the uncertainty as to which
other insureds may be targeted in the future and the uncertainties inherent in
predicting the number of future claims. As of September 30, 2004 and December 31, 2003, CNA carried approximately
$1,707 million and $1,767 million of claim and claim adjustment expense
reserves, net of reinsurance recoverables, for reported and unreported
asbestos-related claims. The Company recorded $44 million of unfavorable
asbestos-related net claim and claim adjustment expense reserve development for
the nine months ended September 30, 2004 and $642 million asbestos-related net
claim and claim adjustment expense development for the same period in 2003.
The 2004 unfavorable net prior year development was primarily related to a
commutation loss related to The Trenwick Group Ltd. (Trenwick). See Note H for
further details. The Company paid asbestos-related claims, net of reinsurance
recoveries, of $104 million and $101 million for the nine months ended
September 30, 2004 and 2003. Some asbestos-related defendants have asserted that their policies issued by
CNA are not subject to aggregate limits on coverage. CNA has such claims from
a number of insureds. Some of these claims involve insureds facing exhaustion
of products liability aggregate limits in their policies, who have asserted
that their asbestos-related claims fall within so-called non-products
liability coverage contained within their policies rather than products
liability coverage, and that the claimed non-products coverage is not subject
to any aggregate limit. It is difficult to predict the ultimate size of any of
the claims for coverage purportedly not subject to aggregate limits or predict
to what extent, if any, the attempts to assert non-products claims outside
the products liability aggregate will succeed. The Company has attempted to
manage its asbestos exposure by aggressively seeking to settle claims on
acceptable terms. There can be no assurance that any of these settlement
efforts will be successful, or that any such claims can be settled on terms
acceptable to CNA. Where CNA cannot settle a claim on acceptable terms, the
Company aggressively litigates the claim. Adverse developments with respect to
such matters could have a material adverse effect on CNAs results of
operations and/or equity. Certain asbestos litigation in which CNA is currently engaged is described
below: On February 13, 2003, CNA announced it had resolved asbestos related coverage
litigation and claims involving A.P. Green Industries, A.P. Green Services and
Bigelow  Liptak Corporation. Under the agreement, CNA is required to pay $74
million, net of reinsurance recoveries, over a ten year period. The settlement
resolves CNAs liabilities for all pending and future asbestos claims involving
A.P. Green Industries, Bigelow  Liptak Corporation and related subsidiaries,
including alleged non-products exposures. The settlement has received
initial bankruptcy court approval and CNA expects to procure confirmation of a
bankruptcy plan containing an injunction to protect CNA from any future claims. CNA is engaged in insurance coverage litigation with underlying plaintiffs who
have asbestos bodily injury claims against the former Robert A. Keasbey Company
(Keasbey) in New York state court (Continental Casualty Co. v. Nationwide
Indemnity Co. et al., No. 601037/03 (N.Y. County)). Keasbey, a currently
dissolved corporation, was a seller and installer of asbestos-containing
insulation products in 19




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 New York and New Jersey. Thousands of plaintiffs have
filed bodily injury claims against Keasbey; however, Keasbeys involvement at a
number of work sites is a highly contested issue. Therefore, the defense
disputes the percentage of valid claims against Keasbey. CNA issued Keasbey
primary policies for 1970-1987 and excess policies for 1972-1978. CNA has paid
an amount substantially equal to the policies aggregate limits for products
and completed operations claims. Claimants against Keasbey
allege, among other things, that CNA owes coverage under sections of the
policies not subject to the aggregate limits, an allegation CNA vigorously
contests in the lawsuit. CNA has insurance coverage disputes related to asbestos bodily injury claims
against Burns & Roe Enterprises, Inc. (Burns & Roe). Originally raised in
litigation, now stayed, these disputes are currently part of In re: Burns & Roe
Enterprises, Inc., pending in the U.S. Bankruptcy Court for the District of New
Jersey, No. 00-41610. Burns & Roe provided engineering and related services in
connection with construction projects. At the time of its bankruptcy filing,
Burns & Roe faced approximately 11,000 claims alleging bodily injury resulting
from exposure to asbestos as a result of construction projects in which Burns &
Roe was involved. CNA allegedly provided primary liability coverage to Burns &
Roe from 1956-1969 and 1971-1974, along with certain project-specific policies
from 1964-1970. CIC issued certain primary and excess policies to Bendix Corporation (Bendix),
now part of Honeywell International, Inc. (Honeywell). Honeywell faces
approximately 75,105 pending asbestos bodily injury claims resulting from
alleged exposure to Bendix friction products. CICs primary policies allegedly
covered the period from at least 1939 (when Bendix began to use asbestos in its
friction products) to 1983, although the parties disagree about whether CICs
policies provided product liability coverage before 1940 and from 1945 to 1956.
CIC asserts that it owes no further material obligations to Bendix under any
primary policy. Honeywell alleges that two primary policies issued by CIC
covering 1969-1975 contain occurrence limits but not product liability
aggregate limits for asbestos bodily injury claims. CIC has asserted, among
other things, which even if Honeywells allegation is correct, which CNA
denies, its liability is limited to a single occurrence limit per policy or per
year, and in the alternative, a proper allocation of losses would substantially
limit its exposure under the 1969-1975 policies to asbestos claims. These and
other issues are being litigated in Continental Insurance Co., et al. v.
Honeywell International Inc., No. MRS-L-1523-00 (Morris County, New Jersey). Policyholders have also initiated litigation directly against CNA and other
insurers in four jurisdictions: Ohio, Texas, West Virginia and Montana. In the
two Ohio actions, plaintiffs allege the defendants negligently performed duties
undertaken to protect workers and the public from the effects of asbestos
(Varner v. Ford Motor Co., et al. (Cuyahoga County, Ohio) and Peplowski v. Ace
American Ins. Co., et al. (U.S.D.C. N.D. Ohio)). The state trial court
recently granted insurers, including CNA, summary judgment against a
representative group of plaintiffs, ruling that insurers had no duty to warn
plaintiffs about asbestos. Similar lawsuits have also been filed in Texas
against CNA, and other insurers and non-insurer corporate defendants asserting
liability for failing to warn of the dangers of asbestos (Boson v. Union
Carbide Corp., et al. (District Court of Nueces County, Texas)). Many of the
Texas claims have been dismissed as time-barred by the applicable statute of
limitations. In other claims, the Texas court recently ruled that the carriers
did not owe any duty to the plaintiffs or the general public to advise on the
effects of asbestos thereby dismissing these claims. The time period for
filing an appeal of this ruling has not expired and it remains uncertain
whether the plaintiffs will continue to pursue their causes of action. CNA has been named in Adams v. Aetna, Inc., et al. (Circuit Court of Kanawha
County, West Virginia), a purported class action against CNA and other
insurers, alleging that the defendants violated West Virginias Unfair Trade
Practices Act in handling and resolving asbestos claims against their
policy-holders. A direct action has also been filed in Montana (Pennock, et
al. v. Maryland Casualty, et al. First Judicial District Court of Lewis &
Clark County, Montana) by eight individual plaintiffs (all employees 20




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 of W.R.
Grace & Co. (W.R. Grace)) and their spouses against CNA, Maryland Casualty and
the State of Montana. This action alleges that the carriers failed to warn of
or otherwise protect W.R. Grace employees from the dangers of asbestos at a
W.R. Grace vermiculite mining facility in Libby, Montana. The Montana direct
action is currently stayed as to CNA because of W.R. Graces pending
bankruptcy. CNA is vigorously defending these and other cases and believes that it has
meritorious defenses to the claims asserted. However, there are numerous
factual and legal issues to be resolved in connection with these claims, and it
is extremely difficult to predict the outcome or ultimate financial exposure
represented by these matters. Adverse developments with respect to any of
these matters could have a material adverse effect on CNAs business, insurer
financial strength and debt ratings, and results of operations and/or equity. As a result of the uncertainties and complexities involved, reserves for
asbestos claims cannot be estimated with traditional actuarial techniques that
rely on historical accident year loss development factors. In establishing
asbestos reserves, CNA evaluates the exposure presented by each insured. As
part of this evaluation, CNA considers the available insurance coverage; limits
and deductibles; the potential role of other insurance, particularly underlying
coverage below any CNA excess liability policies; and applicable coverage
defenses, including asbestos exclusions. Estimation of asbestos-related claim
and claim adjustment expense reserves involves a high degree of judgment on the
part of management and consideration of many complex factors, including:
inconsistency of court decisions, jury attitudes and future court decisions;
specific policy provisions; allocation of liability among insurers and
insureds; missing policies and proof of coverage; the proliferation of
bankruptcy proceedings and attendant uncertainties; novel theories asserted by
policyholders and their counsel; the targeting of a broader range of businesses
and entities as defendants; the uncertainty as to which other insureds may be
targeted in the future and the uncertainties inherent in predicting the number
of future claims; volatility in claim numbers and settlement demands; increases
in the number of non-impaired claimants and the extent to which they can be
precluded from making claims; the efforts by insureds to obtain coverage not
subject to aggregate limits; the long latency period between asbestos exposure
and disease manifestation and the resulting potential for involvement of
multiple policy periods for individual claims; medical inflation trends; the
mix of asbestos-related diseases presented and the ability to recover
reinsurance. Environmental Pollution and Mass Tort Environmental pollution cleanup is the subject of both federal and state
regulation. By some estimates, there are thousands of potential waste sites
subject to cleanup. The insurance industry is involved in extensive litigation
regarding coverage issues. Judicial interpretations in many cases have
expanded the scope of coverage and liability beyond the original intent of the
policies. The Comprehensive Environmental Response Compensation and Liability
Act of 1980 (Superfund) and comparable state statutes (mini-Superfunds) govern
the cleanup and restoration of toxic waste sites and formalize the concept of
legal liability for cleanup and restoration by Potentially Responsible
Parties (PRPs). Superfund and the mini-Superfunds establish mechanisms to pay
for cleanup of waste sites if PRPs fail to do so and assign liability to PRPs.
The extent of liability to be allocated to a PRP is dependent upon a variety of
factors. Further, the number of waste sites subject to cleanup is unknown. To
date, approximately 1,400 cleanup sites have been identified by the
Environmental Protection Agency (EPA) and included on its National Priorities
List (NPL). State authorities have designated many cleanup sites as well. Many policyholders have made claims against various CNA insurance subsidiaries
for defense costs and indemnification in connection with environmental
pollution matters. The vast majority of these claims 21




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 relate to accident years
1989 and prior, which coincides with CNAs adoption of the Simplified
Commercial General Liability coverage form, which includes what is referred to
in the industry as an absolute pollution exclusion. CNA and the insurance
industry are disputing coverage for many such claims. Key coverage issues
include whether cleanup costs are considered damages under the policies,
trigger of coverage, allocation of liability among triggered policies,
applicability of pollution exclusions
and owned property exclusions, the potential for joint and several liability
and the definition of an occurrence. To date, courts have been inconsistent in
their rulings on these issues. A number of proposals to modify Superfund have been made by various parties.
However, no modifications were enacted by Congress during 2003 or in the first
three quarters of 2004, and it is unclear what positions Congress or the
Administration will take and what legislation, if any, will result in the
future. If there is legislation, and in some circumstances even if there is no
legislation, the federal role in environmental cleanup may be significantly
reduced in favor of state action. Substantial changes in the federal statute
or the activity of the EPA may cause states to reconsider their environmental
cleanup statutes and regulations. There can be no meaningful prediction of the
pattern of regulation that would result or the possible effect upon CNAs
results of operations or equity. As of September 30, 2004 and December 31, 2003, CNA carried approximately $508
million and $577 million of claim and claim adjustment expense reserves, net of
reinsurance recoverables, for reported and unreported environmental pollution
and mass tort claims. There was no environmental pollution and mass tort net
claim and claim adjustment expense reserve development for the nine months
ended September 30, 2004 and $153 million of unfavorable reserve development
for the nine months ended September 30, 2003. The Company paid environmental
pollution-related claims and mass tort-related claims, net of reinsurance
recoveries, of $79 million and $68 million for the nine months ended September
30, 2004 and 2003. Additionally, the Company recorded $10 million of current
accident year losses related to mass tort in 2004. CNA has made resolution of large environmental pollution exposures a management
priority. The Company has resolved a number of its large environmental accounts
by negotiating settlement agreements. In its settlements, CNA sought to
resolve those exposures and obtain the broadest release language to avoid
future claims from the same policyholders seeking coverage for sites or claims
that had not emerged at the time CNA settled with its policyholder. While the
terms of each settlement agreement vary, CNA sought to obtain broad
environmental releases that include known and unknown sites, claims and
policies. The broad scope of the release provisions contained in those
settlement agreements should, in many cases, prevent future exposure from
settled policyholders. It remains uncertain, however, whether a court
interpreting the language of the settlement agreements will adhere to the
intent of the parties and uphold the broad scope of language of the agreements. In 2003, CNA observed a marked increase in silica claims frequency in
Mississippi, where plaintiff attorneys appear to have filed claims to avoid the
effect of tort reform. In 2004, silica claims frequency in Mississippi has
moderated notably due to implementation of tort reform measures and favorable
court decisions. To date, the most significant silica exposures identified
included a relatively small number of accounts with significant numbers of new
claims reported in 2003 and continuing in 2004. Establishing claim and claim
adjustment expense reserves for silica claims is subject to uncertainties
because of disputes concerning medical causation with respect to certain
diseases, including lung cancer, geographical concentration of the lawsuits
asserting the claims, and the large rise in the total number of claims without
underlying epidemiological developments suggesting an increase in disease rates
or plaintiffs. Moreover, judicial interpretations regarding application of
various tort defenses, including 22




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 application of various theories of joint and
several liabilities, impede the Companys ability to estimate its ultimate
liability for such claims. Net Prior Year Development Unfavorable net prior year development of $116 million, including $227 million
of unfavorable claim and allocated claim adjustment expense reserve development
and $111 million of favorable premium development, was recorded for the nine
months ended September 30, 2004. Unfavorable net prior year development of
$2,835 million, including $2,312 million of unfavorable claim and allocated
claim adjustment expense reserve development and $523 million of unfavorable
premium development, was recorded for the same period in 2003. The gross
carried claim and claim adjustment expense reserves for CNAF were $31,495
million and $31,730 million at September 30, 2004 and December 31, 2003. The
net carried claim and claim adjustment expense reserves for CNAF were $17,457
million and $17,514 million at September 30, 2004 and December 31, 2003. Standard Lines Unfavorable net prior year development of $13 million, including $111 million
of unfavorable claim and allocated claim adjustment expense reserve development
and $98 million of favorable premium development, was recorded for the nine
months ended September 30, 2004 for Standard Lines. Unfavorable net prior year
development of $1,425 million, including $957 million of unfavorable claim and
allocated claim adjustment expense reserve development and $468 million of
unfavorable premium development, was recorded for the same period in 2003. The
gross and net carried claim and claim adjustment expense reserves were $14,370
million and $9,236 million at September 30, 2004. The gross and net carried
claim and claim adjustment expense reserves for Standard Lines were $14,282
million and $8,967 million at December 31, 2003. In the second quarter of 2004, the Company finalized commutation agreements
with several members of the Trenwick Group. These commutations resulted in
unfavorable claim and claim adjustment expense reserve development which was
more than offset by a release of a previously established allowance for
uncollectible reinsurance. In addition approximately $75 million of unfavorable net prior year claim and
allocated claim adjustment expense development recorded in the second quarter
of 2004 resulted from increased severity trends for workers compensation on
large account policies primarily in accident years 2002 and prior. Favorable
premium development on retrospectively rated large account policies of $25
million was recorded in relation to this unfavorable net prior year claim and
allocated claim adjustment expense development. Also, favorable net prior year
premium development of approximately $60 million resulted primarily from higher
audit and endorsement premiums on workers compensation and general liability
policies. Approximately $30 million of the unfavorable net prior year claim
and allocated claim adjustment expense reserve development was recorded related
to the higher audit and endorsement premium. In the third quarter of 2004, approximately $15 million of unfavorable net
prior claim and allocated claim adjustment expense development was recorded in
relation to the Companys share of the National Workers Compensation
Reinsurance Pool (NWCRP). During the third quarter of 2004, the NWCRP reached
an agreement with a former pool member to settle their pool liabilities at an
amount less than their established share. The result of this settlement will
be a higher allocation to the remaining pool members, including the Company. The following discusses net prior year development for Standard Lines recorded
for the nine months ended September 30, 2003. 23




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 Approximately $495 million of unfavorable claim and allocated claim adjustment
expense reserve development was recorded related to construction defect claims
for the nine months ended September 30, 2003. Based on analyses completed
during the third quarter of 2003, it became apparent that the assumptions
regarding the number of claims, which were used to estimate the expected
losses, were no
longer appropriate. The analyses indicated that the actual number of claims
reported during 2003 was higher than expected primarily in states other than
California. States where this activity is most evident include Texas, Arizona,
Nevada, Washington and Colorado. The number of claims reported in states other
than California during the first six months of 2003 was almost 35% higher than
the last six months of 2002. The number of claims reported during the last six
months of 2002 increased by less than 10% from the first six months of 2002.
In California, claims resulting from additional insured endorsements increased
throughout 2003. Additional insured endorsements are regularly included on
policies provided to subcontractors. The additional insured endorsement names
general contractors and developers as additional insureds covered by the
policy. Current California case law (Presley Homes, Inc. v. American States
Insurance Company, (June 11, 2001) 90 Cal App. 4th 571, 108 Cal. Rptr. 2d 686)
specifies that an individual subcontractor with an additional insured
obligation has a duty to defend the additional insured in the entire action,
subject to contribution or recovery later. In addition, the additional insured
is allowed to choose one specific carrier to defend the entire action. These
additional insured claims can remain open for a longer period of time than
other construction defect claims because the additional insured defense
obligation can continue until the entire case is resolved. The adverse reserve
development recorded related to construction defect claims was primarily
related to accident years 1999 and prior. Unfavorable net prior year development of approximately $595 million, including
$518 million of unfavorable claim and allocated claim adjustment expense
reserve development and $77 million of unfavorable premium development, was
recorded for large account business including workers compensation coverages
for the nine months ended September 30, 2003. Many of the policies issued to
these large accounts include provisions tailored specifically to the individual
accounts. Such provisions effectively result in the insured being responsible
for a portion of the loss. An example of such a provision is a deductible
arrangement where the insured reimburses the Company for all amounts less than
a specified dollar amount. These arrangements often limit the aggregate amount
the insured is required to reimburse the Company. Analyses completed during the second and third quarters of 2003, including
claims handled by third party administrators (TPA), indicated higher losses
from the large accounts. In addition, these analyses indicated that the
provisions that result in the insured being responsible for a portion would
have less of an impact due to the larger size of claims as well as the
increased number of claims. The development recorded was primarily related to
accident years 2000 and prior. Approximately $98 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development recorded for the nine months ended
September 30, 2003, resulted from a program covering facilities that provide
services to developmentally disabled individuals. This net prior year
development was due to an increase in the size of known claims and increases in
policyholder defense costs. With regard to average claim size, updated data
showed the average claim increasing at an annual rate of approximately 20%.
Prior data had shown average claim size to be level. Similar to the average
claim size, updated data showed the average policyholder defense cost
increasing at an annual rate of approximately 20%. Prior data had shown
average policyholder defense cost to be level. The net prior year development
recorded was primarily for accident years 2001 and prior. Approximately $40 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development recorded for the nine months ended
September 30, 2003 was for excess workers compensation coverages due to
increasing severity. The increase in severity means that a higher 24




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 percentage
of the total loss dollars will be the Companys responsibility since more
claims will exceed the point at which the Companys coverage begins. The net
prior year development recorded was primarily for accident year 2000. Approximately $73 million of unfavorable development recorded for the nine
months ended September 30, 2003 was the result of a commutation of all ceded
reinsurance treaties with Gerling Global Group of companies (Gerling), related
to accident years 1999 through 2001, including $41 million of unfavorable claim
and allocated claim adjustment expense development and $32 million of
unfavorable premium development. Unfavorable net prior year claim and allocated claim adjustment expense reserve
development of approximately $40 million recorded for the nine months ended
September 30, 2003 was related to a program covering tow truck and ambulance
operators, primarily impacting the 2001 accident year. The Company had
previously expected that loss ratios for this business would be similar to its
middle market commercial automobile liability business. During 2002, the
Company ceased writing business under this program. Approximately $25 million of unfavorable net prior year premium development was
recorded for the nine months ended September 30, 2003 was related to a second
quarter of 2003 reevaluation of losses ceded to a reinsurance contract covering
middle market workers compensation exposures. The reevaluation of losses led
to a new estimate of the number and dollar amount of claims that would be ceded
under the reinsurance contract. As a result of the reevaluation of losses, the
Company recorded approximately $36 million of unfavorable claim and allocated
claim adjustment expense reserve development, which was ceded under the
contract. The net prior year development was recorded for accident year 2000. Approximately $11 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development recorded for the nine months ended
September 30, 2003 was related to directors and officers exposures in Global
Lines. The unfavorable net prior year reserve development was primarily due
to securities class action cases related to certain known corporate malfeasance
cases and investment banking firms. This net prior year development recorded
was primarily for accident years 2000 through 2002. The following premium and claim and allocated claim adjustment expense
development was recorded in the third quarter of 2003 as a result of the
elimination of deficiencies and redundancies in reserve positions within the
segment. Unfavorable net prior year development of approximately $210 million
related to small and middle market workers compensation exposures and
approximately $110 million related to E&S lines was recorded in the third
quarter of 2003. Offsetting these increases was $210 million of favorable net
prior year development in the property line of business, including $79 million
related to the September 11, 2001 World Trade Center Disaster and related
events (WTC event). Also, offsetting the unfavorable premium and claim and allocated claim
adjustment expense development was a $215 million underwriting benefit from
cessions to corporate aggregate reinsurance treaties recorded in the nine
months ended September 30, 2003 of which $140 million was recorded in the third
quarter of 2003. The benefit is comprised of $480 million of ceded losses and
$265 million of ceded premiums for accident years 2000 and 2001. 25




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 Specialty Lines Unfavorable net prior year development of $39 million, including $65 million of
unfavorable net claim and allocated claim adjustment expense reserve
development and $26 million of favorable premium development, was recorded for
the nine months ended September 30, 2004 for Specialty Lines. Unfavorable net
prior year development of $287 million, including $263 million of unfavorable
net claim and allocated claim adjustment expense reserve development and $24
million of unfavorable premium development, was recorded for the same period in
2003. The gross and net carried claim and claim adjustment expense reserves
were $4,658 million and $3,141 million at September 30, 2004. The gross and
net carried claim and claim adjustment expense reserves for Specialty Lines
were $4,200 million and $2,919 million at December 31, 2003. The Company finalized commutation agreements with several members of the
Trenwick Group in the second quarter of 2004. These commutations resulted in
unfavorable claim and claim adjustment expense reserve development which was
more than offset by a release of a previously established allowance for
uncollectible reinsurance. Additionally, unfavorable net prior year claim and
allocated claim adjustment expense reserve development resulted from the
increased emergence of several large directors and officers (D&O) claims,
primarily in recent accident years. The following discusses net prior year development for Specialty Lines recorded
for the nine months ended September 30, 2003. Approximately $50 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development recorded for the nine months ended
September 30, 2003 was related to increased severity in excess coverages
provided to facilities providing health care services. The increase in
reserves is based on reviews of individual accounts where claims had been
expected to be less than the point at which the Companys coverage applies.
The current claim trends indicated that the layers of coverage provided by the
Company would be impacted. The net prior year development recorded was
primarily for accident years 2001 and prior. Approximately $68 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development recorded for the nine months ended
September 30, 2003 was for surety coverages related to primarily workers
compensation bond exposure from accident years 1990 and prior and large losses
for accident years 1999 and 2002. Approximately $21 million of unfavorable net
prior year claim and allocated claim adjustment expense reserve development was
recorded in the surety line of business in the second quarter of 2003 as the
result of recent developments on one large claim. Approximately $75 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development recorded for the nine months ended
September 30, 2003 was related to directors and officers exposures in CNA Pro.
The unfavorable net prior year reserve development was primarily due to
securities class action cases related to certain known corporate malfeasance
cases and investment banking firms. This net prior year development recorded
was primarily for accident years 2000 through 2002. Approximately $47 million of losses was recorded for third quarter of 2003 as
the result of a commutation of ceded reinsurance treaties with Gerling,
relating to accident years 1999 through 2002. An additional $37 million of
losses was recorded in the second quarter of 2003 as the result of a
commutation of three ceded reinsurance treaties covering CNA HealthPro,
relating to accident years 1999 through 2001. 26




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 The following development was recorded in the third quarter of 2003 as a result
of the elimination of deficiencies and redundancies in reserve positions within
the segment. An additional $50 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development was
recorded related to medical malpractice and long term care facilities.
Partially offsetting this unfavorable claim and allocated claim adjustment
expense reserve development was a $27 million underwriting benefit from
cessions to corporate aggregate reinsurance treaties. The benefit was
comprised of $59 million of ceded losses and $32 million of ceded premiums for
accident years 2000 and 2001. See Note H for further discussion of the
Companys aggregate reinsurance treaties. Corporate and Other Non-Core Unfavorable net prior year development of $76 million, including $63 million of
net unfavorable claim and allocated claim adjustment expense reserve
development and $13 million of unfavorable premium development, was recorded
for the nine months ended September 30, 2004 for Corporate and Other.
Unfavorable net prior year development of $1,058 million, including $1,027
million of net unfavorable claim and allocated claim adjustment expense reserve
development and $31 million of unfavorable premium development, was recorded
for the same period in 2003. The gross and net carried claim and claim
adjustment expense reserves were $8,760 million and $3,277 million at September
30, 2004. The gross and net carried claim and claim adjustment expense
reserves for Corporate and Other were $9,672 million and $3,737 million at
December 31, 2003. The net prior year development recorded for 2004 relates primarily to
commutation agreements with several members of the Trenwick Group which
resulted in unfavorable net prior year development which was partially offset
by a release of a previously established allowance for uncollectible
reinsurance. The following discusses net prior year development for Corporate and Other
Non-Core recorded for the nine months ended September 30, 2003. Unfavorable claim and allocated claim adjustment expense reserve development of
$795 million related to APMT was recorded in the nine months ended September
30, 2003. Unfavorable net prior year development of $148 million, including $109 million
of unfavorable claim and allocated claim adjustment expense reserve development
and $39 million of unfavorable premium development, was recorded for the nine
months ended September 30, 2003 related to CNA Re. The unfavorable net prior year development was primarily a result of a general
change in the reporting pattern of losses as reported by the companies that
purchased reinsurance from CNA Re. Losses have continued to show large
increases for accident years in the late 1990s and into 2000 and 2001. These
increases are greater than the increases indicated by patterns from older
accident years and have a similar effect on several lines of business.
Approximately $67 million unfavorable net prior year development recorded for
nine months ended September 30, 2003 was related to proportional liability
exposures, primarily from multi-line and umbrella treaties in accident years
1997 through 2001. Approximately $32 million of unfavorable net prior year
development recorded for the nine months ended September 30, 2003, was related
to assumed financial reinsurance for accident years 2001 and prior and
approximately 27




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 $24 million of unfavorable net prior year development related to
professional liability exposures in accident years 2001 and prior. CNA Re recorded an additional $15 million of unfavorable development for
construction defect related exposures. Because of the unique nature of this
exposure, losses have not followed expected
development patterns. The continued reporting of claims in California, the
increase in the number of claims from states other than California and a review
of individual ceding companies exposure to this type of claim resulted in an
increase in the estimated reserve. Unfavorable net prior year claim and allocated claim adjustment expense reserve
development of approximately $25 million was recorded primarily for directors
and officers exposures. The net prior year reserve development was a result of
a claims review that was completed during the second quarter of 2003. The
unfavorable net prior year reserve development was primarily due to securities
class action cases related to certain known corporate malfeasance cases and
investment banking firms. The net prior year reserve development recorded was
for accident years 2000 and 2001. The following premium and claim and allocated claim adjustment expense
development, was recorded in the third quarter of 2003 as a result of the
elimination of deficiencies and redundancies in the reserve positions of
individual products within the segment. Unfavorable net prior year premium and
claim and allocated claim adjustment expense development of approximately $42
million related to surety exposures, $32 million related to excess of loss
liability exposures and $12 million related to facultative liability exposures
were recorded in the third quarter of 2003. Offsetting this unfavorable premium
and claim and allocated claim adjustment expense reserve development was
approximately $55 million of favorable development related to the WTC event.
In addition, there was a $47 million underwriting benefit from cessions to
corporate aggregate reinsurance treaties for the nine months ended September
30, 2003 of which $55 million was recorded in the third quarter of 2003. The
benefit was comprised of $104 million of ceded losses and $57 million of ceded
premiums for accident years 2000 and 2001. See Note H for further discussion
of the Companys aggregate reinsurance treaties. Unfavorable net prior year claim and allocated claim adjustment expense reserve
development of approximately $75 million recorded for the nine months ended
September 30, 2003 was related to an adverse arbitration decision in the second
quarter of 2003 involving a single large property and business interruption
loss. The decision was rendered against a voluntary insurance pool in which
the Company was a participant. The loss was caused by a fire which occurred in
1995. The Company no longer participates in this pool. Note H. Reinsurance CNA assumes and cedes reinsurance with other insurers, reinsurers and members
of various reinsurance pools and associations. CNA utilizes reinsurance
arrangements to limit its maximum loss, provide greater diversification of
risk, minimize exposures on larger risks and to exit certain lines of business.
The ceding of insurance does not discharge the primary liability of the
Company. Therefore, a credit exposure exists with respect to property and
casualty and life reinsurance ceded to the extent that any reinsurer is unable
to meet the obligations assumed under reinsurance agreements. Interest cost on reinsurance contracts accounted for on a funds withheld basis
is incurred during all periods in which a funds withheld liability exists.
Interest cost, which is included in net investment income, was $55 million and
$148 million for the three months ended September 30, 2004 and 2003, and $161
million and $288 million for the nine months ended September 30, 2004 and 2003.
The amount 28




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 subject to interest crediting rates on such contracts was $2,726
million and $2,789 million at September 30, 2004 and December 31, 2003.
Certain funds withheld reinsurance contracts, including the corporate aggregate
reinsurance treaties, require interest on additional premiums arising from
ceded losses as if those premiums were payable at the inception of the
contract. The amount subject to interest crediting on these funds withheld contracts will
vary over time based on a number of factors, including the timing of loss
payments and ultimate gross losses incurred. The Company expects that it will
continue to incur significant interest costs on these contracts for several
years. The following table summarizes the amounts receivable from reinsurers at
September 30, 2004 and December 31, 2003. Components of reinsurance receivables September 30,
    
    December 31,2004
    
    2003(In millions)Reinsurance receivables related to insurance reserves:Ceded claim and claim adjustment expense
    
    $
    14,038
    
    
    $
    14,216Ceded future policy benefits
    
    
    1,227
    
    
    
    1,218Ceded policyholders funds
    
    
    60
    
    
    
    7Billed reinsurance receivables
    
    
    587
    
    
    
    813Reinsurance receivables
    
    
    15,912
    
    
    
    16,254Allowance for uncollectible reinsurance
    
    
    (531
    )
    
    
    (573
    )Reinsurance receivables, net of allowance
for uncollectible reinsurance
    
    $
    15,381
    
    
    $
    15,681
 The Company has established an allowance for uncollectible reinsurance. The
allowance for uncollectible reinsurance was $531 million and $573 million at
September 30, 2004 and December 31, 2003. The net decrease in the allowance
for uncollectible reinsurance was primarily due to a release of a previously
established allowance related to The Trenwick Group resulting from the
finalization of commutation agreements in the second quarter of 2004, partially
offset by a net increase in the allowance for other reinsurance receivables.
The expenses incurred related to uncollectible reinsurance receivables are
presented as a component of Insurance claims and policyholders benefits on
the Condensed Consolidated Statements of Operations. The Company attempts to mitigate its credit risk related to reinsurance by
entering into reinsurance arrangements only with reinsurers that have credit
ratings above certain levels and by obtaining substantial amounts of
collateral. The primary methods of obtaining collateral are through
reinsurance trusts, letters of credit and funds withheld balances. 29




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 The effects of reinsurance on earned premiums are shown in the following table. Components of Earned Premiums For the nine months ended September 30
    
    Direct
    
    Assumed
    
    Ceded
    
    Net(In millions)2004Property and casualty
    
    $
    8,059
    
    
    $
    163
    
    
    $
    2,663
    
    
    $
    5,559Accident and health
    
    
    919
    
    
    
    45
    
    
    
    421
    
    
    
    543Life
    
    
    369
    
    
    
    
    
    
    
    250
    
    
    
    119Total earned premiums
    
    $
    9,347
    
    
    $
    208
    
    
    $
    3,334
    
    
    $
    6,2212003Property and casualty
    
    $
    7,977
    
    
    $
    460
    
    
    $
    3,459
    
    
    $
    4,978Accident and health
    
    
    1,196
    
    
    
    78
    
    
    
    42
    
    
    
    1,232Life
    
    
    801
    
    
    
    4
    
    
    
    311
    
    
    
    494Total earned premiums
    
    $
    9,974
    
    
    $
    542
    
    
    $
    3,812
    
    
    $
    6,704
 Life premiums are primarily from long duration contracts; property and casualty
premiums and accident and health premiums are primarily from short duration
contracts. The Company has an aggregate reinsurance treaty related to the 1999 through
2001 accident years that covers substantially all of the Companys property and
casualty lines of business (the Aggregate Cover). The Aggregate Cover provides
for two sections of coverage. These coverages attach at defined loss ratios
for each accident year. Coverage under the first section of the Aggregate
Cover, which was available for all accident years covered by the treaty, had a
$500 million limit per accident year of ceded losses and an aggregate limit of
$1 billion of ceded losses for the three accident years. The ceded premiums
associated with the first section are a percentage of ceded losses and for each
$500 million of limit the ceded premium is $230 million. The second section of
the Aggregate Cover, which only relates to accident year 2001, provides
additional coverage of up to $510 million of ceded losses for a maximum ceded
premium of $310 million. Under the Aggregate Cover, interest charges on the
funds withheld liability accrue at 8% per annum. This rate will increase to
8.25% per annum commencing in 2006. The aggregate loss ratio for the
three-year period has exceeded certain thresholds, which require additional
ceded premiums. The Company recorded $5 million for the three months ended
September 30, 2004 and $8 million for the nine months ended September 30, 2004
of ceded premiums under this provision. The aggregate limits under both
sections of the Aggregate Cover were exhausted in 2003. The pretax impact of the Aggregate Cover was as follows: Pretax Impact of Aggregate Cover Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Ceded earned premiums
    
    $
    3
    
    
    $
    (223
    )
    
    $
    
    
    
    $
    (251
    )Ceded claim and claim adjustment expense
    
    
    
    
    
    
    422
    
    
    
    
    
    
    
    500Interest charges
    
    
    (19
    )
    
    
    (88
    )
    
    
    (61
    )
    
    
    (123
    )Pretax benefit (expense)
    
    $
    (16
    )
    
    $
    111
    
    
    $
    (61
    )
    
    $
    126
 In 2001, the Company entered into a one-year aggregate reinsurance treaty
related to the 2001 accident year covering substantially all property and
casualty lines of business in the Continental Casualty Company pool (the CCC
Cover). The loss protection provided by the CCC Cover has an aggregate limit
of approximately $761 million of ceded losses. 30




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##### Table of Contents



CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 The ceded premiums are a
percentage of ceded losses. The ceded premium related to full utilization of
the $761 million of limit is $456 million. The CCC Cover provides continuous
coverage in excess of the second section of the Aggregate Cover discussed
above. Under the CCC Cover, interest charges on the funds withheld generally
accrue at 8% per annum. The interest rate increases to 10% per annum if the aggregate loss ratio
exceeds certain thresholds. During 2003, the aggregate limits under the CCC
Cover were exhausted. The pretax impact of the CCC Cover was as follows: Pretax Impact of CCC Cover Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Ceded earned premiums
    
    $
    
    
    
    $
    (10
    )
    
    $
    
    
    
    $
    (100
    )Ceded claim and claim adjustment expense
    
    
    
    
    
    
    17
    
    
    
    
    
    
    
    143Interest charges
    
    
    (12
    )
    
    
    (13
    )
    
    
    (34
    )
    
    
    (48
    )Pretax benefit (expense)
    
    $
    (12
    )
    
    $
    (6
    )
    
    $
    (34
    )
    
    $
    (5
    )
 Note I. Debt Debt is composed of the following obligations. Debt September 30,
    
    December 31,2004
    
    2003(In millions)Variable rate debt:Credit facility  CNA Surety, due September 30, 2005
    
    $
    25
    
    
    $
    30Term loan  CNA Surety, due through September 30, 2005
    
    
    10
    
    
    
    20Debenture, CNA Surety, face amount of $31, due April 29, 2034
    
    
    30
    
    
    
    Credit facility  CNAF, due April 30, 2004
    
    
    
    
    
    
    250Senior notes:6.500%, face amount of $493, due April 15, 2005
    
    
    492
    
    
    
    4926.750%, face amount of $250, due November 15, 2006
    
    
    249
    
    
    
    2496.450%, face amount of $150, due January 15, 2008
    
    
    149
    
    
    
    1496.600%, face amount of $200, due December 15, 2008
    
    
    199
    
    
    
    1998.375%, face amount of $70, due August 15, 2012
    
    
    69
    
    
    
    696.950%, face amount of $150, due January 15, 2018
    
    
    149
    
    
    
    149Debenture, CNAF, 7.250%, face amount of $243, due November 15, 2023
    
    
    241
    
    
    
    241Capital leases, 10.400%-11.500%, due through December 31, 2011
    
    
    31
    
    
    
    33Other debt, 1.000%-6.600%, due through 2019
    
    
    23
    
    
    
    23Surplus Note:CCC Group Surplus Note, face amount of $46, due to Loews February of 2024
    
    
    46
    
    
    
    Total debt
    
    $
    1,713
    
    
    $
    1,904Short term debt
    
    $
    531
    
    
    $
    263Long term debt
    
    
    1,182
    
    
    
    1,641Total debt
    
    $
    1,713
    
    
    $
    1,904
 The $250 million CNAF credit facility was repaid on April 20, 2004. 31




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 The CCC Group surplus note has a 20-year term and bears interest at LIBOR plus
350 basis points, reset annually. CNA plans to seek approval from the
insurance regulatory authority for the repayment of the CCC Group surplus note.
CNA received insurance regulatory approval for the repayment of a $300
million CCC Life surplus note issued in February of 2004, and repaid the note,
including accrued interest, on June 16, 2004. In May of 2004, CNA Surety, a 64% owned and consolidated subsidiary of CNA,
issued privately, through a wholly-owned trust, $30 million of preferred
securities through two pooled transactions. These securities bear interest at
a rate of LIBOR plus 337.5 basis points with a thirty-year term and are
redeemable after five years. The securities were issued by CNA Surety Capital
Trust I (Issuer Trust). The sole asset of the Issuer Trust consists of a $31
million junior subordinated debenture issued by CNA Surety to the Issuer Trust.
The subordinated debenture bears interest at a rate of LIBOR plus 337.5 basis
points and matures in April of 2034. As of September 30, 2004, the interest
rate on the junior subordinated debenture was 5.1%. On September 30, 2003, CNA Surety entered into a $50 million credit agreement,
which consisted of a $30 million two-year revolving credit facility and a $20
million two-year term loan, with semi-annual principal payments of $5 million.
The credit agreement is an amendment to a $65 million credit agreement,
extending the revolving loan termination date from September 30, 2003 to
September 30, 2005. The new revolving credit facility was fully utilized at
inception. In June of 2004, CNA Surety reduced the outstanding borrowings
under the credit facility by $10 million, and in September of 2004, CNA Surety
increased the outstanding borrowings under the credit facility by $5 million to
fund the semi-annual term loan payment. Under the new credit facility agreement, CNA Surety pays a facility fee of 35.0
basis points on the revolving credit portion of the facility, interest at LIBOR
plus 90 basis points, and for utilization greater than 50% of the amount
available to borrow an additional fee of 5.0 basis points. On the term loan,
CNA Surety pays interest at LIBOR plus 62.5 basis points. At September 30,
2004, the weighted-average interest rate on the $35 million of outstanding
borrowings under the credit agreement, including facility fees and utilization
fees, was 3.3%. The combined aggregate maturities for debt at September 30, 2004 are presented
in the following table. Maturity of Debt (In millions)2004
    
    $
    12005
    
    
    5312006
    
    
    2542007
    
    
    122008
    
    
    354Thereafter
    
    
    568Less original issue discount
    
    
    (7
    )Total
    
    $
    1,713
 32




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##### Table of Contents



CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)
 Note J. Benefit Plans Pension and Postretirement Healthcare and Life Insurance Benefit Plans CNAF and certain subsidiaries sponsor noncontributory pension plans typically
covering full-time employees age 21 or over who have completed at least one
year of service. While the terms of the plans vary, benefits are generally
based on years of credited service and the employees highest 60 consecutive
months of compensation. CNA uses December 31 as the measurement date for the
majority of its plans. CNAs funding policy is to make contributions in accordance with applicable
governmental regulatory requirements. The assets of the plans are invested
primarily in U.S. government securities with the balance in mortgage-backed
securities, equity investments, limited partnerships and short term
investments. CNA provides certain healthcare and life insurance benefits to eligible retired
employees, their covered dependents and their beneficiaries. The funding for
these plans is generally to pay covered expenses as they are incurred. The components of net periodic benefit costs are presented in the following
table. Net Periodic Benefit Costs Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Pension BenefitsService cost
    
    $
    7
    
    
    $
    8
    
    
    $
    29
    
    
    $
    23Interest cost on projected benefit obligation
    
    
    30
    
    
    
    35
    
    
    
    149
    
    
    
    107Expected return on plan assets
    
    
    (29
    )
    
    
    (37
    )
    
    
    (155
    )
    
    
    (109
    )Prior service cost amortization
    
    
    
    
    
    
    1
    
    
    
    2
    
    
    
    2Actuarial loss
    
    
    3
    
    
    
    2
    
    
    
    13
    
    
    
    5Net periodic pension cost
    
    $
    11
    
    
    $
    9
    
    
    $
    38
    
    
    $
    28Postretirement benefitsService cost
    
    $
    1
    
    
    $
    2
    
    
    $
    5
    
    
    $
    5Interest cost on projected benefit obligation
    
    
    4
    
    
    
    5
    
    
    
    22
    
    
    
    16Prior service cost amortization
    
    
    (4
    )
    
    
    (4
    )
    
    
    (21
    )
    
    
    (12
    )Actuarial loss
    
    
    1
    
    
    
    1
    
    
    
    4
    
    
    
    3Net periodic postretirement cost
    
    $
    2
    
    
    $
    4
    
    
    $
    10
    
    
    $
    12
 At December 31, 2003, CNA expected to contribute $12 million to its pension
plans and $22 million to its postretirement healthcare and life insurance
benefit plans in 2004. As of September 30, 2004, $15 million of contributions
have been made to its pension plans and $16 million to its postretirement
healthcare and life insurance benefit plans. CNA plans to contribute an
additional $3 million to its pension plans and $6 million to its postretirement
healthcare and life insurance benefit plans during the remainder of 2004. 33




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 Note K. Commitments, Contingencies and Guarantees Commitments and Contingencies In the normal course of business, CNA has obtained letters of credit in favor
of various unaffiliated insurance companies, regulatory authorities and other
entities. As of September 30, 2004 and December 31, 2003, there were
approximately $44 million and $58 million of outstanding letters of credit. The Company is obligated to make future payments totaling $322 million for
non-cancelable operating leases expiring from 2004 through 2014 primarily for
office space and data processing, office and transportation equipment.
Estimated future minimum payments under these contracts are as follows: $18
million in 2004; $65 million in 2005; $58 million in 2006; $48 million in 2007;
$39 million in 2008; and $94 million in 2009 and beyond. Additionally, the
Company has entered into a limited number of guaranteed payment contracts,
primarily relating to telecommunication services, amounting to approximately
$15 million. Estimated future minimum payments under these contracts are as
follows: $2 million in 2004; $7 million in 2005; $4 million in 2006; and $2
million in 2007. As of September 30, 2004 and December 31, 2003, the Company had committed
approximately $138 million and $154 million for future capital calls from
various third-party limited partnership investments in exchange for an
ownership interest in the related partnership. The Company invests in multiple bank loan participations as part of its overall
investment strategy and has committed to additional future purchases and sales.
The purchase and sale of these investments are recorded on the date that the
legal agreements are finalized and cash settlement is made. As of September
30, 2004, the Company had commitments to purchase $29 million and sell $17
million of various bank loan participations. In the normal course of investing activities, CCC had committed approximately
$51 million as of September 30, 2004 to future capital calls from certain of
its unconsolidated affiliates in exchange for an ownership interest in such
affiliates. During 2002, CNAF sold $750 million of a new issue of preferred stock,
designated Series H Cumulative Preferred Issue (Series H Issue), to Loews.
The Series H Issue accrues cumulative dividends at an initial rate of 8% per
year, compounded annually. As of September 30, 2004, the Company had $110
million of undeclared but accumulated dividends. Guarantees The Company has provided guarantees related to irrevocable standby letters of
credit for certain of its subsidiaries. Certain of these subsidiaries have
been sold; however, the irrevocable standby letter of credit guarantees remain
in effect. The Company would be required to remit prompt payment on the
letters of credit in question if the primary obligor drew down on these letters
of credit and failed to repay such amounts in accordance with the terms of the
letters of credit. The maximum potential amount of future payments that CNA
could be required to pay under these guarantees is approximately $30 million at
September 30, 2004. CNAF has provided parent company guarantees, which expire in 2015, related to
lease obligations of certain subsidiaries. Certain of those subsidiaries have
been sold; however, the lease obligation guarantees remain in effect. CNAF
would be required to remit prompt payment on leases in question if the primary
obligor fails to observe and perform its covenants under the lease agreements.
The maximum 34




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 potential amount of future payments that the Company could be
required to pay under these guarantees are approximately $7 million at
September 30, 2004. CCC and CAC are parties to a corporate guarantee whereby CCC agrees to cause
CAC to have sufficient cash for the timely payment of claims under certain
insurance policies or contracts issued by CAC so long as CAC is owned directly
or indirectly by CNAF. The Company holds an investment in a real estate joint venture. In the normal
course of business, CNA, 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, CNA 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 and continues 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 maximum potential future lease payments at September 30,
2004 that the Company could be required to pay under this guarantee are
approximately $303 million. If CNA were required to assume the entire lease
obligation, the Company would have the right to pursue reimbursement from the
other shareholders and would have the right to all sublease revenues. CNA has provided guarantees of the indebtedness of certain of its independent
insurance producers. These guarantees expire in 2008. The Company would be
required to remit prompt and complete payment when due, should the primary
obligor default. In the event of default on the part of the primary obligor,
the Company has a right to any and all shares of common stock of the primary
obligor. The maximum potential amount of future payments that CNA could be
required to pay under these guarantees is approximately $7 million at September
30, 2004. 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, 2004, the aggregate amount of quantifiable indemnification
agreements in effect for sales of business entities, assets and third party
loans was $970 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,
2004, the Company had outstanding unlimited indemnifications in connection with
the sales of certain of its business entities or assets for 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.
Additionally, the Company has provided a contingent guarantee to the lenders of
two third parties, related to loans extended by their lenders. The Company had
recorded approximately $21 million and $16 million of other liabilities related
to these indemnification agreements as of September 30, 2004 and December 31,
2003. 35




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 In connection with the issuance of preferred securities by CNA Surety Capital
Trust I, CNA Surety issued a guarantee of $75 million to guarantee the payment
by CNA Surety Capital Trust I of annual dividends
of $1.5 million over 30 years and redemption of $30 million of preferred
securities. See Note I for further description of debentures issued by CNA
Surety, which are the sole assets of CNA Surety Capital Trust I. Note L. Comprehensive Income (Loss) Comprehensive income is composed of all changes to stockholders equity, except
those changes resulting from transactions with stockholders in their capacity
as stockholders. The components of comprehensive income (loss) are shown
below. Comprehensive Income (Loss) Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Net income (loss)
    
    $
    (28
    )
    
    $
    (1,760
    )
    
    $
    136
    
    
    $
    (1,607
    )Other comprehensive income (loss):Change in unrealized gains/losses on general account investments:Holding gains (losses) arising during the period
    
    
    990
    
    
    
    (664
    )
    
    
    379
    
    
    
    299Net unrealized gains/losses at beginning of period included in
realized gains (losses) during the period
    
    
    (60
    )
    
    
    172
    
    
    
    (585
    )
    
    
    341Net change in unrealized gains/losses on general account
investments
    
    
    930
    
    
    
    (492
    )
    
    
    (206
    )
    
    
    640Net change in unrealized gains/losses on separate accounts and
other
    
    
    5
    
    
    
    (25
    )
    
    
    (69
    )
    
    
    16Foreign currency translation adjustment
    
    
    (4
    )
    
    
    (32
    )
    
    
    (17
    )
    
    
    (11
    )Allocation to participating policyholders and minority interests
    
    
    (2
    )
    
    
    11
    
    
    
    15
    
    
    
    (4
    )Other comprehensive income (loss), before tax
    
    
    929
    
    
    
    (538
    )
    
    
    (277
    )
    
    
    641Deferred income tax (expense) benefit related to other comprehensive
income
    
    
    (329
    )
    
    
    180
    
    
    
    88
    
    
    
    (233
    )Other comprehensive income (loss), net of tax
    
    
    600
    
    
    
    (358
    )
    
    
    (189
    )
    
    
    408Total comprehensive income (loss)
    
    $
    572
    
    
    $
    (2,118
    )
    
    $
    (53
    )
    
    $
    (1,199
    )
 The significant increase in unrealized gains during the three months ended
September 30, 2004 was primarily due to a decrease in long term interest rates. 36




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 Note M. Business Segments As a result of the Companys decisions to focus on Property and Casualty
operations and to exit certain businesses, the Company revised its reportable
segment structure in the first quarter of 2004 to reflect changes in its core
operations and how it makes business decisions. CNA now manages its property
and casualty operations in two operating segments which represent CNAs core
operations: Standard Lines and Specialty Lines. The non-core operations are
now managed in Life and Group Non-Core and Corporate and Other Non-Core
segments. Standard Lines includes standard property and casualty coverages
sold to small and middle market commercial businesses primarily through an
independent agency distribution system, and excess and surplus lines, as well
as insurance and risk management products sold to large corporations in the
U.S. as well as globally. Specialty Lines provides a broad array of
professional, financial and specialty property and casualty products and
services. Life and Group Non-Core primarily includes the results of the life
and group lines of business sold or placed in run-off. Corporate and Other
Non-Core primarily includes the results of certain property and casualty lines
of business placed in run-off, including CNA Re (formerly a stand-alone
property and casualty segment). This segment also includes the results related
to the centralized adjusting and settlement of APMT claims as well as the
results of CNAs participation in voluntary insurance pools, which are
primarily in run-off, and various other non-insurance operations. Prior period
segment disclosures have been conformed to the current year presentation. The changes made to the Companys reportable segments were as follows: 1) CNA
Global (formerly included in Specialty Lines) which consists of marine and
global standard lines is now included in Standard Lines; 2) CNA Guaranty and
Credit (formerly included in Specialty Lines) is currently in run-off and is
now included in the Corporate and Other Non-Core segment; 3) CNA Re is
currently in run-off and is also now included in the Corporate and Other
Non-Core segment; 4) Group Operations and Life Operations (formerly separate
reportable segments) have now been combined into one reportable segment where
the run-off of the retained group and life products will be managed; 5) certain
run-off life and group operations formerly included in the Corporate and Other
segment are now included in the Life and Group Non-Core segment. The Company manages most of its assets on a legal entity basis, while segment
operations are conducted across legal entities. As such, only reinsurance and
insurance receivables, insurance reserves and deferred acquisition costs are
readily identifiable for each individual segment. Distinct investment
portfolios are not maintained for each 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. Income taxes have been allocated on the basis of the taxable income of the
segments. In the following tables, certain GAAP and non-GAAP financial measures are
presented to provide information used by management to monitor the Companys
operating performance. Management utilizes various financial measures to
monitor the Companys insurance operations and investment portfolio. Net
operating income, which is derived from certain income statement amounts, is
considered a non-GAAP financial measure and is used by management to monitor
performance of the Companys insurance operations. The Companys investment
portfolio is monitored through analysis of various quantitative and qualitative
factors and certain decisions related to the sale or impairment of investments
that produce realized gains and losses. Net realized investment gains and
losses, which are comprised of after-tax realized investment gains and losses
net of participating policyholders and minority interests, are a non-GAAP
financial measure. 37




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##### Table of Contents



CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 Net operating income is calculated by excluding from net income the after-tax
effects of 1) net realized investment gains or losses, 2) gains or losses from
discontinued operations and 3) cumulative effects of changes in accounting
principles. In the calculation of net operating income, management excludes
after-tax net realized investment gains or losses because net realized
investment gains or losses related to the Companys investment portfolio are
largely discretionary, except for losses related to other-than-temporary
impairments, are generally driven by economic factors that are not necessarily
consistent with key drivers of underwriting performance, and are therefore not
an indication of trends in insurance operations. The Companys investment portfolio is monitored by management through analyses
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 impair an investment security in
accordance with its policy, or sell a security. Such activities will produce
realized gains and losses. While management uses various non-GAAP financial measures to monitor various
aspects of the Companys performance, relying on any measure other than net
income (loss), which is the most directly comparable GAAP measure to net
operating income and realized gains and losses, is not a complete
representation of financial performance. Management believes that its process
of evaluating performance through the use of these non-GAAP financial measures
provides a basis for understanding the operations and the impact on net income
(loss) as a whole. Management also believes that investors find these non-GAAP
financial measures described above useful to help interpret the underlying
trends and performance, as well as to provide visibility into the significant
components of net income (loss). 38




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##### Table of Contents



CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 CorporateStandard
    
    Specialty
    
    Life and Group
    
    and OtherFor the three months endedSeptember 30, 2004
    
    Lines
    
    Lines
    
    Non-Core
    
    Non-Core
    
    Eliminations
    
    Total(In millions)Net earned premiums
    
    $
    1,183
    
    
    $
    576
    
    
    $
    182
    
    
    $
    10
    
    
    $
    (4
    )
    
    $
    1,947Net investment income
    
    
    125
    
    
    
    61
    
    
    
    109
    
    
    
    64
    
    
    
    
    
    
    
    359Other revenues
    
    
    32
    
    
    
    36
    
    
    
    12
    
    
    
    9
    
    
    
    (16
    )
    
    
    73Total operating revenues
    
    
    1,340
    
    
    
    673
    
    
    
    303
    
    
    
    83
    
    
    
    (20
    )
    
    
    2,379Claims, benefits and expenses
    
    
    1,470
    
    
    
    550
    
    
    
    330
    
    
    
    61
    
    
    
    (20
    )
    
    
    2,391Operating income (loss)
before income tax and
minority interest
    
    
    (130
    )
    
    
    123
    
    
    
    (27
    )
    
    
    22
    
    
    
    
    
    
    
    (12
    )Income tax (expense) benefit
on operating income (loss)
    
    
    58
    
    
    
    (39
    )
    
    
    14
    
    
    
    (1
    )
    
    
    
    
    
    
    32Minority interest
    
    
    (2
    )
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6
    )Net operating income (loss)
    
    
    (74
    )
    
    
    80
    
    
    
    (13
    )
    
    
    21
    
    
    
    
    
    
    
    14Realized investment gains
(losses), net of
participating policyholders
and minority interests
    
    
    (33
    )
    
    
    (13
    )
    
    
    2
    
    
    
    (18
    )
    
    
    
    
    
    
    (62
    )Income tax (expense) benefit
on realized investment gains
(losses)
    
    
    10
    
    
    
    5
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    20Net income (loss)
    
    $
    (97
    )
    
    $
    72
    
    
    $
    (11
    )
    
    $
    8
    
    
    $
    
    
    
    $
    (28
    )
 39




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##### Table of Contents



CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)
 CorporateStandard
    
    Specialty
    
    Life and Group
    
    and OtherFor the three months endedSeptember 30, 2003
    
    Lines
    
    Lines
    
    Non-Core
    
    Non-Core
    
    Eliminations
    
    Total(In millions)Net earned premiums
    
    $
    1,001
    
    
    $
    451
    
    
    $
    611
    
    
    $
    95
    
    
    $
    (32
    )
    
    $
    2,126Net investment income
    
    
    55
    
    
    
    47
    
    
    
    204
    
    
    
    46
    
    
    
    
    
    
    
    352Other revenues
    
    
    34
    
    
    
    35
    
    
    
    34
    
    
    
    8
    
    
    
    (28
    )
    
    
    83Total operating revenues
    
    
    1,090
    
    
    
    533
    
    
    
    849
    
    
    
    149
    
    
    
    (60
    )
    
    
    2,561Claims, benefits and expenses
    
    
    2,555
    
    
    
    791
    
    
    
    851
    
    
    
    1,368
    
    
    
    (60
    )
    
    
    5,505Operating income (loss)
before income tax and
minority interest
    
    
    (1,465
    )
    
    
    (258
    )
    
    
    (2
    )
    
    
    (1,219
    )
    
    
    
    
    
    
    (2,944
    )Income tax (expense) benefit
on operating income (loss)
    
    
    520
    
    
    
    103
    
    
    
    11
    
    
    
    431
    
    
    
    
    
    
    
    1,065Minority interest
    
    
    (2
    )
    
    
    15
    
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    14Net operating income (loss)
    
    
    (947
    )
    
    
    (140
    )
    
    
    9
    
    
    
    (787
    )
    
    
    
    
    
    
    (1,865
    )Realized investment gains
(losses), net of
participating policyholders
and minority interests
    
    
    58
    
    
    
    19
    
    
    
    60
    
    
    
    27
    
    
    
    
    
    
    
    164Income tax (expense) benefit
on realized investment gains
(losses)
    
    
    (22
    )
    
    
    (7
    )
    
    
    (21
    )
    
    
    (9
    )
    
    
    
    
    
    
    (59
    )Net income (loss)
    
    $
    (911
    )
    
    $
    (128
    )
    
    $
    48
    
    
    $
    (769
    )
    
    $
    
    
    
    $
    (1,760
    )
 40




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##### Table of Contents



CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)
 Standard
    
    Specialty
    
    Life and Group
    
    Corporateand OtherFor the three months endedSeptember 30, 2004
    
    Lines
    
    Lines
    
    Non-Core
    
    Non-Core
    
    Eliminations
    
    Total(In millions)Net earned premiums
    
    $
    3,756
    
    
    $
    1,672
    
    
    $
    710
    
    
    $
    112
    
    
    $
    (29
    )
    
    $
    6,221Net investment income
    
    
    382
    
    
    
    182
    
    
    
    457
    
    
    
    191
    
    
    
    
    
    
    
    1,212Other revenues
    
    
    102
    
    
    
    93
    
    
    
    72
    
    
    
    25
    
    
    
    (65
    )
    
    
    227Total operating revenues
    
    
    4,240
    
    
    
    1,947
    
    
    
    1,239
    
    
    
    328
    
    
    
    (94
    )
    
    
    7,660Claims, benefits and expenses
    
    
    4,095
    
    
    
    1,591
    
    
    
    1,286
    
    
    
    289
    
    
    
    (94
    )
    
    
    7,167Operating income (loss) before
income tax and minority interest
    
    
    145
    
    
    
    356
    
    
    
    (47
    )
    
    
    39
    
    
    
    
    
    
    
    493Income tax (expense) benefit on
operating income (loss)
    
    
    (1
    )
    
    
    (107
    )
    
    
    27
    
    
    
    
    
    
    
    
    
    
    
    (81
    )Minority interest
    
    
    (6
    )
    
    
    (13
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (19
    )Net operating income (loss)
    
    
    138
    
    
    
    236
    
    
    
    (20
    )
    
    
    39
    
    
    
    
    
    
    
    393Realized investment gains (losses),
net of participating policyholders
and minority interests
    
    
    101
    
    
    
    37
    
    
    
    (616
    )
    
    
    63
    
    
    
    
    
    
    
    (415
    )Income tax (expense) benefit on realized investment gains (losses)
    
    
    (36
    )
    
    
    (14
    )
    
    
    231
    
    
    
    (23
    )
    
    
    
    
    
    
    158Net income (loss)
    
    $
    203
    
    
    $
    259
    
    
    $
    (405
    )
    
    $
    79
    
    
    $
    
    
    
    $
    136As of September 30, 2004(In millions)Reinsurance receivables
    
    $
    5,267
    
    
    $
    1,566
    
    
    $
    3,312
    
    
    $
    5,767
    
    
    $
    
    
    
    $
    15,912Insurance receivables
    
    $
    2,040
    
    
    $
    337
    
    
    $
    104
    
    
    $
    189
    
    
    $
    
    
    
    $
    2,670Insurance reserves:Claim and claim adjustment expense
    
    $
    14,370
    
    
    $
    4,658
    
    
    $
    3,707
    
    
    $
    8,760
    
    
    $
    
    
    
    $
    31,495Unearned premiums
    
    
    2,046
    
    
    
    1,544
    
    
    
    171
    
    
    
    624
    
    
    
    (4
    )
    
    
    4,381Future policy benefits
    
    
    
    
    
    
    
    
    
    
    5,743
    
    
    
    
    
    
    
    
    
    
    
    5,743Policyholders funds
    
    
    49
    
    
    
    
    
    
    
    1,719
    
    
    
    
    
    
    
    
    
    
    
    1,768Deferred acquisition costs
    
    $
    481
    
    
    $
    283
    
    
    $
    543
    
    
    $
    5
    
    
    $
    
    
    
    $
    1,312
 41




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##### Table of Contents



CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)
 For the nine months ended
    
    
    
    
    
    
    
    
    
    
    
    
    
    CorporateSeptember 30, 2003
    
    Standard
    
    Specialty
    
    Life and Group
    
    and Other(In millions)
    
    Lines
    
    Lines
    
    Non-Core
    
    Non-Core
    
    Eliminations
    
    TotalNet earned premiums
    
    $
    3,238
    
    
    $
    1,338
    
    
    $
    1,800
    
    
    $
    414
    
    
    $
    (86
    )
    
    $
    6,704Net investment income
    
    
    289
    
    
    
    149
    
    
    
    618
    
    
    
    155
    
    
    
    
    
    
    
    1,211Other revenues
    
    
    166
    
    
    
    82
    
    
    
    110
    
    
    
    23
    
    
    
    (93
    )
    
    
    288Total operating revenues
    
    
    3,693
    
    
    
    1,569
    
    
    
    2,528
    
    
    
    592
    
    
    
    (179
    )
    
    
    8,203Claims, benefits and expenses
    
    
    5,329
    
    
    
    1,766
    
    
    
    2,434
    
    
    
    1,918
    
    
    
    (179
    )
    
    
    11,268Operating income (loss) before
income tax and minority interest
    
    
    (1,636
    )
    
    
    (197
    )
    
    
    94
    
    
    
    (1,326
    )
    
    
    
    
    
    
    (3,065
    )Income tax (expense) benefit on
operating income (loss)
    
    
    600
    
    
    
    88
    
    
    
    (18
    )
    
    
    474
    
    
    
    
    
    
    
    1,144Minority interest
    
    
    (1
    )
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9Net operating income (loss)
    
    
    (1,037
    )
    
    
    (99
    )
    
    
    76
    
    
    
    (852
    )
    
    
    
    
    
    
    (1,912
    )Realized investment gains (losses),
net of participating policyholders
and minority interests
    
    
    249
    
    
    
    81
    
    
    
    9
    
    
    
    127
    
    
    
    
    
    
    
    466Income tax (expense) benefit on
realized investment gains (losses)
    
    
    (88
    )
    
    
    (29
    )
    
    
    (3
    )
    
    
    (41
    )
    
    
    
    
    
    
    (161
    )Net income (loss)
    
    $
    (876
    )
    
    $
    (47
    )
    
    $
    82
    
    
    $
    (766
    )
    
    $
    
    
    
    $
    (1,607
    )As of December 31, 2003(In
millions)Reinsurance receivables
    
    $
    5,508
    
    
    $
    1,497
    
    
    $
    2,999
    
    
    $
    6,250
    
    
    $
    
    
    
    $
    16,254Insurance receivables
    
    $
    2,264
    
    
    $
    320
    
    
    $
    282
    
    
    $
    216
    
    
    $
    
    
    
    $
    3,082Insurance reserves:Claim and claim adjustment expense
    
    $
    14,282
    
    
    $
    4,200
    
    
    $
    3,576
    
    
    $
    9,672
    
    
    $
    
    
    
    $
    31,730Unearned premiums
    
    
    2,267
    
    
    
    1,480
    
    
    
    153
    
    
    
    991
    
    
    
    
    
    
    
    4,891Future policy benefits
    
    
    
    
    
    
    
    
    
    
    8,161
    
    
    
    
    
    
    
    
    
    
    
    8,161Policyholders funds
    
    
    79
    
    
    
    3
    
    
    
    522
    
    
    
    (3
    )
    
    
    
    
    
    
    601Deferred acquisition costs
    
    $
    499
    
    
    $
    257
    
    
    $
    1,745
    
    
    $
    32
    
    
    $
    
    
    
    $
    2,533
 42




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)
 The following table provides revenue by line of business for each reportable
segment. Revenue by Line of Business Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Standard LinesProperty
    
    $
    159
    
    
    $
    170
    
    
    $
    492
    
    
    $
    494Casualty
    
    
    939
    
    
    
    763
    
    
    
    3,174
    
    
    
    2,807CNA Global
    
    
    209
    
    
    
    215
    
    
    
    675
    
    
    
    641Standard Lines revenue
    
    
    1,307
    
    
    
    1,148
    
    
    
    4,341
    
    
    
    3,942Specialty LinesProfessional Liability Insurance (CNA Pro)
    
    
    487
    
    
    
    385
    
    
    
    1,484
    
    
    
    1,163Surety
    
    
    92
    
    
    
    87
    
    
    
    267
    
    
    
    259Warranty
    
    
    81
    
    
    
    80
    
    
    
    233
    
    
    
    228Specialty Lines revenue
    
    
    660
    
    
    
    552
    
    
    
    1,984
    
    
    
    1,650Life and Group Non-CoreLife & Annuity
    
    
    41
    
    
    
    314
    
    
    
    (217
    )
    
    
    770Health
    
    
    265
    
    
    
    558
    
    
    
    786
    
    
    
    1,646Other
    
    
    (1
    )
    
    
    37
    
    
    
    54
    
    
    
    121Life and Group Non-Core revenue
    
    
    305
    
    
    
    909
    
    
    
    623
    
    
    
    2,537Corporate and Other Non-CoreCNA Re
    
    
    27
    
    
    
    105
    
    
    
    187
    
    
    
    481Other
    
    
    38
    
    
    
    71
    
    
    
    204
    
    
    
    238Corporate and Other Non-Core revenue
    
    
    65
    
    
    
    176
    
    
    
    391
    
    
    
    719Eliminations
    
    
    (20
    )
    
    
    (60
    )
    
    
    (94
    )
    
    
    (179
    )Total revenue
    
    $
    2,317
    
    
    $
    2,725
    
    
    $
    7,245
    
    
    $
    8,669
 Note N. Significant Transactions CNA Trust On August 1, 2004, the Company completed the sale of the retirement plan trust
and recordkeeping business portfolio of CNA Trust to Union Bank of California,
N.A. (Union Bank) for approximately $12 million. As a result of the sale, CNA
recorded a realized investment gain of approximately $9 million pretax ($5
million after-tax) for the three and nine months ended September 30, 2004. Union Bank assumed assets and liabilities of $172 million and $172 million at
August 1, 2004. The assets and liabilities of CNA Trust were $216 million and
$184 million at December 31, 2003. The revenues of the business sold through
the sale date were $1 million and $6 million for the three months ended
September 30, 2004 and 2003, and $11 million and $20 million for the nine
months ended September 30, 2004 and 2003. Net results of this business through
the sale date were a net loss of $0.3 million and $0.4 million for the three
months ended September 30, 2004 and 2003, and a net loss of $2 million and
$0.03 million for the nine months ended September 30, 2004 and 2003. 43




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 Individual Life Sale On April 30, 2004, the Company completed the sale of its individual life
insurance business to Swiss Re. The business sold included term, universal and
permanent life insurance policies and individual annuity products. CNAs
individual long term care and structured settlement businesses were excluded
from the sale. Swiss Re acquired VFL, a wholly owned subsidiary of CAC, and
CNAs Nashville, Tennessee insurance servicing and administration building as
part of the sale. In connection with the sale, CNA entered into a reinsurance
agreement in which CAC ceded its individual life insurance business to Swiss Re
on a 100% indemnity reinsurance basis. As a result of this reinsurance
agreement, approximately $1 billion of future policy benefit reserves were
ceded to Swiss Re. CNA received consideration of approximately $700 million
and recorded a realized investment loss of $622 million pretax ($389 million
after-tax) during the six months ended June 30, 2004. Swiss Re assumed assets and liabilities of $6.6 billion and $5.2 billion at
April 30, 2004. The assets and liabilities of the individual life business
sold were $6.6 billion and $5.4 billion at December 31, 2003. The revenues
of the individual life business through the sale date were $151 million for the
nine months ended September 30, 2004 and $168 million and $475 million for the
three and nine months ended September 30, 2003. The net results for this
business through the sale date were a net loss of $6 million for the nine
months ended September 30, 2004 and net income of $23 million and $27 million
for the three and nine months ended September 30, 2003. Group Benefits Sale On December 31, 2003, the Company completed the sale of the majority of its
group benefits business through the sale of CNAGLA to Hartford. The business
sold included group life and accident, short and long term disability and
certain other products. CNAs group long term care and specialty medical
businesses were excluded from the sale. In connection with the sale, CNA
received consideration of approximately $530 million and recorded an after-tax
realized investment loss on the sale of $122 million ($163 million pretax),
including an after tax realized investment gain of $8 million ($13 million
pretax) recorded in the second quarter of 2004. As a result of this agreement, Hartford assumed assets and liabilities of $2.4
billion and $1.6 billion at December 31, 2003. The revenues of the group
benefits business were $314 million and $910 million for the three and nine
months ended September 30, 2003. Net income was $12 million and $27 million
for the three and nine months ended September 30, 2003. Personal Insurance Transaction As part of the sale of CNAs personal insurance business to The Allstate
Corporation on October 1, 1999, the Company shared in claim and allocated claim
adjustment expenses if payments related to losses incurred prior to October 1,
1999 on the CNA policies transferred to Allstate exceeded the claim and
allocated claim adjustment expense reserves of approximately $1 billion at the
date of sale. The Companys remaining obligation with respect to claim and
allocated claim adjustment expense reserves, valued as of October 1, 2003, was
settled in March of 2004 and the sharing agreement was terminated. This
settlement did not have a material impact on the results of operations of the
Company for the nine months ended September 30, 2004. 44




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 Note O. Related Party Transactions CNA reimburses Loews, or pays directly to Loews employees, approximately $24
million annually for management fees, travel and related expenses and expenses
of investment facilities and services provided to CNA. CNA and its eligible subsidiaries are included in the consolidated federal
income tax return of Loews and its eligible subsidiaries. For the nine months
ended September 30, 2004 and 2003, CNA received $530 million and $258 million
from Loews related to federal income taxes. CNA previously sponsored a stock ownership plan whereby the Company financed
the purchase of Company common stock by certain officers, including executive
officers. Interest charged on the principal amount of these outstanding stock
purchase loans is generally equivalent to the long term applicable federal
rate, compounded semi-annually, in effect on the disbursement date of the loan.
Loans made pursuant to the plan are generally full recourse with a ten-year
term and are secured by the stock purchased. The balance of the loans as of
September 30, 2004 exceeds the fair value of the related common stock
collateral by $38 million. CNAF has entered into a credit agreement with a large national contractor that
undertakes projects for the construction of government and private facilities
to provide an $86 million credit facility. CNA Surety has provided significant
surety bond protection for projects by this contractor through surety bonds
underwritten by CCC or its affiliates. The loans were provided by CNAF to help
the contractor meet its liquidity needs. The credit facility and all loans
under it will mature in March of 2006. Advances under the credit facility bear
interest at the prime rate plus 6%. Interest of 3% is deferred until the
credit facility matures, and the remainder is to be paid monthly in cash.
Loans under the credit facility are secured by a pledge of substantially all of
the assets of the contractor and certain of its affiliates. Loews and CNAF have entered into a participation agreement, pursuant to which
Loews has purchased a participation interest in one-third of the loans and
commitments under the credit facility, on a dollar-for-dollar basis, up to a
maximum of $25 million. Although Loews does not have rights against the
contractor directly under the participation agreement, it shares recoveries and
certain fees under the facility proportionally with CNAF. In March of 2003, CNAF purchased the contractors outstanding bank debt for $16
million. The contractor purchased the bank debt from CNAF and retired it, with
$11 million of the purchase price being funded under the new credit facility
and $5 million from money loaned to the contractor by its shareholders. Under
its purchase agreement with the banks, CNAF is also required to reimburse the
banks for any draws upon outstanding letters of credit issued by the banks for
the contractors benefit. Letters of credit in the amount of $3 million are
due to expire in August of 2005. CNAF has also provided collateral for letters
of credit issued by another bank for the contractors benefit in the aggregate
amount of $8 million. Any CNAF reimbursements or access of CNAF collateral for
draws upon the banks letters of credit will become obligations of the
contractor to CNAF as draws upon the credit facility. As of September 30,
2004, the aggregate amount of outstanding principal and accrued interest under
the credit facility was $61 million, net of participation by Loews in the
amount of $24 million. As of March 31, 2004, the credit facility was amended to provide for
calculating the amount available for borrowing without regard to approximately
$1.1 million representing accrued interest on a bridge loan provided by CNAF
that became a borrowing under the facility; the elimination of a reduction in
CNAFs commitment upon receipt by the contractor of certain claim proceeds; and
an increase in the monthly compensation limits for the contractors principals.
In connection with the amendment, the principals and 45




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 an affiliate contributed $5 million in the aggregate to the contractors
capital by forgiving certain of the contractors indebtedness. The contractor is implementing a restructuring plan that is intended to reduce
costs and improve cash flow, and a chief restructuring officer has been
appointed to manage execution of the plan. CNA Surety intends to continue to
provide surety bonds on behalf of the contractor during this restructuring
period, subject to the contractors initial and ongoing compliance with CNA
Suretys underwriting standards and ongoing management of CNA Suretys exposure
to the contractor. Based on the contractors restructuring efforts to date,
the Company estimates that amounts due under the credit facility are
collectible. Any losses to CNA Surety arising from bonds issued to the contractor or assumed
are excluded from CNA Suretys $40 million excess of $20 million per principal
reinsurance program with unaffiliated reinsurers in place in 2002. As a
result, CNA Surety retains the first $60 million of losses on bonds written
with an effective date of September 30, 2002 and prior, and CCC will incur 100%
of losses above that retention level. Through facultative reinsurance
contracts with CCC, CNA Suretys exposure on bonds written from October 1, 2002
through October 31, 2003 has been limited to $20 million per bond. For bonds
written subsequent to November 1, 2003, CNA Suretys exposure is limited to
$14.5 million per bond subject to an aggregate limit of $150 million under all
facultative insurance coverage and two excess of loss treaties between CNA
Surety and CCC. Both excess of loss contracts are effective January 1, 2004.
The first excess of loss contract, $40 million excess of $60 million, provides
CNA Surety coverage exclusively for the national contractor, while the second
excess of loss contract, $50 million excess of $100 million, provides CNA
Surety with coverage for the national contractor as well as other CNA Surety
risks. CCC and CNA Surety have had discussions with their insurance regulatory
authorities regarding the level of bonds provided for this principal and will
continue to apprise the insurance regulators regarding their ongoing exposure
to this account. Indemnification and subrogation rights, including rights to contract proceeds
on construction projects in the event of default, exist that reduce CNA
Suretys and ultimately the Companys exposure to loss. While CNAF believes
that the contractors restructuring efforts may be successful and provide
sufficient cash flow for its operations, the contractors failure to achieve
its restructuring plan or perform its contractual obligations under the credit
facility or under the Companys surety bonds could have a material adverse
effect on the Companys results of operations and/ or equity. If such failures
occur, the Company estimates the surety loss, net of indemnification and
subrogation recoveries, but before the effects of minority interest, to be
approximately $200 million pretax. In addition, such failures could cause the
full amount due under the credit facility to be uncollectible. CNA Surety Corporation CCC provided an excess of loss reinsurance contract to the insurance
subsidiaries of CNA Surety over a period that expired on December 31, 2000 (the
stop loss contract). The stop loss contract limits the net loss ratios for CNA
Surety with respect to certain accounts and lines of insurance business. In
the event that CNA Suretys accident year net loss ratio exceeds 24% for 1997
through 2000 (the contractual loss ratio), the stop loss contract requires CCC
to pay amounts equal to the amount, if any, by which CNA Suretys actual
accident year net loss ratio exceeds the contractual loss ratio multiplied by
the applicable net earned premiums. The minority shareholders of CNA Surety do
not share in any losses that apply to 46




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 this contract. There were no reinsurance balances payable under this stop loss
contract as of September 30, 2004 and December 31, 2003. Effective October 1, 2002, CCC provided an excess of loss protection for new
and renewal bonds for CNA Surety for each principal exposures that exceed $60
million since October 1, 2002 in two parts  a) $40 million excess of $60
million and b) $50 million excess of $100 million for CNA Surety. Effective
January 1, 2004, this contract was commuted and CCC paid CNA Surety $11 million
in return premium in the first quarter of 2004 based on experience under the
contract. Effective October 1, 2003, the CCC entered into a $3 million excess
of $12 million excess of loss contract with CNA Surety. The reinsurance premium
for the coverage provided by the $3 million excess of $12 million contract was
$0.3 million plus, if applicable, additional premiums based on paid losses. The
contract provided for aggregate coverage of $12 million. This contract was to
expire on December 31, 2004. Effective January 1, 2004, the Company obtained
replacement coverage from third party reinsurers as part of the 2004 Excess of
Loss Treaty. Note P. Statutory Accounting Practices CNAs insurance subsidiaries maintain their accounts in conformity with
accounting practices prescribed or permitted by state insurance regulatory
authorities which vary in certain respects from GAAP. In converting from
statutory to GAAP, typical adjustments include deferral of policy acquisition
costs and the inclusion of net realized holding gains or losses in
shareholders equity relating to fixed maturity securities. The National
Association of Insurance Commissioners (NAIC) developed a codified version of
statutory accounting principles, designed to foster more consistency among the
states for accounting guidelines and reporting. CNAs insurance subsidiaries are domiciled in various jurisdictions. These
subsidiaries prepare statutory financial statements in accordance with
accounting practices prescribed or permitted by the respective jurisdictions
insurance regulators. Prescribed statutory accounting practices are set forth
in a variety of publications of the NAIC as well as state laws, regulations and
general administrative rules. The Company follows a permitted practice that allows CIC to classify voluntary
pools that are unauthorized in South Carolina but were classified as authorized
in New Hampshire, CICs former state of domicile, as authorized in order to
allow credit for the related reinsurance balances. Due to CICs
redomestication to South Carolina effective January 1, 2004, this permitted
practice was requested and has been granted through the period ended December
31, 2004, and is intended to allow CIC time to pursue the authorization of
certain reinsurers on a South Carolina basis. The Company has now determined
that pool members representing approximately 80% of the participation in the
underlying pools are either currently licensed or authorized in the State of
South Carolina. As of December 31, 2003, the ceded reserve credit for the
entire reinsurance recoverable from voluntary pools classified as authorized
was $348 million. The impact of this permitted practice on statutory surplus
has not been fully quantified as the Companys review of the South Carolina
status of the underlying pool members is still in process. CNAFs ability to pay dividends and other credit obligations is significantly
dependent on receipt of dividends from its subsidiaries. The payment of
dividends to CNAF by its insurance subsidiaries without prior approval of the
insurance department of each subsidiarys domiciliary jurisdiction is limited
by formula. Dividends in excess of these amounts are subject to prior approval
by the respective state insurance departments. 47




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CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued  (UNAUDITED)
 Dividends from CCC are subject to the insurance holding company laws of the
State of Illinois, the domiciliary state of CCC. Under these laws, ordinary
dividends, or dividends that do not require prior approval of the Illinois
Department of Insurance (the Department), may be paid only from earned surplus,
which is calculated by removing unrealized gains from unassigned surplus. As
of September 30, 2004, CCC is in a negative earned surplus position. Until CCC
is in a positive earned surplus position, all dividends require prior approval
of the Department. In January of 2004, the Department approved extraordinary
dividend capacity in the amount of approximately $312 million to be used to
fund CNAFs 2004 debt service and principal repayment requirements. As of
September 30, 2004, there is approximately $41 million of this dividend
capacity available. Combined statutory capital and surplus and net income (loss), determined in
accordance with accounting practices prescribed or permitted by insurance
regulatory authorities for the property and casualty and the life and group
insurance subsidiaries, were as follows. Statutory Information Statutory Capital and SurplusSeptember 30, 2004
    
    December 31, 2003(In millions)Property and
casualty insurance
companies
    
    $
    6,603
    
    
    $
    6,170Life and group
    
    
    1,255
    
    
    
    707
 Statutory Information Statutory Net Income (Loss)Three months endedSeptember 30,
    
    Nine months endedSeptember 30,2004
    
    2003
    
    2004
    
    2003(In millions)Property and
casualty insurance
companies
    
    $
    (132
    )
    
    $
    (1,886
    )
    
    $
    259
    
    
    $
    (1,886
    )Life and group (a)
    
    
    20
    
    
    
    50
    
    
    
    709
    
    
    
    (11
    )
   (a)
    
    The Statutory Net Income (Loss) for the nine months ended September 30,
2004 and the three and nine months ended September 30, 2003 includes the
individual life insurance business. The Statutory Net Income (Loss) for the
three and nine months ended September 30, 2003 includes the group benefits
business sold on December 31, 2003. 48




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##### Table of Contents



CNA FINANCIAL CORPORATION 
 ITEM 2.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF OPERATIONS
 Overview The following discussion highlights significant factors impacting the
consolidated operations and financial condition of CNA Financial Corporation
(CNAF) and its subsidiaries (collectively CNA or the Company). CNA is one of
the largest commercial insurance organizations in the United States and based
on 2003 statutory net written premiums, is the fourteenth largest property and
casualty company. Loews Corporation (Loews) owned approximately 91% of the outstanding common
stock and 100% of the Series H preferred stock of CNAF as of September 30,
2004. The following discussion should be read in conjunction with the
Condensed Consolidated Financial Statements in Item 1 of Part 1. CONSOLIDATED OPERATIONS Results of Operations The following table includes the consolidated results of operations. For more
detailed components of CNAs business operations, see the segment discussions
within this Management's Discussion and Analysis (MD&A). Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions, except per share data)RevenuesNet earned premiums
    
    $
    1,947
    
    
    $
    2,126
    
    
    $
    6,221
    
    
    $
    6,704Net investment income
    
    
    359
    
    
    
    352
    
    
    
    1,212
    
    
    
    1,211Realized investment gains (losses), net of
participating policyholders and minority
interests
    
    
    (62
    )
    
    
    164
    
    
    
    (415
    )
    
    
    466Other revenues
    
    
    73
    
    
    
    83
    
    
    
    227
    
    
    
    288Total revenues
    
    
    2,317
    
    
    
    2,725
    
    
    
    7,245
    
    
    
    8,669Claims, Benefits and ExpensesInsurance claims and policyholders benefits
    
    
    1,596
    
    
    
    4,342
    
    
    
    4,859
    
    
    
    8,320Amortization of deferred acquisition costs
    
    
    374
    
    
    
    495
    
    
    
    1,114
    
    
    
    1,434Other operating expenses
    
    
    393
    
    
    
    635
    
    
    
    1,100
    
    
    
    1,414Interest
    
    
    28
    
    
    
    33
    
    
    
    94
    
    
    
    100Total claims, benefits and expenses
    
    
    2,391
    
    
    
    5,505
    
    
    
    7,167
    
    
    
    11,268Income (loss) before income tax and minority interest
    
    
    (74
    )
    
    
    (2,780
    )
    
    
    78
    
    
    
    (2,599
    )Income tax benefit
    
    
    52
    
    
    
    1,006
    
    
    
    77
    
    
    
    983Minority interest
    
    
    (6
    )
    
    
    14
    
    
    
    (19
    )
    
    
    9Net income (loss)
    
    $
    (28
    )
    
    $
    (1,760
    )
    
    $
    136
    
    
    $
    (1,607
    )Basic and Diluted Earnings (Loss) Per Share
Basic and diluted earnings (loss) per share
available to common stockholders
    
    $
    (0.17
    )
    
    $
    (7.94
    )
    
    $
    0.35
    
    
    $
    (7.39
    )Weighted average outstanding common stock and common
stock equivalents
    
    
    256.0
    
    
    
    223.6
    
    
    
    256.0
    
    
    
    223.6
 Three Month Comparison Net results from operations for the three months ended September 30, 2004 were
adversely impacted by recent catastrophes including estimated net losses
related to Hurricanes Charley, Frances, Ivan and 49




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF
OPERATIONS, Continued Jeanne. The four storms negatively impacted third quarter results by $174
million after-tax ($268 million pretax). This estimate is net of anticipated
reinsurance recoveries, and includes the impact of reinstatement premiums and
insurance assessments. Actual losses from these catastrophes could exceed the
Companys current estimates. In addition, the Company recorded a bad debt
provision for insurance receivables related to Professional Employer
Organization (PEO) accounts in the third quarter of 2004 of $62 million
after-tax ($95 million pretax). Favorably impacting the quarter was a $36
million after-tax ($55 million pretax) reduction of current accident year
losses established during the first half of the year. The third quarter of
2003 net results were adversely impacted by significant charges, primarily
related to net prior year development and increases in the provisions for
insurance and reinsurance receivables. For the three months ended September 30, 2004, net results increased $1,732
million as compared with the same period in 2003. This improvement in net
results was due principally to decreased net unfavorable prior year development
of $1,517 million after-tax ($2,331 million pretax) and a $249 million
after-tax ($383 million pretax) decrease in the bad debt provisions for
insurance and reinsurance receivables. Additionally, net results for the
period were favorably impacted by the absence of a $65 million after-tax ($100
million pretax) increase in ULAE reserves and a $48 million after-tax ($73
million pretax) increase in insurance related assessments recorded in the third
quarter of 2003. These favorable items were partially offset by increased
catastrophe impacts and decreased net realized investment results. Catastrophe
impacts were $181 million after-tax ($278 million pretax) and $37 million
after-tax ($57 million pretax) for the three months ended September 30, 2004
and 2003. The increased catastrophe impacts were primarily due to a $174
million after-tax ($268 million pretax) loss resulting from the hurricanes in
the third quarter of 2004. Realized investment losses were $62 million for the three months ended
September 30, 2004 as compared to realized investment gains of $164 million for
the three months ended September 30, 2003. The decline was primarily due to
losses related to derivative securities held to mitigate the effect of changes
in long term interest rates on the value of the fixed maturity portfolio.
While a decrease in long term interest rates during the third quarter of 2004
resulted in a realized loss related to these derivatives, the fair value of the
Companys fixed maturity portfolio was benefited by the interest rate movements
resulting in a substantial increase in Accumulated Other Comprehensive Income
and Stockholders Equity. Net earned premiums decreased $179 million for the three months ended September
30, 2004 as compared with the same period in 2003. The decrease in net earned
premiums was due primarily to reduced premium from the Life and Group
businesses as well as CNA Re as a result of the decisions made in 2003 to focus
on the core property and casualty business. Partially offsetting these
decreases was a reduction in premiums ceded to corporate aggregate reinsurance
treaties and other treaties in the third quarter of 2004 as compared to the
third quarter of 2003. The 2003 cessions were principally due to the
unfavorable net prior year claim and allocated claim adjustment expense reserve
development recorded in the third quarter of 2003. Nine Month Comparison Net income increased $1,743 million for the nine months ended September 30,
2004 as compared with the same period in 2003. This improvement in net results
was due principally to decreased net unfavorable prior year development of
$1,769 million after-tax ($2,719 million pretax) and a $338 million after-tax
($520 million pretax) decrease in the bad debt provisions for insurance and
reinsurance receivables.
Additionally, net results for the period were favorably impacted by the absence
of a $65 million after-tax ($100 million pretax) increase in ULAE reserves and
a $48 million after-tax ($73 million pretax) increase in insurance related
assessments recorded in 2003. These favorable impacts to net income in 2004
were partially offset by increased catastrophe impacts and decreased net
realized investment results. 50




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF
OPERATIONS, Continued Catastrophe impacts were $189 million after-tax
($291 million pretax) and $87 million after-tax ($132 million pretax) for the
nine months ended September 30, 2004 and 2003. Realized investment losses were $415 million for the nine months ended
September 30, 2004 as compared to realized investment gains of $466 million for
the nine months ended September 30, 2003. The decrease in the pretax
investment results was primarily due to a $622 million pretax loss on the sale
of the individual life insurance business, losses related to derivative
securities, and decreased realized gains for fixed maturity securities. These
decreases were partially offset by a $162 million pretax gain on the
disposition of the Companys equity holdings of Canary Wharf Group PLC (Canary
Wharf), a London-based real estate company. Net earned premiums decreased $483 million for the nine months ended September
30, 2004 as compared with the same period in 2003. The decrease in net earned
premiums was due primarily to reduced premium from the individual life and
group benefits businesses as well as CNA Re as a result of the decisions made
in 2003 to focus on the core property and casualty business. Partially
offsetting these unfavorable impacts was a reduction in premiums ceded to
corporate aggregate and other reinsurance treaties in 2004 as compared to 2003.
The 2003 cessions were principally due to the unfavorable net prior year
development recorded in the third quarter of 2003. Net Prior Year Development A significant component of the results of operations for the three and nine
months ended September 30, 2003 was unfavorable net prior year development
recorded for the property and casualty and the non-core segments. Changes in
estimates of claim and allocated claim adjustment expense reserves and premium
accruals, net, for prior years, are defined as net prior year development
within this MD&A. These changes can be favorable or unfavorable. The following tables summarize the pretax net prior year development for core
operations and asbestos and environmental pollution and mass tort (APMT) by segment
for the three and nine months ended September 30, 2004 and 2003. 51




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF
OPERATIONS, Continued Net Prior Year Development
For the three months ended September 30, 2004 CorporateStandard
    
    Specialty
    
    and OtherLines
    
    Lines
    
    Non-Core
    
    Total(In millions)Pretax unfavorable (favorable) net prior year claim and allocated claim adjustment expense
development excluding the impact of the corporate aggregate reinsurance treaties:Core (Non-APMT)
    
    $
    (6
    )
    
    $
    
    
    
    $
    1
    
    
    $
    (5
    )APMT
    
    
    
    
    
    
    
    
    
    
    4
    
    
    
    4Ceded losses related to corporate aggregate reinsurance treaties
    
    
    4
    
    
    
    (9
    )
    
    
    5
    
    
    
    Pretax unfavorable (favorable) net prior year development before impact of premium development
    
    
    (2
    )
    
    
    (9
    )
    
    
    10
    
    
    
    (1
    )Unfavorable (favorable) premium development, excluding the impact of corporate aggregate
reinsurance treaties
    
    
    11
    
    
    
    (15
    )
    
    
    5
    
    
    
    1Ceded premiums related to corporate aggregate reinsurance treaties
    
    
    (3
    )
    
    
    3
    
    
    
    (3
    )
    
    
    (3
    )Total unfavorable (favorable) premium development
    
    
    8
    
    
    
    (12
    )
    
    
    2
    
    
    
    (2
    )Total unfavorable (favorable) net prior year development (pretax)
    
    $
    6
    
    
    $
    (21
    )
    
    $
    12
    
    
    $
    (3
    )Total unfavorable (favorable) net prior year development (after-tax)
    
    $
    4
    
    
    $
    (14
    )
    
    $
    8
    
    
    $
    (2
    )
 Net Prior Year Development
For the three months ended September 30, 2003 CorporateStandard
    
    Specialty
    
    and OtherLines
    
    Lines
    
    Non-Core
    
    Total(In millions)Pretax unfavorable net prior year claim and allocated claim adjustment expense development excluding
the impact of the corporate aggregate reinsurance treaties:Core (Non-APMT)
    
    $
    1,123
    
    
    $
    223
    
    
    $
    188
    
    
    $
    1,534APMT
    
    
    
    
    
    
    
    
    
    
    795
    
    
    
    795Ceded losses related to corporate aggregate reinsurance treaties
    
    
    (300
    )
    
    
    (59
    )
    
    
    (80
    )
    
    
    (439
    )Pretax unfavorable net prior year development before impact of premium development
    
    
    823
    
    
    
    164
    
    
    
    903
    
    
    
    1,890Unfavorable (favorable) premium development, excluding the impact of corporate aggregate
reinsurance treaties
    
    
    128
    
    
    
    (1
    )
    
    
    (3
    )
    
    
    124Ceded premiums related to corporate aggregate reinsurance treaties
    
    
    160
    
    
    
    32
    
    
    
    43
    
    
    
    235Total premium development
    
    
    288
    
    
    
    31
    
    
    
    40
    
    
    
    359Total unfavorable net prior year development (pretax)
    
    $
    1,111
    
    
    $
    195
    
    
    $
    943
    
    
    $
    2,249Total unfavorable net prior year development (after-tax)
    
    $
    722
    
    
    $
    128
    
    
    $
    613
    
    
    $
    1,463
 52




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF
OPERATIONS, Continued Net Prior Year Development
For the nine months ended September 30, 2004 CorporateStandard
    
    Specialty
    
    and OtherLines
    
    Lines
    
    Non-Core
    
    Total(In millions)Pretax unfavorable net prior year claim and allocated claim adjustment expense development excluding
the impact of the corporate aggregate reinsurance treaties:Core (Non-APMT)
    
    $
    107
    
    
    $
    74
    
    
    $
    14
    
    
    $
    195APMT
    
    
    
    
    
    
    
    
    
    
    44
    
    
    
    44Ceded losses related to corporate aggregate reinsurance treaties
    
    
    4
    
    
    
    (9
    )
    
    
    5
    
    
    
    Pretax unfavorable net prior year development before impact of premium development
    
    
    111
    
    
    
    65
    
    
    
    63
    
    
    
    239Unfavorable (favorable) premium development, excluding the impact of corporate aggregate
reinsurance treaties
    
    
    (97
    )
    
    
    (29
    )
    
    
    15
    
    
    
    (111
    )Ceded premiums related to corporate aggregate reinsurance treaties
    
    
    (1
    )
    
    
    3
    
    
    
    (2
    )
    
    
    Total unfavorable (favorable) premium development
    
    
    (98
    )
    
    
    (26
    )
    
    
    13
    
    
    
    (111
    )Total unfavorable net prior year development (pretax)
    
    $
    13
    
    
    $
    39
    
    
    $
    76
    
    
    $
    128Total unfavorable net prior year development (after-tax)
    
    $
    8
    
    
    $
    25
    
    
    $
    49
    
    
    $
    82
 Net Prior Year Development
For the nine months ended September 30, 2003 CorporateStandard
    
    Specialty
    
    and OtherLines
    
    Lines
    
    Non-Core
    
    Total(In millions)Pretax unfavorable net prior year claim and allocated claim
adjustment expense development excluding the impact of the
corporate aggregate reinsurance treaties:Core (Non-APMT)
    
    $
    1,437
    
    
    $
    322
    
    
    $
    336
    
    
    $
    2,095APMT
    
    
    
    
    
    
    
    
    
    
    795
    
    
    
    795Ceded losses related to corporate aggregate reinsurance treaties
    
    
    (480
    )
    
    
    (59
    )
    
    
    (104
    )
    
    
    (643
    )Pretax unfavorable net prior year development before impact of
premium development
    
    
    957
    
    
    
    263
    
    
    
    1,027
    
    
    
    2,247Unfavorable (favorable) premium development, excluding
the impact of corporate aggregate reinsurance treaties
    
    
    203
    
    
    
    (8
    )
    
    
    (26
    )
    
    
    169Ceded premiums related to corporate aggregate reinsurance
treaties
    
    
    265
    
    
    
    32
    
    
    
    57
    
    
    
    354Total premium development
    
    
    468
    
    
    
    24
    
    
    
    31
    
    
    
    523Total unfavorable net prior year development (pretax)
    
    $
    1,425
    
    
    $
    287
    
    
    $
    1,058
    
    
    $
    2,770Total unfavorable net prior year development (after-tax)
    
    $
    926
    
    
    $
    187
    
    
    $
    688
    
    
    $
    1,801
 Strategic Review During 2003, CNA completed a strategic review of its operations and decided to
concentrate its efforts on the property and casualty business. As a result of
this review, and several significant charges in 2003, a capital plan was
developed to replenish the statutory capital of the property and casualty
subsidiaries. A summary of the capital plan, related actions, and other
significant business decisions is discussed below. 53




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF OPERATIONS, Continued Sale of Individual Life Business On April 30, 2004, CNA completed the sale of
its individual life insurance business. The business sold included term,
universal and permanent life insurance policies and
individual annuity products. CNAs individual long term care and structured
settlement businesses were excluded from the sale. Consideration from the sale
was approximately $700 million. CNA recorded a realized investment loss of
$389 million after-tax ($622 million pretax) during the first six months of
2004. See Note N to the Condensed Consolidated Financial Statements in Item 1
for further discussion. Sale of Group Benefits Business On December 31, 2003, CNA completed the sale
of the majority of its group benefits business. The business sold included
group life and accident, short and long term disability and certain other
products. CNAs group long term care and specialty medical businesses were
excluded from the sale. Consideration from the sale was approximately $530
million, resulting in an after-tax realized investment loss on the sale of $122
million after-tax ($163 million pretax), including an after-tax realized
investment gain of $8 million after-tax ($13 million pretax) recorded in the
second quarter of 2004. Assumed Reinsurance Renewal Rights Sale During 2003, the Company sold the
renewal rights for most of the treaty business of CNA Re and withdrew from the
assumed reinsurance business. CNA is managing the run-off of its retained
liabilities. Expense Initiatives The group benefits business, individual life and annuity
insurance business and CNA Re absorbed approximately $150 million of the total
shared corporate overhead expenses that are allocated to all of CNAs
businesses. The Company expects that the 2004 consolidated net operating
results will include approximately $35 million after-tax of losses for these
three businesses, largely due to these corporate overhead expenses. This
amount has been revised from the $50 million loss estimate that was previously
disclosed in the Companys 2003 Form 10-K primarily because of the impact of
the loss on the sale of the individual life business and favorable mortality
and investment results in the first quarter of 2004. The 2003 expense
initiative did not contemplate the sale or exit of these businesses, and
therefore the savings from that initiative will be partially offset by these
expenses. The primary components of the 2003 expense initiative were a reduction of the
workforce by approximately five percent, lower commissions and other
acquisition costs, principally related to workers compensation, and reduced
spending in other areas. As of December 31, 2003, the Company achieved the
targeted workforce reduction. Actions related to reducing commissions and
other acquisition expenses began in 2003 and were completed in 2004. The Company has undertaken additional expense initiatives in 2004 that are
expected to produce expense savings in excess of $100 million beginning in 2004
and continuing through 2005. The primary components of the expense initiatives
are a reduction in certain business expenses through more stringent expense
policies and guidelines, reduced facilities cost through consolidation of
locations, and to a lesser extent, workforce reductions. Capital Plan The capital plan established in November of 2003 consisted of
the November sale of $750 million of a new series of CNA convertible preferred
stock to Loews. The preferred stock converted into 32,327,015 shares of CNAF
common stock on April 20, 2004. Additionally, the capital plan included a
commitment from Loews for additional capital support of up to $500 million by
February 27, 2004 through the purchase of surplus notes of Continental Casualty
Company (CCC), CNAs principal insurance subsidiary, in the event certain
additions to CCCs statutory capital were not achieved through asset sales and
up to an additional $150 million to support the statutory capital of CCC in the
event of additional shortfalls in relation to business and asset sales. In
accordance with such commitments, in February of 2004, Loews purchased $46
million of surplus notes from CCC, in relation to the sale of CNAs group
benefits business, and also purchased $300 million of additional surplus notes
of CCC
in 54




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##### Table of Contents



CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF
OPERATIONS, Continued relation to the sale of CNAs individual life business, discussed
above. The sale of the individual life business resulted in an addition to
statutory capital in excess of $550 million. CCC received insurance regulatory
approval for the repayment of the $300 million CCC Life surplus note issued in
February of
2004, including accrued interest, and repaid these amounts in full on June 16,
2004. CCC plans to seek approval from the insurance regulatory authority for
the repayment of the CCC Group surplus note in 2004. The purchase of the
preferred stock and the surplus notes fulfilled the commitment from Loews in
relation to the capital plan. Sale of CNA Trust On August 1, 2004, CNA completed the sale of the retirement
plan trust and recordkeeping business portfolio of CNA Trust to Union Bank of
California. Consideration from the sale was approximately $12 million,
resulting in an after-tax realized investment gain on the sale of $5 million
($9 million pretax). Revised Business Segment Reporting As a result of the strategic review and
other actions described above, in 2004 CNA changed how it manages its core
operations and makes business decisions. Accordingly, the Company revised its
reportable business segment structure to reflect these changes. CNAs core
operations, property and casualty operations, are now reported in two business
segments: Standard Lines and Specialty Lines. CNAs non-core operations are
managed in two segments: Life and Group Non-Core and Corporate and Other
Non-Core. Prior period segment disclosures have been conformed to the current
year presentation. Standard Lines includes standard property and casualty coverages, excess and
surplus lines, and insurance and risk management products. CNA Global
(formerly included in Specialty Lines), which consists of marine and global
standard lines, is included in Standard Lines. Specialty Lines includes professional financial and specialty property and
casualty products and services. Life and Group Non-Core includes the results of the life and group lines of
business which have been sold or placed in run-off. This segment also includes Group Operations and Life Operations
(formerly separate reportable segments) and
certain run-off life and group operations formerly included in the Corporate
and Other segment. Corporate and Other Non-Core includes the results of several property and
casualty and other lines placed in run-off, including CNA Re (formerly a stand
alone property and casualty segment), CNA Guaranty and Credit (formerly
included in Specialty Lines) and other property and casualty lines placed in
run-off. This segment also includes results related to the centralized
adjusting and settlement of APMT claims, participation in voluntary insurance
pools and other non-insurance operations. Results of Retained and Sold Businesses Throughout this
MD&A, the results of operations include discussion
and results for all of CNAs businesses, including those sold or exited as
described above. The following tables provide information about CNAs results
of operations for the retained and sold businesses for the three and nine
months ended September 30, 2004 and 2003. Included in the net income (loss) of
the businesses sold are the realized gains (losses) on the sale of these
businesses as well as the effects of shared corporate overhead expenses which
continue to be allocated to the sold businesses. 55




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF
OPERATIONS, Continued Consolidated Net Income (Loss) CorporateStandard
    
    Specialty
    
    Life and Group
    
    and OtherLines
    
    Lines
    
    Non-Core
    
    Non-Core (b)
    
    TotalThree months ended September 30,
2004Net results of businesses retained
    
    $
    (97
    )
    
    $
    72
    
    
    $
    3
    
    
    $
    8
    
    
    $
    (14
    )Net results of businesses sold (a)
    
    
    
    
    
    
    
    
    
    
    (14
    )
    
    
    
    
    
    
    (14
    )Total consolidated net income
(loss) for the three months ended
September 30, 2004
    
    $
    (97
    )
    
    $
    72
    
    
    $
    (11
    )
    
    $
    8
    
    
    $
    (28
    )Three months ended September 30,
2003Net results of businesses retained
    
    $
    (911
    )
    
    $
    (128
    )
    
    $
    14
    
    
    $
    (769
    )
    
    $
    (1,794
    )Net results of businesses sold (a)
    
    
    
    
    
    
    
    
    
    
    34
    
    
    
    
    
    
    
    34Total consolidated net income(loss) for the three months ended
September 30, 2003
    
    $
    (911
    )
    
    $
    (128
    )
    
    $
    48
    
    
    $
    (769
    )
    
    $
    (1,760
    )
   (a)
    
    Included the group benefits business sold on December 31, 2003, the
individual life business sold on April 30, 2004 and the CNA Trust
business sold on August 1, 2004.(b)
    
    Included $5 million of Net Income for the three months ended
September 30, 2004 and $74 million of Net Loss for the three months
ended September 30, 2003, from CNA Re, which is in run-off. Consolidated Net Income (Loss) CorporateStandard
    
    Specialty
    
    Life and Group
    
    and OtherLines
    
    Lines
    
    Non-Core
    
    Non-Core (b)
    
    TotalNine months ended September 30,
2004Net results of businesses retained
    
    $
    203
    
    
    $
    259
    
    
    $
    11
    
    
    $
    79
    
    
    $
    552Net results of businesses sold (a)
    
    
    
    
    
    
    
    
    
    
    (416
    )
    
    
    
    
    
    
    (416
    )Total consolidated net income
(loss) for the nine months ended
September 30, 2004
    
    $
    203
    
    
    $
    259
    
    
    $
    (405
    )
    
    $
    79
    
    
    $
    136Nine months ended September 30,
2003Net results of businesses retained
    
    $
    (876
    )
    
    $
    (47
    )
    
    $
    28
    
    
    $
    (766
    )
    
    $
    (1,661
    )Net results of businesses sold (a)
    
    
    
    
    
    
    
    
    
    
    54
    
    
    
    
    
    
    
    54Total consolidated net income
(loss) for the nine months ended
September 30, 2003
    
    $
    (876
    )
    
    $
    (47
    )
    
    $
    82
    
    
    $
    (766
    )
    
    $
    (1,607
    )
   (a)
    
    Included the group benefits business sold on December 31, 2003, the
individual life business sold on April 30, 2004 and the CNA Trust
business sold on August 1, 2004. The sale of the individual life
business resulted in an after-tax realized investment loss on sale of
$389 million. An after-tax realized investment gain of $8 million was
recorded for the nine months ended September 30, 2004 related to the
sale of the group benefits business.(b)
    
    Included $42 million of Net Income for the nine months ended
September 30, 2004 and $5 million of Net Loss for the nine months ended
September 30, 2003 from CNA Re, which is in run-off. 56




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
ANDRESULTS OF
OPERATIONS, Continued Net Earned Premiums CorporateStandard
    
    Specialty
    
    Life and Group
    
    and OtherLines
    
    Lines
    
    Non-Core
    
    Non-Core (b)
    
    TotalThree months ended
September 30, 2004Net earned premiums
of businessesretained
    
    $
    1,183
    
    
    $
    576
    
    
    $
    182
    
    
    $
    6
    
    
    $
    1,947Net earned premiums
of businesses sold
(a)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total net earned
premiums for the
three months ended
September 30, 2004
    
    $
    1,183
    
    
    $
    576
    
    
    $
    182
    
    
    $
    6
    
    
    $
    1,947Three months ended
September 30, 2003Net earned premiums
of businesses
retained
    
    $
    1,001
    
    
    $
    451
    
    
    $
    239
    
    
    $
    63
    
    
    $
    1,754Net earned premiums
of businesses sold
(a)
    
    
    
    
    
    
    
    
    
    
    372
    
    
    
    
    
    
    
    372Total net earned
premiums for the
three months ended
September 30, 2003
    
    $
    1,001
    
    
    $
    451
    
    
    $
    611
    
    
    $
    63
    
    
    $
    2,126
 Net Earned Premiums CorporateStandard
    
    Specialty
    
    Life and Group
    
    and OtherLines
    
    Lines
    
    Non-Core
    
    Non-Core (b)
    
    TotalNine months ended
September 30, 2004Net earned premiums
of businesses
retained
    
    $
    3,756
    
    
    $
    1,672
    
    
    $
    595
    
    
    $
    83
    
    
    $
    6,106Net earned premiums
of businesses sold
(a)
    
    
    
    
    
    
    
    
    
    
    115
    
    
    
    
    
    
    
    115Total net earned
premiums for the
nine months ended
September 30, 2004
    
    $
    3,756
    
    
    $
    1,672
    
    
    $
    710
    
    
    $
    83
    
    
    $
    6,221Nine months ended
September 30, 2003Net earned premiums
of businesses
retained
    
    $
    3,238
    
    
    $
    1,338
    
    
    $
    697
    
    
    $
    328
    
    
    $
    5,601Net earned premiums
of businesses sold
(a)
    
    
    
    
    
    
    
    
    
    
    1,103
    
    
    
    
    
    
    
    1,103Total net earned
premiums for the
nine months ended
September 30, 2003
    
    $
    3,238
    
    
    $
    1,338
    
    
    $
    1,800
    
    
    $
    328
    
    
    $
    6,704
 57




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF
OPERATIONS, Continued   (a)
    
    Includes the group benefits business sold on December 31, 2003 and
the individual life business sold on April 30, 2004.(b)
    
    Includes $14 million and $84 million of Net Earned Premiums for the
three months ended September 30, 2004 and 2003 and $115 million and
$371 million of Net Earned Premiums for the nine months ended September
30, 2004 and 2003 from CNA Re, which is in run-off. Also includes Net
Earned Premiums related to intercompany eliminations. See Note M in
the Notes to the Condensed Consolidated Financial Statements for more
information on intercompany eliminations. Reclassification of Change in Allowance for Uncollectible Reinsurance In the
second quarter of 2004, the expenses incurred related to uncollectible
reinsurance receivables were reclassified from Other operating expenses to
Insurance claims and policyholders benefits on the Condensed Consolidated
Statements of Operations. Prior period amounts and ratios have been
reclassified to conform to the current year presentation. This
reclassification had no impact on net income (loss) or the combined ratios
in any period; however, this change generally had an unfavorable impact on the
loss and loss adjustment expense ratios and a favorable impact on the expense
ratios. Critical Accounting Estimates The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America (GAAP)
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
amounts of revenues and expenses reported during the period. Actual results
may differ from those estimates. CNAs Condensed Consolidated Financial Statements and accompanying notes have
been prepared in accordance with GAAP applied on a consistent basis. CNA
continually evaluates the accounting policies and estimates used to prepare the
Condensed Consolidated Financial Statements. In general, managements
estimates are based on historical experience, evaluation of current trends,
information from third party professionals and various other assumptions that
are believed to be reasonable under the known facts and circumstances. The accounting estimates discussed below are considered by management to be
critical to an understanding of CNAs Condensed Consolidated Financial
Statements as their application places the most significant demands on
managements judgment. Note A of the Consolidated Financial Statements
included under Item 8 of the Companys Form 10-K for the year ended December
31, 2003 should be read in conjunction with this section to assist with
obtaining an understanding of the underlying accounting policies related to
these estimates. Due to the inherent uncertainties involved with these types
of judgments, actual results could differ significantly from estimates and have
a material adverse impact on the Companys results of operations or equity. Insurance Reserves Insurance reserves are established for both short and long-duration insurance
contracts. Short-duration contracts are primarily related to property and
casualty insurance policies where the reserving process is based on actuarial
estimates of the amount of loss, including amounts for known and unknown
claims. Long-duration contracts typically include traditional life insurance
and long term care products and are estimated using actuarial estimates about
mortality and morbidity, as well as assumptions about expected investment
returns. Changes in estimates of claim and allocated claim adjustment expense
reserves and premium accruals for prior accident years are defined as
development within this MD&A. These changes 58




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF
OPERATIONS, Continued can be favorable or unfavorable.
The inherent risks associated with the reserving process are discussed in the
Reserves  Estimates and Uncertainties section below. Reinsurance Amounts recoverable from reinsurers are estimated in a manner consistent with
claim and claim adjustment expense reserves or future policy benefits reserves
and are reported as receivables in the Condensed Consolidated Balance Sheets.
The ceding of insurance does not discharge the primary liability of the
Company. An estimated allowance for doubtful accounts is recorded on the basis
of periodic evaluations of balances due from reinsurers, reinsurer solvency,
managements experience and current economic conditions. Further information
on reinsurance is provided in the Reinsurance section below. Valuation of Investments and Impairment of Securities Invested assets are exposed to various risks, such as interest rate, market and
credit risks. Due to the level of risk associated with certain invested assets
and the level of uncertainty related to changes in the value of these assets,
it is possible that changes in risks in the near term could have an adverse
material impact on the Companys results of operations or equity. The Companys investment portfolio is subject to market declines below book
value that may be other-than-temporary. The Company has an Impairment
Committee, which reviews the investment portfolio on a quarterly basis, with
ongoing analysis as new information becomes available. Any decline that is
determined to be other-than-temporary is recorded as an impairment loss in the
results of operations in the period in which the determination occurred. In March of 2004, the Emerging Issues Task Force (EITF) reached consensus on
the guidance provided in EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain Investments
(EITF 03-1), as applicable to debt and equity securities that are within the
scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities (SFAS 115) and equity securities that are accounted for using the
cost method specified in Accounting Principles Board Opinion No. 18, The Equity
Method of Accounting for Investments in Common Stock. Under EITF 03-1 an
investment is impaired if the fair value of the investment is less than its
cost including adjustments for amortization, accretion, foreign exchange, and
hedging. An impairment would be considered other-than-temporary unless a) the
investor has the ability and intent to hold an investment for a reasonable
period of time sufficient for the recovery of the fair value up to (or beyond)
the cost of the investment and b) evidence indicating that the cost of the
investment is recoverable within a reasonable period of time outweighs evidence
to the contrary. The investor should consider its cash or working capital
needs to assess its intent and ability to hold an investment for a reasonable
period of time for the recovery of fair value up to or beyond the cost of the
investment. Although not presumptive, a pattern of selling investments prior
to the forecasted recovery of fair value may call into question the investors
intent. In addition, the severity and duration of the impairment should also
be considered in determining whether the impairment is other-than-temporary. This new guidance for
determining whether an impairment is other-than-temporary
was to be effective for reporting periods beginning after June 15, 2004. In
September 2004, the FASB issued FASB Staff Position (FSP) EITF Issue 03-1-1,
which delayed the effective date for the measurement and recognition guidance
included in EITF Issue 03-1 related to other-than-temporary impairment until
additional implementation guidance is provided. As a result of the delay,
during the three month period ended 59




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF
OPERATIONS, Continued September 30, 2004, the Company continued
to apply existing accounting literature for determining when a decline in fair
value is other-than-temporary. The Company continues to evaluate the impact of this new accounting standard on
its process for determining other-than-temporary impairment of equity and fixed
maturity securities, including the potential impacts from any revisions to the
original guidance issued. Adoption of this standard as originally issued may
cause the Company to recognize impairment losses in the Consolidated Statements
of Operations which would not have been recognized under the current guidance
or to recognize such losses in earlier periods, especially those due to
increases in interest rates, and would likely also impact the recognition of
investment income on impaired securities. Such an impact would likely increase
earnings volatility in future periods. However, since fluctuations in the fair
value for available-for-sale securities are already recorded in Accumulated
Other Comprehensive Income, adoption of this standard as originally issued is
not expected to have a significant impact on equity. Further information on
the Companys investments is provided in the Investments section below. Individual Long Term Care Products The Companys reserves and deferred acquisition costs for its individual long
term care product offerings are based on certain assumptions including
morbidity, policy persistency and interest rates. Actual experience may differ
from these assumptions. The recoverability of deferred acquisition costs and
the adequacy of the reserves are contingent on actual experience related to
these key assumptions and other factors including potential future premium
increases and future health care cost trends. The results of operations and/or
equity may be materially affected if actual experience varies significantly
from these assumptions. Legal Proceedings The Company is involved in various legal proceedings that have arisen during
the ordinary course of business. The Company evaluates the facts and
circumstances of each situation, and when the Company determines it necessary,
a liability is estimated and recorded. Further information on the Companys
legal proceedings and related contingent liabilities is provided in Notes F and
G of the Condensed Consolidated Financial Statements included under Item 1. Loans to National Contractor CNAF has made loans through a credit facility provided to a national contractor
to whom CNA Surety Corporation (CNA Surety) provides significant amounts of
surety bond insurance coverage. As of September 30, 2004, the aggregate amount
of outstanding principal and accrued interest under the credit facility was $61
million, net of participation by Loews in the amount of $24 million. The
credit facility was established to help the contractor meet its liquidity
needs. The contractor is implementing restructuring efforts to reduce costs
and improve cash flow. Based on the contractors restructuring efforts to
date, the Company estimates that amounts due under the credit facility are
collectible. Indemnification and subrogation rights, including rights to contract proceeds
on construction projects in the event of default, exist that reduce CNA
Suretys and ultimately the Companys exposure to loss. While CNAF believes
that the contractors restructuring efforts may be successful and provide
sufficient cash flow for its operations, the contractors failure to achieve
its restructuring plan or perform its contractual obligations under the credit
facility or under the Companys surety bonds could have a material adverse
effect on the Companys results of operations and/ or equity. If such failures
occur, the Company estimates the surety loss, net of indemnification and
subrogation recoveries, but before the 60




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF
OPERATIONS, Continued effects of minority interest, to be
approximately $200 million pretax. In addition, such failures could cause the
full amount due under the credit facility to be uncollectible. Further information on the Companys exposure to this national contractor and
this credit agreement are provided in Note O of the Condensed Consolidated
Financial Statements included under Item 1, and the Liquidity and Capital
Resources section below. Reserves  Estimates and Uncertainties The Company maintains reserves to cover its estimated ultimate unpaid liability
for claim and claim adjustment expenses and future policy benefits, including
the estimated cost of the claims adjudication process, for claims that have
been reported but not yet settled and claims that have been incurred but not
reported (IBNR). Claim and claim adjustment expense and future policy benefit
reserves are reflected as liabilities on the Condensed Consolidated Balance
Sheets under the heading Insurance Reserves. Adjustments to prior year
reserve estimates, if necessary, are reflected in the results of operations in
the period that the need for such adjustments is determined. The level of Insurance Reserves maintained by the Company represents
managements best estimate, as of a particular point in time, of what the
ultimate settlement and administration of claims will cost based on its
assessment of facts and circumstances known at that time. Insurance Reserves
are not an exact calculation of liability but instead are complex estimates
that are derived by the Company, generally utilizing a variety of actuarial
reserve estimation techniques, from numerous assumptions and expectations about
future events, both internal and external, many of which are highly uncertain. Among the many uncertain future events about which the Company makes
assumptions and estimates, many of which have become increasingly
unpredictable, are claims severity, frequency of claims, mortality, morbidity,
expected interest rates, inflation, claims handling and case reserving policies
and procedures, underwriting and pricing policies, changes in the legal and
regulatory environment and the lag time between the occurrence of an insured
event and the time it is ultimately settled, referred to in the insurance
industry as the tail. These factors must be individually considered in
relation to the Companys evaluation of each type of business. Many of these
uncertainties are not precisely quantifiable, particularly on a prospective
basis, and require significant management judgment. Given the factors described above, it is not possible to quantify precisely the
ultimate exposure represented by claims and related litigation. As a result,
the Company regularly reviews the adequacy of its reserves and reassesses its
reserve estimates as historical loss experience develops, additional claims are
reported and settled and additional information becomes available in subsequent
periods. In addition, the Company is subject to the uncertain effects of emerging or
potential claims and coverage issues that arise as industry practices and
legal, judicial, social and other environmental conditions change. These
issues have had, and may continue to have, a negative effect on the Companys
business by either extending coverage beyond the original underwriting intent
or by increasing the number or size of claims. Recent examples of emerging or
potential claims and coverage issues include:  
    
    increases in the number and size of water damage claims, including
those related to expenses for testing and remediation of mold
conditions;
    
    increases in the number and size of claims relating to injuries
from medical products, and exposure to lead; 61




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF OPERATIONS, Continued  
    
    the effects of accounting and financial reporting scandals and
other major corporate governance failures, which have resulted in an
increase in the number and size of claims, including director and
officer and errors and omissions insurance claims;
    
    class action litigation relating to claims handling and other
practices;
    
    increases in the number of construction defect claims, including
claims for a broad range of additional insured endorsements on
policies; and
    
    increases in the number of claims alleging abuse by members of the
clergy. The impact of these and other unforeseen emerging or potential claims and
coverage issues is difficult to predict and could materially adversely affect
the adequacy of the Companys claim and claim adjustment expense reserves and
could lead to future reserve additions. See the Segment Results sections of
this MD&A for a discussion of changes in reserve estimates and the impact on
the Companys results of operations. The Companys experience has been that establishing reserves for casualty
coverages relating to APMT claim and claim adjustment expenses is subject to
uncertainties that are greater than those presented by
other claims. Estimating the ultimate cost of both reported and unreported
APMT claims is subject to a higher degree of variability due to a number of
additional factors, including among others:  
    
    coverage issues, including whether certain costs are covered under
the policies and whether policy limits apply;
    
    inconsistent court decisions and developing legal theories;
    
    increasingly aggressive tactics of plaintiffs lawyers;
    
    the risks and lack of predictability inherent in major litigation;
    
    changes in the volume of asbestos and environmental pollution and
mass tort claims which cannot now be anticipated;
    
    continued increase in mass tort claims relating to silica and
silica-containing products;
    
    the impact of the exhaustion of primary limits and the resulting
increase in claims on any umbrella or excess policies the Company has
issued;
    
    the number and outcome of direct actions against the Company; and
    
    the Companys ability to recover reinsurance for asbestos and
environmental pollution and mass tort claims. It is also not possible to predict changes in the legal and legislative
environment and the impact on the future development of APMT claims. This
development will be affected by future court decisions and interpretations, as
well as changes in applicable legislation. It is difficult to predict the
ultimate outcome of large coverage disputes until settlement negotiations near
completion and significant legal questions are resolved or, failing settlement,
until the dispute is adjudicated. This is particularly the case with
policyholders in bankruptcy where negotiations often involve a large number of
claimants and other parties and require court approval to be effective. A
further uncertainty exists as to whether a national 62




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF OPERATIONS, Continued privately financed trust to
replace litigation of asbestos claims with payments to claimants from the trust
will be established and approved through federal legislation, and, if
established and approved, whether it will contain funding requirements in
excess of the Companys carried loss reserves. Due to the factors described above, among others, establishing reserves for
APMT claim and claim adjustment expenses is subject to uncertainties that are
greater than those presented by other claims. Traditional actuarial methods
and techniques employed to estimate the ultimate cost of claims for more
traditional property and casualty exposures are less precise in estimating
claim and claim adjustment reserves for APMT, particularly in an environment of
emerging or potential claims and coverage issues that arise from industry
practices and legal, judicial and social conditions. Therefore, these
traditional actuarial methods and techniques are necessarily supplemented with
additional estimating techniques and methodologies, many of which involve
significant judgments that are required of management. Due to the inherent
uncertainties in estimating reserves for APMT claim and claim adjustment
expenses and the degree of variability due to, among other things, the factors
described above, the Company may be required to record material changes in its
claim and claim adjustment expense reserves in the future, should new
information become available or other developments emerge. See the APMT
Reserves section of this MD&A for additional information relating to APMT
claims and reserves. The Companys recorded Insurance Reserves, including APMT reserves, reflect
managements best estimate as of a particular point in time based upon known
facts, current law and managements
judgment. In light of the many uncertainties associated with establishing the
estimates and making the assumptions necessary to establish reserve levels, the
Company reviews its reserve estimates on a regular basis and makes adjustments
in the period that the need for such adjustments is determined. These reviews
have resulted in the Company identifying information and trends that have
caused the Company to increase its reserves in prior periods and could lead to
the identification of a need for additional material increases in claim and
claim adjustment expense reserves, which could materially adversely affect the
Companys results of operations, equity, business, insurer financial strength
and debt ratings. See the Ratings section of this MD&A for further information
on the Companys ratings. In addition, the Company periodically undergoes
state regulatory financial examinations. Such examinations are currently
underway. The Company is presently engaged in discussions related to the
examination with state regulatory agencies. See the Regulatory Matters section
of the MD&A for further information. Reinsurance CNA assumes and cedes reinsurance with other insurers, reinsurers and members
of various reinsurance pools and associations. CNA utilizes reinsurance
arrangements to limit its maximum loss, provide greater diversification of
risk, minimize exposures on larger risks and to exit certain lines of business.
The ceding of insurance does not discharge the primary liability of the
Company. Therefore, a credit exposure exists with respect to property and
casualty and life reinsurance ceded to the extent that any reinsurer is unable
to meet the obligations assumed under reinsurance agreements. Interest cost on reinsurance contracts accounted for on a funds withheld basis
is incurred during all periods in which a funds withheld liability exists.
Interest cost, which is included in net investment income, was $55 million and
$148 million for the three months ended September 30, 2004 and 2003, and $161
million and $288 million for the nine months ended September 30, 2004 and 2003.
The amount subject to interest crediting rates on such contracts was $2,726
million and $2,789 million at September 30, 2004 and December 31, 2003.
Certain funds withheld reinsurance contracts, including the corporate aggregate
reinsurance treaties, require interest on additional premiums arising from
ceded losses as if those premiums were payable at the inception of the
contract. 63




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued The amount subject to interest crediting on these funds withheld contracts will
vary over time based on a number of factors, including the timing of loss
payments and ultimate gross losses incurred. The Company expects that it will
continue to incur significant interest costs on these contracts for several
years. The following table summarizes the amounts receivable from reinsurers at
September 30, 2004 and December 31, 2003. Components of reinsurance receivables September 30,2004
    
    December 31,2003(In millions)Reinsurance receivables related to insurance reserves:Ceded claim and claim adjustment expense
    
    $
    14,038
    
    
    $
    14,216Ceded future policy benefits
    
    
    1,227
    
    
    
    1,218Ceded policyholders funds
    
    
    60
    
    
    
    7Billed reinsurance receivables
    
    
    587
    
    
    
    813Reinsurance receivables
    
    
    15,912
    
    
    
    16,254Allowance for uncollectible reinsurance
    
    
    (531
    )
    
    
    (573
    )Reinsurance receivables, net of allowance for
uncollectible reinsurance
    
    $
    15,381
    
    
    $
    15,681
 The Company has established an allowance for uncollectible reinsurance
receivables. The allowance for uncollectible reinsurance receivables was $531
million and $573 million at September 30, 2004 and December 31, 2003. The net
decrease in the allowance was primarily due to a release of a previously
established allowance related to The Trenwick Group resulting from the
finalization of commutation agreements in the second quarter of 2004, partially
offset by a net increase in the allowance for other reinsurance receivables.
The expenses incurred related to uncollectible reinsurance receivables are
presented as a component of Insurance claims and policyholders benefits on
the Condensed Consolidated Statements of Operations. The Company attempts to mitigate its credit risk related to reinsurance by
entering into reinsurance arrangements only with reinsurers that have credit
ratings above certain levels and by obtaining substantial amounts of
collateral. The primary methods of obtaining collateral are through
reinsurance trusts, letters of credit and funds withheld balances. In certain circumstances, including significant deterioration of a reinsurers
financial strength ratings, the Company may engage in commutation discussions
with individual reinsurers. The outcome of such discussions may result in a
lump sum settlement that is less than the recorded receivable, net of any
applicable allowance for doubtful accounts. Losses arising from commutations
could have an adverse material impact on the Companys results of operations. 64




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued The effects of reinsurance on earned premiums are shown in the following table. Components of Earned Premiums For the nine months ended September 30
    
    Direct
    
    Assumed
    
    Ceded
    
    Net(In millions)2004Property and casualty
    
    $
    8,059
    
    
    $
    163
    
    
    $
    2,663
    
    
    $
    5,559Accident and health
    
    
    919
    
    
    
    45
    
    
    
    421
    
    
    
    543Life
    
    
    369
    
    
    
    
    
    
    
    250
    
    
    
    119Total earned premiums
    
    $
    9,347
    
    
    $
    208
    
    
    $
    3,334
    
    
    $
    6,2212003Property and casualty
    
    $
    7,977
    
    
    $
    460
    
    
    $
    3,459
    
    
    $
    4,978Accident and health
    
    
    1,196
    
    
    
    78
    
    
    
    42
    
    
    
    1,232Life
    
    
    801
    
    
    
    4
    
    
    
    311
    
    
    
    494Total earned premiums
    
    $
    9,974
    
    
    $
    542
    
    
    $
    3,812
    
    
    $
    6,704
 The Company has an aggregate reinsurance treaty related to the 1999 through
2001 accident years that covers substantially all of the Companys property and
casualty lines of business (the Aggregate Cover). The Aggregate Cover provides
for two sections of coverage. These coverages attach at defined loss ratios
for each accident year. Coverage under the first section of the Aggregate
Cover, which is available for all accident years covered by the treaty, has a
$500 million limit per accident year of ceded losses and an aggregate limit of
$1 billion of ceded losses for the three accident years. The ceded premiums
associated with the first section are a percentage of ceded losses and for each
$500 million of limit the ceded premium is $230 million. The second section of
the Aggregate Cover, which only relates to accident year 2001, provides
additional coverage of up to $510 million of ceded losses for a maximum ceded
premium of $310 million. Under the Aggregate Cover, interest charges on the
funds withheld liability accrue at 8% per annum. The aggregate loss ratio has
exceeded certain thresholds which requires additional premiums to be paid and
an increase in the rate at which interest charges are accrued. This rate will
increase to 8.25% per annum commencing in 2006. The aggregate limits under
both sections of the Aggregate Cover were fully utilized in 2003. The pretax impact of the Aggregate Cover was as follows: Pretax Impact of Aggregate Cover Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Ceded earned premiums
    
    $
    3
    
    
    $
    (223
    )
    
    $
    
    
    
    $
    (251
    )Ceded claim and claim adjustment expense
    
    
    
    
    
    
    422
    
    
    
    
    
    
    
    500Interest charges
    
    
    (19
    )
    
    
    (88
    )
    
    
    (61
    )
    
    
    (123
    )Pretax benefit (expense)
    
    $
    (16
    )
    
    $
    111
    
    
    $
    (61
    )
    
    $
    126
 In 2001, the Company entered into a one-year aggregate reinsurance treaty
related to the 2001 accident year covering substantially all property and
casualty lines of business in the Continental Casualty Company pool (the CCC
Cover). The loss protection provided by the CCC Cover has an aggregate limit
of approximately $761 million of ceded losses. The ceded premiums are a
percentage of ceded losses. The ceded premium related to full utilization of
the $761 million of limit is $456 million. The CCC Cover provides continuous
coverage in excess of the second section of the Aggregate Cover discussed
above. Under the CCC Cover, interest charges on the funds withheld generally
accrue at 8% per annum. 65




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued The interest rate increases to 10% per annum if the aggregate loss ratio
exceeds certain thresholds. If the aggregate loss ratio would exceed these
certain thresholds, then additional interest charges on funds withheld would be
approximately $34 million in 2004. During 2003, the aggregate limits under the
CCC Cover were fully utilized. The pretax impact of the CCC Cover was as follows: Pretax Impact of CCC Cover Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Ceded earned premiums
    
    $
    
    
    
    $
    (10
    )
    
    $
    
    
    
    $
    (100
    )Ceded claim and claim adjustment expense
    
    
    
    
    
    
    17
    
    
    
    
    
    
    
    143Interest charges
    
    
    (12
    )
    
    
    (13
    )
    
    
    (34
    )
    
    
    (48
    )Pretax benefit (expense)
    
    $
    (12
    )
    
    $
    (6
    )
    
    $
    (34
    )
    
    $
    (5
    )
 The pretax impact by operating segment of the Aggregate Cover and the CCC Cover
was as follows: Pretax Impact of Aggregate Cover and CCC Cover Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Standard Lines
    
    $
    (23
    )
    
    $
    72
    
    
    $
    (66
    )
    
    $
    93Specialty Lines
    
    
    6
    
    
    
    17
    
    
    
    
    
    
    
    16Corporate and Other
    
    
    (11
    )
    
    
    16
    
    
    
    (29
    )
    
    
    12Pretax benefit (expense)
    
    $
    (28
    )
    
    $
    105
    
    
    $
    (95
    )
    
    $
    121
 Terrorism Insurance CNA and the insurance industry incurred substantial losses related to the 2001
World Trade Center event. For the most part, the industry was able to absorb
the loss of capital from these losses, but the capacity to withstand the effect
of any additional terrorism events was significantly diminished. The Terrorism Risk Insurance Act of 2002 (the Act) established a program within
the Department of the Treasury under which the federal government will share
the risk of loss by commercial property and casualty insurers arising from
future terrorist attacks. The Act expires on December 31, 2005. Each
participating insurance company must pay a deductible, ranging from 7% of
direct earned premiums from commercial insurance lines in 2003 to 15% in 2005,
before federal government assistance becomes available. For losses in excess
of a companys deductible, the federal government will cover 90% of the excess
losses, while companies retain the remaining 10%. Losses covered by the
program will be capped annually at $100 billion; above this amount, insurers
are not liable for covered losses and Congress is to determine the procedures
for and the source of any payments. Amounts paid by the federal government
under the program over certain phased limits are to be recouped by the
Department of the Treasury through policy surcharges, which cannot exceed 3% of
annual premium. The Company is required to participate in the program, but it does not cover
life or health insurance products. State law limitations applying to premiums
and policies for terrorism coverage are not generally affected under the
program. The Act requires insurers to offer terrorism coverage through 2004.
On June 18, 2004, the Department of the Treasury announced its decision to
extend this offer requirement until December 31, 2005. 66




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued While the Act provides the property and casualty industry with an increased
ability to withstand the effect of a terrorist event through 2005, given the
unpredictability of the nature, targets, severity or frequency of potential
terrorist events, the Companys results of operations or equity could
nevertheless be materially adversely impacted by them. The Company is
attempting to mitigate this exposure through its underwriting practices, policy
terms and conditions (where applicable) and the use of reinsurance. In
addition, under state laws, the Company is generally prohibited from excluding
terrorism exposure from its primary workers compensation policies. In those
states that mandate property insurance coverage of damage from fire following a
loss, the Company is also prohibited from excluding terrorism exposure under
such coverage. Reinsurers obligations for terrorism-related losses under reinsurance
agreements are not covered by the Act. The Companys assumed reinsurance
arrangements,beginning with the January 1, 2002 renewal period, either exclude
terrorism coverage or significantly limit the level of coverage. As noted, the Act expires on December 31, 2005. In anticipation of the
expiration of the Act, the Company is participating in a coalition to encourage
reauthorization of the Act. The Financial Services Committee of the House of
Representatives has passed a reauthorization bill, H.R. 4634, but it has not
been voted on by the entire House. A similar Senate measure, S. 2764, is
pending in the Senate Banking Committee, but no vote has yet been taken.
Although the Congress is expected to reconvene in mid-November of 2004, it is
not expected that they will resume debate on this matter until early in 2005. The pending bills described above would extend the Act for two additional years
and require that terrorism coverage be made available for all years.
Deductibles under the bills would be held at 15% in year four and raised to 20%
in year five. Notwithstanding these developments, enactment of a law extending
the Act is not assured. If the Act is not extended
CNA will, among other steps, seek to exclude risks with
perceived terrorism exposure, to the extent permitted by law. Strict
underwriting standards and risk avoidance measures will be taken where
exclusions are not permitted. Annual policy renewals with effective dates of
January 1, 2005 or later will be underwritten with the assumption that the Act
will not be extended and that no Federal backstop for terrorism exposure will
be available. In advance of that date, CNA expects to apply for regulatory
approval of terrorism exclusions. There is no assurance that CNA will be able
to eliminate or limit terrorism exposure risks in coverages, or that regulatory
authorities will approve policy exclusions for terrorism. Restructuring As discussed in the Companys 2003 Form 10-K, the Company continues to manage
the liabilities from two separate restructuring plans. The first plan related
to the Companys Information Technology operations (the IT Plan). The second
plan related to restructuring the property and casualty segments and the former
Life Operations, discontinuation of the variable life and annuity business and
consolidation of real estate locations (the 2001 Plan). No restructuring and other related charges related to the IT Plan were incurred
for the three or nine months ended September 30, 2004 and 2003. During the
third quarter of 2004, the remaining IT Plan accrual was released. No restructuring and other related charges related to the 2001 Plan were
incurred for the three or nine months ended September 30, 2004 and 2003.
During 2004, $5 million in payments for lease termination costs were charged
against the liability. As of September 30, 2004, the accrued liability,
relating 67




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued primarily to lease termination costs, was $15 million. Of the remaining
accrual, approximately $1 million is expected to be paid in 2004. Non-GAAP Financial Measures This MD&A discusses certain GAAP and non-GAAP financial measures to provide
information used by management to monitor the Companys operating performance.
Management utilizes various financial measures to monitor the Companys
insurance operations and investment portfolio. Underwriting results, which are
derived from certain income statement amounts, are considered non-GAAP
financial measures and are used by management to monitor performance of the
Companys insurance operations. The Companys investment portfolio is
monitored through analysis of various quantitative and qualitative factors and
certain decisions are made related to the sale or impairment of investments
that will produce realized gains and losses. Net realized investment gains and
losses, which are comprised of after-tax realized investment gains and losses
net of participating policyholders and minority interests are a non-GAAP
financial measure. Underwriting results are computed as net earned premiums less net incurred
claims and the cost incurred to settle these claims, acquisition expenses,
underwriting expenses and dividend expenses. Management uses underwriting
results and operating ratios to monitor its insurance operations results
without the impact of certain factors, including investment income, other
revenues, other expenses, minority interest, income tax benefit (expense) and
net realized investment gains or losses. Management excludes these factors in
order to analyze the direct relationship between the net earned premiums and
the related claims and the cost incurred to settle these claims, acquisition
expenses, underwriting expenses and dividend expenses. Management excludes after-tax net realized investment gains or losses when
analyzing the insurance operations because net realized investment gains or
losses related to the Companys available-for-sale investment portfolio are
largely discretionary, except for losses related to other-than-temporary
impairments, and are generally driven by economic factors that are not
necessarily consistent with key drivers of underwriting performance. The Companys investment portfolio is monitored by management through analyses
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 impair an investment security in
accordance with its policy, or sell a security. Such activities will produce
realized gains and losses. Operating ratios are calculated using insurance results and are used by the
insurance industry and regulators such as state departments of insurance and
the National Association of Insurance Commissioners for financial regulation
and as a basis of comparison among companies. The ratios discussed in this
MD&A are calculated using GAAP financial results and include the loss and loss
adjustment expense ratio (loss ratio) as well as the expense, dividend and
combined ratios. 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 underwriting and acquisition expenses, including the amortization
of deferred acquisition costs, to net earned premiums. The dividend ratio is
the ratio of dividends incurred to net earned premiums. The combined ratio is
the sum of the loss, expense and dividend ratios. While management uses various non-GAAP financial measures to monitor various
aspects of the Companys performance, relying on any measure other than net
income (loss), which is the most directly comparable GAAP measure to
underwriting results and realized gains and losses, is not a complete
representation of financial performance. Management believes that its process
of evaluating performance 68




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued through the use of these non-GAAP financial measures provides a basis for
understanding the operations and the impact to net income (loss) as a whole.
Management also believes that investors find these non-GAAP financial measures
described above useful to help interpret the underlying trends and performance,
as well as to provide visibility into the significant components of net income
(loss). Throughout this MD&A, certain business segment results are discussed using
underwriting results, which as described above is a non-GAAP measure. The
following reconciliation provides the differences between Underwriting Income
(Loss) and Net Income (Loss). Reconciliation of Underwriting Income (Loss) to Net Income (Loss) Standard
    
    SpecialtyThree months endedSeptember 30, 2004
    
    Lines
    
    Lines(In millions)Underwriting income (loss)
    
    $
    (262
    )
    
    $
    55Net investment income
    
    
    125
    
    
    
    61Other revenues
    
    
    32
    
    
    
    36Other expenses
    
    
    (25
    )
    
    
    (29
    )Income (loss) before income tax (expense) benefit, minority interest and net
realized investment losses
    
    
    (130
    )
    
    
    123Income tax (expense) benefit
    
    
    58
    
    
    
    (39
    )Minority interest
    
    
    (2
    )
    
    
    (4
    )Income (loss) before net realized investment losses
    
    
    (74
    )
    
    
    80Realized investment losses, net of participating policyholders and minority interest
    
    
    (33
    )
    
    
    (13
    )Income tax benefit on realized investment losses
    
    
    10
    
    
    
    5Net income (loss)
    
    $
    (97
    )
    
    $
    72
 Reconciliation of Underwriting Loss to Net Loss Standard
    
    SpecialtyThree months endedSeptember 30, 2003
    
    Lines
    
    Lines(In millions)Underwriting loss
    
    $
    (1,519
    )
    
    $
    (310
    )Net investment income
    
    
    55
    
    
    
    47Other revenues
    
    
    34
    
    
    
    35Other expenses
    
    
    (35
    )
    
    
    (30
    )Loss before income tax benefit, minority interest and net realized investment gains
    
    
    (1,465
    )
    
    
    (258
    )Income tax benefit
    
    
    520
    
    
    
    103Minority interest
    
    
    (2
    )
    
    
    15Loss before net realized investment gains
    
    
    (947
    )
    
    
    (140
    )Realized investment gains, net of participating policyholders and minority interest
    
    
    58
    
    
    
    19Income tax expense on realized investment gains
    
    
    (22
    )
    
    
    (7
    )Net loss
    
    $
    (911
    )
    
    $
    (128
    )
 69




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CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued Reconciliation of Underwriting Income (Loss) to Net Income Standard
    
    SpecialtyNine months endedSeptember 30, 2004
    
    Lines
    
    Lines(In millions)Underwriting income (loss)
    
    $
    (255
    )
    
    $
    165Net investment income
    
    
    382
    
    
    
    182Other revenues
    
    
    102
    
    
    
    93Other expenses
    
    
    (84
    )
    
    
    (84
    )Income before income tax expense, minority interest and net realized investment
gains
    
    
    145
    
    
    
    356Income tax expense
    
    
    (1
    )
    
    
    (107
    )Minority interest
    
    
    (6
    )
    
    
    (13
    )Income before net realized investment gains
    
    
    138
    
    
    
    236Realized investment gains, net of participating policyholders and minority interest
    
    
    101
    
    
    
    37Income tax expense on realized investment gains
    
    
    (36
    )
    
    
    (14
    )Net income
    
    $
    203
    
    
    $
    259
 Reconciliation of Underwriting Loss to Net Loss Standard
    
    SpecialtyNine months endedSeptember 30, 2003
    
    Lines
    
    Lines(In millions)Underwriting loss
    
    $
    (1,933
    )
    
    $
    (360
    )Net investment income
    
    
    289
    
    
    
    149Other revenues
    
    
    166
    
    
    
    82Other expenses
    
    
    (158
    )
    
    
    (68
    )Loss before income tax benefit, minority interest and net realized investment gains
    
    
    (1,636
    )
    
    
    (197
    )Income tax benefit
    
    
    600
    
    
    
    88Minority interest
    
    
    (1
    )
    
    
    10Loss before net realized investment gains
    
    
    (1,037
    )
    
    
    (99
    )Realized investment gains, net of participating policyholders and minority interest
    
    
    249
    
    
    
    81Income tax expense on realized investment gains
    
    
    (88
    )
    
    
    (29
    )Net loss
    
    $
    (876
    )
    
    $
    (47
    )
 70




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CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued SEGMENT RESULTS The following discusses the results of operations for the Companys operating
segments. Prior period segment disclosures have been presented in conformity
with the current segment classification. STANDARD LINES Business Overview Standard Lines works with an independent agency distribution system and network
of brokers to market a broad range of property and casualty insurance products
and services to small, middle-market and large businesses. The Standard Lines
operating model focuses on underwriting performance, relationships with
selected distribution sources and understanding customer needs. CNA Global (formerly included in Specialty Lines), which consists of marine and
global standard lines, was combined into Standard Lines in the new segment
presentation. Standard Lines now includes Property, Casualty and CNA Global. Propertyprovides standard and excess property coverage, as well as boiler and
machinery to a wide range of businesses. Casualtyprovides standard casualty insurance products such as workers
compensation, general and product liability, and commercial auto coverage
through traditional and advanced financial risk products to a wide range of
businesses. The majority of Casualty customers are small and middle-market
businesses, with less than $1 million in annual insurance premiums. Most
insurance programs are provided on a guaranteed cost basis; however, Casualty
has the capability to offer specialized, loss-sensitive insurance programs to
those customers viewed as higher risk and less predictable in exposure. Excess & Surplus (E&S) is included in Casualty. E&S provides specialized
insurance and other financial products for selected commercial risks on both an
individual customer and program basis. Customers insured by E&S are generally
viewed as higher risk and less predictable in exposure than those covered by
standard insurance markets. E&Ss products are distributed throughout the
United States through specialist producers, program agents, and P&Cs agents
and brokers. E&S has specialized underwriting and claim resources in Chicago,
New York, Denver and Columbus. Property and Casualtysfield structure consists of 33 branch locations across
the country organized into 4 regions. Each branch provides the marketing,
underwriting and risk control expertise on the entire portfolio of products.
In addition, these branches provide streamlined claim services utilizing the
same regional structure. The Centralized Processing Operation for small and
middle-market customers, located in Maitland, Florida, handles policy
processing and accounting, and also acts as a call center to optimize customer
service. Also, Standard Lines, primarily through a wholly owned subsidiary,
ClaimPlus, Inc., a third party administrator, began providing total risk
management services relating to claim services, risk control, cost management
and information services to the large commercial insurance marketplace in 2003. CNA Globalconsists of Marine and Global Standard Lines. Marine serves domestic and global ocean marine needs, with markets extending
across North America, Europe and throughout the world. Marine offers hull,
cargo, primary and excess marine liability, marine 71




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CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued claims and recovery products and services. Business is sold through national
brokers, regional marine specialty brokers and independent agencies. Global Standard Lines is responsible for coordinating and managing the direct
business of CNAs overseas property and casualty operations. This business
identifies and capitalizes on strategic indigenous opportunities and currently
has operations in Hawaii, Europe, Latin America and Canada. The following table summarizes the results of operations for Standard Lines. Results of Operations Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Net written premiums
    
    $
    1,046
    
    
    $
    1,028
    
    
    $
    3,520
    
    
    $
    3,388Net earned premiums
    
    
    1,183
    
    
    
    1,001
    
    
    
    3,756
    
    
    
    3,238Underwriting loss
    
    
    (262
    )
    
    
    (1,519
    )
    
    
    (255
    )
    
    
    (1,933
    )Income (loss) before net realized investment gains (losses)
    
    
    (74
    )
    
    
    (947
    )
    
    
    138
    
    
    
    (1,037
    )Net realized investment gains (losses)
    
    
    (23
    )
    
    
    36
    
    
    
    65
    
    
    
    161Net income (loss)
    
    
    (97
    )
    
    
    (911
    )
    
    
    203
    
    
    
    (876
    )RatiosLoss and loss adjustment expense
    
    
    80.4
    %
    
    
    177.9
    %
    
    
    71.9
    %
    
    
    110.2
    %Expense
    
    
    41.1
    
    
    
    67.8
    
    
    
    34.8
    
    
    
    46.8Dividend
    
    
    0.7
    
    
    
    6.0
    
    
    
    0.1
    
    
    
    2.7Combined
    
    
    122.2
    %
    
    
    251.7
    %
    
    
    106.8
    %
    
    
    159.7
    %
 Three Month Comparison Net results for Standard Lines for the three months ended September 30, 2004
were adversely impacted by recent catastrophes including estimated net losses
related to Hurricanes Charley, Frances, Ivan and Jeanne. The four storms
negatively impacted third quarter Standard Lines results by $165 million
after-tax ($254 million pretax). This estimate is net of anticipated
reinsurance recoveries, and includes the impact of reinstatement premiums and
insurance assessments. Actual losses for these catastrophes could exceed the
Companys current estimates. In addition, the Company recorded a bad debt
provision for insurance receivables related to PEO accounts in the third
quarter of 2004 of $62 million after-tax ($95 million pretax). Favorably
impacting the quarter was a $36 million after-tax ($55 million pretax)
reduction of current accident year losses established during the first half of
the year. The third quarter of 2003 net results were adversely impacted by
significant charges primarily related to net prior year development and
increases in the provision for insurance and reinsurance receivables. For the three months ended September 30, 2004, net results increased $814
million as compared with the same period in 2003. This improvement was due
primarily to decreased unfavorable net prior year development of $718 million
after-tax ($1,105 million pretax), a decrease in the bad debt provision
recorded for insurance receivables of $66 million after-tax ($102 million
pretax) and a decrease in the bad debt provision for reinsurance receivables of
$24 million after-tax ($36 million pretax) and increased net investment income.
Additionally, net results for the period were favorably impacted by the
absence of a $29 million after-tax ($44 million pretax) increase in
insurance-related assessments and a $7 million after-tax ($11 million pretax)
increase in ULAE reserves recorded in the third quarter of 2003. These
favorable items were partially offset by decreased net realized investment
results and increased catastrophe impacts in 2004. Catastrophe impacts were
$172 million after-tax ($264 million pretax) and $29 million after-tax ($46 million
pretax) for the three months ended September 30, 2004 and 2003, as discussed
below. See the Investments section of the MD&A for further discussion on net
investment income and net realized investment gains. 72




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued Net written premiums for Standard Lines increased $18 million for the three
months ended September 30, 2004 as compared with the same period in 2003. This
increase was primarily driven by decreased premiums ceded to corporate
aggregate and other reinsurance treaties in 2004 as compared with 2003. The
2003 cessions were principally due to the unfavorable net prior year
development recorded in the third quarter of 2003. Net written premiums were
unfavorably impacted by continued decreases in retention and new business
across most property and casualty lines in 2004. Specifically impacting
retention was the impact of intentional underwriting actions, including
reductions in certain E&S programs, habitational construction business,
silica-related risks, and workers compensation policies classified as high
hazard. The net written premium results are consistent with the Companys
strategy of portfolio optimization. The Companys priority is a diversified
portfolio in profitable classes of business. Standard Lines averaged rate increases of 3% and 15% for the three months ended
September 30, 2004 and 2003 for the contracts that renewed during the period.
Retention rates of 65% and 71% were achieved for those contracts that were up
for renewal. Net earned premiums increased $182 million for the three months ended September
30, 2004 as compared with the same period in 2003. This increase was primarily
driven by decreased ceded premiums related to corporate aggregate and other
reinsurance treaties. Underwriting results improved by $1,257 million and the combined ratio
decreased 129.5 points for the three months ended September 30, 2004 as
compared with the same period in 2003. The loss ratio decreased 97.5 points
for the three months ended September 30, 2004 as compared with the same period
in 2003. These improvements were primarily due to decreased net unfavorable
prior year development of $1,105 million and a decrease in the bad debt
provision recorded for reinsurance receivables of $36 million. Additionally,
the loss ratio for the period was favorably impacted by the absence of an $11
million increase in ULAE reserves recorded in the third quarter of 2003. These
favorable impacts on the 2004 loss ratio were partially offset by increased
catastrophe impacts. Catastrophe losses of $245 million and $46 million were
recorded for the three months ended September 30, 2004 and 2003. The increased
catastrophe losses were primarily due to a $235 million loss resulting from
Hurricanes Charley, Frances, Ivan and Jeanne. Additionally, underwriting
results for the third quarter of 2004 were favorably impacted by a $55 million
reduction of current accident year losses established during the first half of
the year. The expense ratio decreased 26.7 points for the three months ended September
30, 2004 as compared with the same period in 2003. This decrease was primarily
due to an increased net earned premium base, a $102 million decrease in the
provision for uncollectible insurance receivables recorded in 2004 and reduced
expenses as a result of the expense initiatives as compared with the same
period in 2003. Also contributing to these favorable impacts was the absence
of a $44 million increase in certain insurance-related assessments recorded in
the third quarter of 2003. Partially offsetting these favorable impacts was a
$14 million increase in estimated underwriting assessments for the hurricanes. The substantial bad debt provisions for insurance receivables in the third
quarter of 2004 and 2003 were primarily related to PEO accounts. During 2002,
Standard Lines ceased writing coverages for PEO businesses, with the last
contracts expiring on June 30, 2003. In the third quarter of 2003, the Company
performed a review of PEO accounts to estimate ultimate losses and the
indicated recoveries under retrospective premium or high-deductible provisions
of the insurance contracts. Based on the 2003 analysis of the credit standing
of the individual PEO accounts and the amount of collateral held, the Company
recorded an estimated bad debt provision of $187 million. In the third quarter
of 2004, the review of PEO accounts was updated and the population of accounts
reviewed was expanded to include Temporary Help accounts as well. Payroll
audits performed since the last study identified that the exposure base for
many accounts was higher than expected. In addition, recovery estimates were
updated 73




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued based on current credit information on the insured. Based on the updated
study, the Company recorded an estimated bad debt provision of $95 million in
the third quarter of 2004 for these accounts. The dividend ratio decreased 5.3 points for the three months ended September
30, 2004 as compared with the same period in 2003 due to net prior year
favorable dividend development, primarily related to workers compensation
products, and due to unfavorable net prior year development in 2003.
Unfavorable dividend development of $46 million was primarily related to
workers compensation products for the three months ended September 30, 2003. A
review was completed in the third quarter of 2003 indicating dividend
development that was higher than prior expectations. This development was
recorded for accident years 2002 and prior. Unfavorable net prior year development of $6 million was recorded for the three
months ended September 30, 2004, including $2 million of favorable claim and
allocated claim adjustment expense reserve development and $8 million of
unfavorable premium development. Unfavorable net prior year development of
$1,111 million, including $823 million of unfavorable claim and allocated claim
adjustment expense reserve development and $288 million of unfavorable premium
development, was recorded for the same period in 2003. In the third quarter of 2004, approximately $15 million of unfavorable net
prior claim and allocated claim adjustment expense reserve development was recorded in
relation to the Companys share of the National Workers Compensation
Reinsurance Pool (NWCRP). During the third quarter of 2004, the NWCRP reached
an agreement with a former pool member to settle their pool liabilities at an
amount less than their established share. The result of this settlement will
be a higher allocation to the remaining pool members, including the Company. The following discusses net prior year development for Standard Lines recorded
for the three months ended September 30, 2003. Approximately $495 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development was recorded related to
construction defect claims. Based on analyses completed during the third
quarter of 2003, it became apparent that the assumptions regarding the number
of claims, which were used to estimate the expected losses, were no longer
appropriate. The analyses indicated that the actual number of claims reported
during 2003 was higher than expected primarily in states other than California.
States where this activity is most evident include Texas, Arizona, Nevada,
Washington and Colorado. The number of claims reported in states other than
California during the first six months of 2003 was nearly 35% higher than the
last six months of 2002. The number of claims reported during the last six
months of 2002 increased by less than 10% from the first six months of 2002.
In California, claims resulting from additional insured endorsements increased
throughout 2003. Additional insured endorsements are regularly included on
policies provided to subcontractors. The additional insured endorsement names
general contractors and developers as additional insureds covered by the
policy. Current California case law (Presley Homes, Inc. v. American States
Insurance Company, (June 11, 2001) 90 Cal App. 4th 571, 108 Cal. Rptr. 2d 686)
specifies that an individual subcontractor with an additional insured
obligation has a duty to defend the additional insured in the entire action,
subject to contribution or recovery later. In addition, the additional insured
is allowed to choose one specific carrier to defend the entire action. These
additional insured claims can remain open for a longer period of time than
other construction defect claims because the additional insured defense
obligation can continue until the entire case is resolved. The recorded net
prior year development related to construction defect claims was primarily for
accident years 1999 and prior. Unfavorable net prior year claim and allocated claim adjustment expense
development of approximately $285 million, was recorded for large account
business including workers compensation coverages. Many 74




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued of the policies issued to these large accounts include provisions tailored
specifically to the individual accounts. Such provisions effectively result in
the insured being responsible for a portion of the loss. An example of such a
provision is a deductible arrangement where the insured reimburses the Company
for all amounts less than a specified dollar amount. These arrangements often
limit the aggregate amount the insured is required to reimburse the Company.
Analyses completed during the third quarter of 2003 included claims handled by
third party administrators (TPA), which indicated higher losses from large
accounts including an increase in the amounts of losses in excess of
policyholder deductibles. The net prior year development was recorded
primarily for accident years 2000 and prior. Approximately $77 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development resulted from a program covering
facilities that provide services to developmentally disabled individuals. This
net prior year development was due to an increase in the size of known claims
and increases in policyholder defense costs. Updated data showed the average
claim size increasing at an annual rate of approximately 20%. Prior data had
shown average claim size to be level. Similar to the average claim size,
updated data showed the average policyholder defense cost increasing at an
annual rate of approximately 20%. Prior data had shown average policyholder
defense cost to be level. The net prior year reserve development recorded was
primarily for accident years 2001 and prior. Approximately $40 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development resulted from excess workers
compensation coverages due to increasing severity. The increase in severity
means that a higher percentage of the total loss dollars will be the Companys
responsibility since more claims will exceed the point at which the Companys
coverage begins. The net prior year reserve development recorded was primarily
for accident year 2000. Approximately $73 million of unfavorable development was recorded as the result
of a commutation of all ceded reinsurance treaties with Gerling, related to
accident years 1999 through 2001, including $41 million of unfavorable claim
and allocated claim adjustment expense development and $32 million of
unfavorable premium development. Approximately $11 million of unfavorable net prior year claim and allocated
claim adjustment expense development was recorded for directors and officers
exposures in Global Lines. The unfavorable net prior year reserve development
was primarily due to securities class action cases related to certain known
corporate malfeasance cases and investment banking firms. The reserve
development recorded was primarily for accident years 2000 and 2001. The following net prior year development was recorded in the third quarter of
2003 as a result of the elimination of deficiencies and redundancies in reserve
positions of individual products within the segment. Unfavorable net prior
year development of approximately $210 million related to small and middle
market workers compensation exposures and approximately $110 million related to
E&S lines was recorded in the third quarter of 2003. Partially offsetting this
unfavorable net prior year development was favorable net prior year development
of approximately $210 million in the property line of business, including $79
million related to the September 11, 2001 World Trade Center Disaster and
related events (WTC event). Also, offsetting the net prior year unfavorable development was a $140 million
underwriting benefit from cessions to corporate aggregate reinsurance treaties.
The benefit is comprised of $300 million of ceded losses and $160 million of
ceded premiums for accident years 2000 and 2001. See the Reinsurance section
of this MD&A for further discussion of the Companys aggregate reinsurance
treaties. 75




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued Nine Month Comparison Net income increased $1,079 million for the nine months ended September 30,
2004 as compared with the same period in 2003. This improvement was due
primarily to decreased unfavorable prior year development of $918 million
after-tax ($1,412 million pretax), as discussed below, an $80 million after-tax
($124 million pretax) decrease in the bad debt provision for insurance
receivables, a $32 million after-tax ($49 million pretax) decrease in the bad
debt provision for reinsurance receivables and increased net investment income.
Additionally, net results for the period were favorably impacted by the
absence of $29 million after-tax ($44 million pretax) increase in
insurance-related assessments and a $7 million after-tax ($11 million pretax)
increase in ULAE reserves recorded in the third quarter of 2003. These
favorable impacts on 2004 net income were partially offset by decreased net
realized investment gains and increased catastrophe losses in the third quarter
of 2004. Catastrophe impacts were $178 million after-tax ($274 million pretax)
and $70 million after-tax ($108 million pretax) for the nine months ended
September 30, 2004 and 2003, as discussed below. See the Investments section
of the MD&A for further discussion on net investment income and net realized
investment gains. Net written premiums for Standard Lines increased $132 million and net earned
premiums increased $518 million for the nine months ended September 30, 2004 as
compared with the same period in 2003. These increases in net written and
earned premiums were attributable to the same reasons as discussed above in the
three month comparison. Standard Lines averaged rate increases of 5% and 17% for the nine months ended
September 30, 2004 and 2003 for the contracts that renewed during the period.
Competitive market pressures are expected to continue to contribute to the
moderation of rate increases as property and casualty market pricing continues
to soften. Retention rates of 69% and 72% were achieved for those contracts
that were up for renewal. Retention for the nine month period was impacted for
the same reasons discussed above for the three month period. Underwriting results improved by $1,678 million and the combined ratio
decreased 52.9 points for the nine months ended September 30, 2004 as compared
with the same period in 2003. The loss ratio decreased 38.3 points for the
nine months ended September 30, 2004 as compared with the same period in 2003.
This improvement was primarily due to decreased net unfavorable prior year
development of $1,412 million and a decrease in the bad debt provision for
reinsurance receivables of $49 million. Additionally, the loss ratio for the
period was favorably impacted by the absence of an $11 million increase in ULAE
reserves. These favorable impacts on 2004 underwriting results were partially
offset by increased catastrophe impacts in 2004. Catastrophe losses of $255
million and $108 million were recorded for the nine months ended September 30,
2004 and 2003. The expense ratio decreased 12.0 points for the nine months ended September 30,
2004 as compared with the same period in 2003. The dividend ratio decreased
2.6 points for the nine months ended September 30, 2004 as compared with the
same period in 2003. These decreases were attributable to the same reasons as
discussed in the three month comparison. Unfavorable net prior year development of $13 million was recorded for the nine
months ended September 30, 2004, including $111 million of unfavorable claim
and allocated claim adjustment expense reserve development and $98 million of
favorable premium development. Unfavorable net prior year development of
$1,425 million, including $957 million of unfavorable claim and allocated claim
adjustment expense reserve development and $468 million of unfavorable premium
development, was recorded for the same period in 2003. The gross carried claim
and claim adjustment expense reserves for Standard Lines were $14,370 million
and $14,282 million at September 30, 2004 and December 31, 2003. 76




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued The net carried claim and claim adjustment expense reserves were $9,236 million
and $8,967 million at September 30, 2004 and December 31, 2003. See the three months comparison above for discussion of net prior year
development for the nine months ended September 30, 2004. In addition to the development recorded in the third quarter of 2004 discussed
in the three month comparison, the Company finalized commutation agreements
with several members of the Trenwick Group in the second quarter of 2004.
These commutations resulted in unfavorable claim and claim adjustment expense
reserve development which was more than offset by a release of a previously
established allowance for uncollectible reinsurance. Approximately $75 million of unfavorable net prior year claim and allocated
claim adjustment expense development recorded in the second quarter of 2004
resulted from increased severity trends for workers compensation on large
account policies primarily in accident years 2002 and prior. Favorable premium
development on retrospectively rated large account policies of $25 million was
recorded in relation to this unfavorable net prior year claim and allocated
claim adjustment expense development. Also, favorable net prior year premium
development of approximately $60 million resulted primarily from higher audit
and endorsement premiums on workers compensation and general liability
policies. Approximately $30 million of the unfavorable net prior year claim
and allocated claim adjustment expense reserve development was recorded related
to the higher audit and endorsement premium. See the three months comparison above for discussion of net prior year
development for the nine months ended September 30, 2003. In addition to the development recorded in the third quarter of 2003 discussed
in the three month comparison, unfavorable net prior year development of
approximately $310 million, including $233 million of unfavorable claim and
allocated claim adjustment expense reserve development and $77 million of
unfavorable premium development, was recorded for large account business in the
second quarter of 2003, primarily driven by workers compensation exposures.
This development resulted from the completion of reserve reviews for large
account business where the insured is often responsible for a portion of the
losses, and claims are handled by the Company. Initial reserves for this
business are set based on the expected losses associated with the individual
accounts covered and the terms of the individual plans. Based on analyses
completed during the second quarter of 2003, it became apparent that the
assumptions regarding the number and size of the losses, which were used to
estimate the expected losses, were no longer appropriate. The analyses showed
that the actual number of claims and the average claim size were larger than
expected. The development recorded was for accident years prior to 2002. Approximately $21 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development during the first and second
quarters of 2003 resulted from a program covering facilities that provide
services to developmentally disabled individuals. This development was due to
an increase in the size of known claims and increases in policyholder defense
costs. The reserve development recorded was for accident years prior to 2001. Unfavorable net prior year claim and allocated claim adjustment expense reserve
development of approximately $40 million was recorded for a program covering
tow truck and ambulance operators, primarily impacting the 2001 accident year,
of which, $36 million was recorded in the second quarter of 2003 and $4 million
was recorded in the third quarter of 2003. The Company had previously expected
that loss ratios for this business would be similar to its middle market
commercial automobile liability business. During 2002, the Company ceased
writing business under this program. 77




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued Approximately $25 million of unfavorable net prior year premium development was
recorded related to a second quarter 2003 reevaluation of losses ceded to a
reinsurance contract covering middle market workers compensation exposures
recorded in the second quarter of 2003. The reevaluation of losses led to a
new estimate of the number and dollar amount of claims that would be ceded
under the reinsurance contract. As a result of the reevaluation of losses, the
Company recorded approximately $36 million of unfavorable claim and allocated
claim adjustment expense net prior year reserve development, which was ceded
under this contract. The development was recorded for accident year 2000. Offsetting these unfavorable net prior year developments was a $75 million
underwriting benefit from cessions to corporate aggregate reinsurance treaties
recorded in the first and second quarters of 2003. The first and second
quarter 2003 benefit is comprised of $180 million of ceded losses and $105
million of ceded premiums for accident years 2000 and 2001. See the
Reinsurance section of this MD&A for further discussion of the Companys
aggregate reinsurance treaties. Favorable net prior year claim and allocated claim adjustment expense reserve
development was also recorded in property lines, primarily in the first quarter
of 2003. The favorable reserve development was principally from accident years
2001 and 2002 and was the result of the lower than expected number of large
losses in recent years. SPECIALTY LINES Business Overview Specialty Lines provides professional, financial and specialty property and
casualty products and services through a network of brokers, managing general
underwriters and independent agencies. Specialty Lines provides solutions for
managing the risks of its clients, including architects, engineers, lawyers,
healthcare professionals, financial intermediaries and corporate directors and
officers (D&O). Product offerings also include surety and fidelity bonds and
vehicle and equipment warranty services. Specialty Lines includes the following business groups: Professional Liability
Insurance, Surety and Warranty. Professional Liability Insurance(CNA Pro) provides management and professional
liability insurance and risk management services, primarily in the United
States. This unit provides professional liability coverages to various
professional firms, including architects and engineers, realtors, non-Big Four
accounting firms, law firms and technology firms. CNA Pro also has market
positions in directors and officers, errors and omissions, employment
practices, fiduciary and fidelity coverages. Specific areas of focus include
larger firms as well as privately held firms and not-for-profit organizations
where CNA offers tailored products for this client segment. Products within
CNA Pro are distributed through brokers, agents and managing general
underwriters. CNA Pro, through CNA HealthPro, also offers insurance products to serve the
healthcare delivery system. Products are distributed on a national basis
through a variety of channels including brokers, agents and managing general
underwriters. Key customer segments include long term care facilities, allied
healthcare providers, life sciences, dental professionals and mid-size and
large healthcare facilities and delivery systems. Additionally, CNA HealthPro
offers risk management consulting services to assist customers in managing
quality of care risks associated with the delivery of healthcare. Claim
services are provided to manage and resolve claims. 78




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued Suretyconsists primarily of CNA Surety and its insurance subsidiaries and
offers small, medium and large contract and commercial surety bonds. CNA
Surety provides surety and fidelity bonds in all 50 states through a combined
network of independent agencies. CNA owns approximately 64% of CNA Surety. Warrantyprovides warranty service contracts that protect individuals and
businesses from the financial burden associated with breakdown,
under-performance or maintenance of a product. Warrantys business activities
are primarily performed through a wholly owned subsidiary, CNA National
Warranty Corporation, which sells vehicle service contracts in the United
States and Canada. The following table summarizes the results of operations for Specialty Lines. Results of Operations Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Net written premiums
    
    $
    599
    
    
    $
    528
    
    
    $
    1,772
    
    
    $
    1,491Net earned premiums
    
    
    576
    
    
    
    451
    
    
    
    1,672
    
    
    
    1,338Underwriting income (loss)
    
    
    55
    
    
    
    (310
    )
    
    
    165
    
    
    
    (360
    )Income (loss) before net realized investment gains (losses)
    
    
    80
    
    
    
    (140
    )
    
    
    236
    
    
    
    (99
    )Net realized investment gains (losses)
    
    
    (8
    )
    
    
    12
    
    
    
    23
    
    
    
    52Net income (loss)
    
    
    72
    
    
    
    (128
    )
    
    
    259
    
    
    
    (47
    )RatiosLoss and loss adjustment expense
    
    
    62.8
    %
    
    
    138.1
    %
    
    
    63.4
    %
    
    
    97.8
    %Expense
    
    
    27.2
    
    
    
    30.3
    
    
    
    26.4
    
    
    
    28.9Dividend
    
    
    0.4
    
    
    
    0.3
    
    
    
    0.3
    
    
    
    0.2Combined
    
    
    90.4
    %
    
    
    168.7
    %
    
    
    90.1
    %
    
    
    126.9
    %
 Three Month Comparison Net results improved $200 million for the three months ended September 30, 2004
as compared with the same period in 2003. This improvement was driven
primarily by decreased unfavorable net prior year development of $142 million
after-tax ($216 million pretax), a decrease in the bad debt provision for
reinsurance receivables of $41 million after-tax ($64 million pretax) and
increased net investment income. Additionally, net results for the period were
favorably impacted by the absence of a $14 million after-tax ($22 million
pretax) increase in ULAE reserves and a $7 million after-tax ($11 million
pretax) increase in insurance related assessments recorded in the third quarter
of 2003. These improvements were partially offset by decreased net realized
investment gains and increased catastrophe impacts in 2004. Catastrophe
impacts were $7 million after-tax ($11 million pretax) and $1 million after-tax
($1 million pretax) for the three months ended September 30, 2004 and 2003, as
discussed below. See the Investments section of this MD&A for further
discussion on net investment income and net realized investment gains. Net written premiums for Specialty Lines increased $71 million and net earned
premiums increased $125 million for the three months ended September 30, 2004
as compared with the same period in 2003. This increase was primarily driven
by rate increases and retention, principally in Professional Liability
Insurance (CNA Pro) and decreased premiums ceded to corporate aggregate and
other reinsurance treaties in 2004 as compared with 2003, principally due to
the unfavorable net prior year development recorded in the third quarter of
2003. Specialty Lines averaged rate increases of 6% and 24% for the three months
ended September 30, 2004 and 2003 for the contracts that renewed during the
period. Retention rates of 81% and 82% were achieved for those contracts that
were up for renewal. 79




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued Underwriting results improved by $365 million and the combined ratio decreased
78.3 points for the three months ended September 30, 2004 as compared with the
same period in 2003. The loss ratio decreased 75.3 points due principally to
decreased unfavorable net prior year development of $216 million, a $64 million
decrease in bad debt reserves for uncollectible reinsurance and an improvement
in the current net accident year loss ratio. Additionally, the loss ratio for
the period was favorably impacted by the absence of a $22 million increase in
ULAE reserves recorded in the third quarter of 2003. These favorable impacts
to the loss ratio were partially offset by increased catastrophe impacts.
Catastrophe losses of $10 million and $1 million were recorded for the three
months ended September 30, 2004 and 2003. The increased catastrophe losses
were due to a $10 million loss resulting from Hurricanes Charley, Frances, Ivan
and Jeanne. The expense ratio decreased 3.1 points primarily due to the increased earned
premium base and the absence of an $11 million increase in certain insurance
related assessments recorded in the third quarter of 2003. Additionally, the
expense ratio was favorably impacted by decreased underwriting expenses due to
the Companys expense initiatives. Partially offsetting these favorable
impacts are reduced ceding commissions due to the intentional reduction of the
use of reinsurance. Favorable net prior year development was $21 million, including $9 million of
favorable claim and allocated claim adjustment expense and $12 million of
favorable premium development, for the three months ended September 30, 2004.
Unfavorable net prior year development of $195 million, including $164 million
of unfavorable claim and allocated claim adjustment expense development and $31
million of unfavorable premium development, was recorded for the same period in
2003. The following discusses net prior year development for Specialty Lines recorded
for the three months ended September 30, 2003. Approximately $50 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development was recorded relating to increased
severity in excess coverages provided to facilities providing health care
services. The development was based on reviews of individual accounts where
claims had been expected to be less than the point at which the Companys
coverage applies. The current claim trends indicated that the layers of
coverage provided by the Company would be impacted. The reserve development
recorded was primarily for accident years 2001 and prior. Approximately $47 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development was recorded for Surety for
workers compensation bond exposure from accident years 1990 and prior and large
losses for accident years 1999 and 2002. Approximately $25 million of unfavorable net prior year claim and allocated
claim adjustment expense development was recorded for directors and officers
exposures in CNA Pro. The unfavorable net prior year reserve development was
primarily due to securities class action cases related to certain known
corporate malfeasance cases and investment banking firms. The reserve
development recorded was primarily for accident years 2000 and 2001. Approximately $47 million of losses were recorded as the result of a
commutation of ceded reinsurance treaties with Gerling, relating to accident
years 1999 through 2002. The following development was recorded in the third quarter of 2003 as a result
of the elimination of deficiencies and redundancies in reserve positions of
individual products within the segment. An additional $50 million of
unfavorable net prior year claim and allocated claim adjustment expense reserve
development was recorded related to medical malpractice and long term care
facilities. Offsetting this net prior year unfavorable reserve development was
a $27 million underwriting benefit from cessions to corporate aggregate
reinsurance treaties. The benefit was comprised of $59 million of ceded losses
and 80




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued $32 million of ceded premiums for accident years 2000 and 2001. See the
Reinsurance section of this MD&A for further discussion of the Companys
aggregate reinsurance treaties. Nine Month Comparison Net results improved $306 million for the nine months ended September 30, 2004
as compared with the same period in 2003. This improvement was driven
primarily by decreased unfavorable net prior year development of $162 million
after-tax ($248 million pretax), a decrease in the bad debt provision for
reinsurance receivables of $80 million after-tax ($123 million pretax) and
increased net investment income. Additionally, net results for the period were
favorably impacted by the absence of a $14 million after-tax ($22 million
pretax) increase in ULAE reserves and a $7 million after-tax ($11 million
pretax) increase in insurance related assessments recorded in the third quarter
of 2003. The increases in net income were partially offset by decreased net
realized investment gains and increased catastrophe impacts. Catastrophe
impacts were $9 million after-tax ($14 million pretax) and $2 million after-tax
($3 million pretax) for the nine months ended September 30, 2004 and 2003, as
discussed below. See the Investments section of the MD&A for further discussion
on net investment income and net realized investment gains. Net written premiums for Specialty Lines increased $281 million and net earned
premiums increased $334 million for the nine months ended September 30, 2004 as
compared with the same period in 2003. These increases in net written and net
earned premiums were primarily attributable to the same reasons as discussed
above in the three month comparison. Specialty Lines averaged rate increases of 10% and 29% for the nine months
ended September 30, 2004 and 2003 for the contracts that renewed during the
period. Retention rates of 82% and 81% were achieved for those contracts that
were up for renewal. Underwriting results improved by $525 million and the combined ratio decreased
36.8 points for the nine months ended September 30, 2004 as compared with the
same period in 2003. The loss ratio decreased 34.4 points due principally to
decreased unfavorable net prior year development of $248 million, a decrease in
the bad debt provisions for uncollectible reinsurance of $123 million and an
improvement in the current net accident year loss ratio. Additionally, the
loss ratio for the period was favorably impacted by the absence of a $22
million increase in ULAE reserves recorded in the third quarter of 2003.
Catastrophe losses of $13 million and $3 million were recorded for the three
months ended September 30, 2004 and 2003. The expense ratio decreased 2.5 points due primarily to the reasons discussed
above in the three month comparison. Unfavorable net prior year development was $39 million, including $65 million
of unfavorable claim and allocated claim adjustment expense and $26 million of
favorable premium development for the nine months ended September 30, 2004.
Unfavorable net prior year development of $287 million, including $263 million
of unfavorable claim and allocated claim adjustment expense development and $24
million of unfavorable premium development, was recorded for the same period in
2003. The gross carried claim and claim adjustment expense reserves for
Specialty Lines were $4,658 million and $4,200 million at September 30, 2004
and December 31, 2003. The net carried claim and claim adjustment expense
reserves were $3,141 million and $2,919 million at September 30, 2004 and
December 31, 2003. In the second quarter of 2004, the Company finalized commutation agreements
with several members of the Trenwick Group. These commutations resulted in
unfavorable claim and claim adjustment expense 81




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued reserve development which was more than offset by a release of a previously
established allowance for uncollectible reinsurance. Additionally, unfavorable
net prior year claim and allocated claim adjustment expense reserve development
resulted from the increased emergence of several large D&O claims primarily in
recent accident years. In addition to the unfavorable net prior year development recorded in the third
quarter of 2003 as discussed in the three month comparison, approximately $50
million of unfavorable net prior year claim and allocated claim adjustment
expense reserve development was recorded for D&O exposures in the second
quarter of 2003. The unfavorable net prior year reserve development was a
result of a claims review that was completed during the second quarter of 2003.
The unfavorable net prior year reserve development was primarily due to
securities class action cases related to certain known corporate malfeasance
cases and investment banking firms. The unfavorable net prior year reserve
development recorded was primarily for accident years 2001 and 2002. Approximately $21 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development was recorded in the Surety line of
business as the result of adverse developments on one large claim in the second
quarter of 2003. Approximately $37 million of losses were recorded in the second quarter of 2003
as the result of a commutation of three ceded reinsurance treaties covering CNA
HealthPro, related to accident years 1999 through 2001. Further information
regarding this commutation is provided in the Reinsurance section of this MD&A. LIFE AND GROUP NON-CORE Business Overview Group Operations and Life Operations (formerly separate reportable segments)
have been combined into one reportable segment where the operating results from
the run-off of the retained group and life products will be reported as Life
and Group Non-Core. Additionally, certain run-off life and group operations,
including group reinsurance, are also included in the Life and Group Non-Core
segment. The segment includes results for periods prior to sale of the group
business that was sold on December 31, 2003, the individual life business, that
was sold on April 30, 2004, the CNA Trust business that was sold on August 1,
2004 and the effects of the shared corporate overhead expenses which continue
to be allocated to the sold businesses. Life and Group Non-Core includes the following lines of business: Life &
Annuity, Health and Other. Life & Annuityconsists primarily of individual term, universal life and
permanent life insurance products, as well as individual annuity products. On
April 30, 2004, CNA completed the sale of this individual life business as
described in the Consolidated Operations section of this MD&A. Healthconsists primarily of group long term care, individual long term care
and specialty medical products and related services. CNA is continuing to
service its existing group and individual long term care commitments and is
managing these businesses as a run-off operation. Otherconsists primarily of traditional and synthetic guaranteed investment
contracts, indexed group annuity contracts, group reinsurance, structured
settlements, life settlement contracts and group annuities. These businesses
are being managed as a run-off operation and are accepting new deposits from
existing customers on a limited number of these products. 82




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued The following table summarizes the results of operations for Life and Group
Non-Core. Results of Operations Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Net earned premiums
    
    $
    182
    
    
    $
    611
    
    
    $
    710
    
    
    $
    1,800Income (loss) before net realized investment gains (losses)
    
    
    (13
    )
    
    
    9
    
    
    
    (20
    )
    
    
    76Net realized investment gains (losses)
    
    
    2
    
    
    
    39
    
    
    
    (385
    )
    
    
    6Net income (loss)
    
    
    (11
    )
    
    
    48
    
    
    
    (405
    )
    
    
    82
 Three Month Comparison Net earned premiums for Life and Group Non-Core decreased $429 million in the
third quarter of 2004 as compared with the same period in 2003. The decrease
in net earned premiums was due primarily to the absence of premiums from the
group benefits and the individual life businesses. The group benefits business
was sold on December 31, 2003 and the individual life business was sold on
April 30, 2004. There were no net earned premiums from the sold life and group
businesses for the three months ended September 30, 2004 as compared with $372
million for the same time period in 2003. Net earned premiums also decreased in
most of the remaining lines of business, which are in run-off and are expected
to continue to decrease. Net results decreased $59 million in the third quarter of 2004 as compared with
the same period in 2003. The decrease in net results related primarily to the
absence of favorable results from the group benefits and individual life
businesses, decreased net realized investment gains and decreased net
investment income for the remaining lines of business. Net income for the sold
life and group businesses was $34 million for the three months ended September
30, 2003. Included in the net results for the three months ended September 30,
2004 is the $5 million after-tax ($9 million pretax) realized gain on the sale
of the CNA Trust business and the effects of the shared corporate overhead
expenses which continue to be allocated to the sold businesses. Partially
offsetting these negative impacts to 2004 net results is the absence of the $50
million pretax unfavorable net prior year claim and allocated claim adjustment
expense reserve development recorded in the third quarter of 2003 related to
the Companys past participation in several insurance pools, which is part of
the group reinsurance run-off business. Nine Month Comparison Net earned premiums for Life and Group Non-Core decreased $1,090 million for
the nine months ended September 30, 2004 as compared with the same period in
2003. The decrease in net earned premiums was due primarily to the absence of
premiums from the group benefits and the individual life businesses. Net
earned premiums for the sold life and group businesses were $115 million and
$1,103 million for the nine months ended September 30, 2004 and 2003. Net
earned premiums also decreased in most of the remaining lines of business,
which are in run-off and are expected to continue to decrease. Net results decreased $487 million for the nine months ended September 30, 2004
as compared with the same period in 2003. The decrease in net results related
primarily to net realized investment losses, including the realized loss of
approximately $389 million after-tax ($622 million pretax) for the sale of the
individual life business and the absence of favorable results from the group
benefits and individual life businesses. Net results for the sold life and
group businesses were $416 million of net loss (including the loss on sales and
the effects of shared corporate overhead expenses) and $54 million of net
income for the nine months ended September 30, 2004 and 2003. 83




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued Net results also decreased as a result of the $22 million after-tax ($34
million pretax) increase in insurance reserves and the allowance for
uncollectible reinsurance in the second quarter of 2004 related to assumed
business underwritten through a managing general agent, IOA Global, which
consists primarily of certain accident and health exposures (IGI Program) and
the Companys past participation in accident and health reinsurance programs.
Partially offsetting these unfavorable impacts to the 2004 results is the
absence of the $50 million unfavorable net prior year claim and allocated claim
adjustment expense reserve development recorded in the third quarter of 2003 as
discussed in the three month comparison, which was also primarily related to
the Companys past participation in the IGI Program. CORPORATE AND OTHER NON-CORE Business Overview Corporate and Other Non-Core includes the results of the property and casualty
lines of business placed in run-off. CNA Re, formerly a separate property and
casualty operating segment, is currently in run-off and is now included in the
Corporate and Other Non-Core segment. This segment also includes the results
related to the centralized adjusting and settlement of APMT claims as well as
the results of CNAs participation in voluntary insurance pools and various
other non-insurance operations. Other operations also include interest expense
on corporate borrowings and intercompany eliminations. The following table summarizes the results of operations for the Corporate and
Other Non-Core segment, including APMT and intrasegment eliminations. Results of Operations Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Revenues
    
    $
    45
    
    
    $
    116
    
    
    $
    297
    
    
    $
    540Net income (loss)
    
    
    8
    
    
    
    (769
    )
    
    
    79
    
    
    
    (766
    )
 Three Month Comparison Revenues decreased $71 million for the three months ended September 30, 2004 as
compared with the same period in 2003. The decrease in revenues was due
primarily to reduced net earned premiums in CNA Re due to the exit of the
assumed reinsurance market in 2003 and decreased pretax realized investment
gains. Partially offsetting these unfavorable impacts to revenues in 2004 as
compared to 2003, were favorable impacts from the absence of ceded premiums to
corporate aggregate reinsurance treaties, and a $10 million decrease in the
interest expense related to the corporate aggregate reinsurance treaties. See
the Investments section of this MD&A for additional information on realized
investment gains (losses) and net investment income, which is reflected net of
this interest expense. Net income increased $777 million for the three months ended September 30, 2004
as compared with the same period in 2003. The increase in net income was due
primarily to a $605 million after-tax ($931 million pretax) decrease in
unfavorable net prior year development, a $44 million after-tax decrease in
ULAE reserves, a $118 million after-tax decrease in the provision for
uncollectible reinsurance receivables, the absence of the $12 million after-tax
increase in certain insurance related assessments during the third quarter of
2003 and decreased net realized investment gains. Unfavorable net prior year development of $12 million was recorded for the
three months ended September 30, 2004, including $10 million of unfavorable net
prior year claim and allocated claim 84




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued adjustment expense reserve development and $2 million of unfavorable premium
development. Unfavorable net prior year development of $943 million was
recorded for the three months ended September 30, 2003,
including $903 million
of unfavorable net prior year claim and allocated claim adjustment expense
reserve development and $40 million of unfavorable premium development. The following discusses net prior year development for the Corporate and Other
Non-Core Segment recorded for the three months ended September 30, 2003. This development was primarily driven by $795 million of unfavorable net prior
year claim and allocated claim adjustment expense reserve development related
to APMT. See the APMT Reserves section of this MD&A for a further discussion
of APMT development. The unfavorable net prior year development in 2003 was also driven by a change
in the reporting pattern of losses as reported by the companies that purchased
reinsurance from CNA Re. Losses continued to show large increases for accident
years in the late 1990s and into 2000 and 2001. These increases were greater
than the increases indicated by patterns from older accident years and had a
similar effect on several lines of business. Unfavorable net prior year
development of approximately $67 million was recorded related to proportional
liability exposures, primarily from multi-line and umbrella treaties in
accident years 1997 through 2001. Approximately $32 million of unfavorable net
prior year development related to assumed financial reinsurance covers in
accident years 2001 and prior and approximately $24 million of unfavorable net
prior year development related to professional liability exposures in accident
years 2001 and prior was recorded in the three months ended September 30, 2003. CNA Re recorded an additional $15 million of unfavorable net prior year
development for construction defect related exposures in the third quarter of
2003. Because of the unique nature of this exposure, losses will not follow
normal development patterns. The continued reporting of claims in California,
the increase in the number of claims from states other than California and a
review of individual ceding companies exposure to this type of claim resulted
in an increase in the estimated reserve. The following development was recorded in the third quarter of 2003 as a result
of the elimination of deficiencies and redundancies in reserve positions of
individual products within CNA Re. Unfavorable net prior year development of
approximately $42 million related to surety exposures, $32 million related to
excess of loss liability exposures and $12 million related to facultative
liability exposures were recorded in the third quarter of 2003. Offsetting
this unfavorable net prior year development was approximately $55 million of
favorable development related to the WTC event. In addition, there was a $37
million underwriting benefit from cessions to corporate aggregate reinsurance
treaties. This benefit was comprised of $80 million of ceded losses and $43
million of ceded premiums for accident years 2000 and 2001. See the
Reinsurance section of this MD&A for further discussion of the Companys
aggregate reinsurance treaties. Nine Month Comparison Revenues decreased $243 million for the nine months ended September 30, 2004 as
compared with the same period in 2003. The decrease in revenues was due
primarily to reduced net earned premiums in CNA Re due to the exit of the
assumed reinsurance market in 2003 and decreased pretax realized investment
gains. Partially offsetting these decreases was an increase in net investment
income. See the Investments section of this MD&A for additional information on
net realized investment gains (losses) and net investment income. 85




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued Net income increased $845 million for the nine months ended September 30, 2004
as compared with the same period in 2003. The increase in net income was
primarily attributable to the same items discussed in the three month
comparison. Unfavorable net prior year development of $76 million was recorded for the nine
months ended September 30, 2004, including $63 million of unfavorable net prior
year claim and allocated claim adjustment expense reserve development and $13
million of unfavorable premium development. Unfavorable net prior year
development of $1,058 million was recorded for the nine months
ended September 30, 2003, including $1,027 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development and $31 million of
unfavorable premium development. The gross carried claim and claim adjustment
expense reserves for Corporate and Other Non-Core were $8,760 million and
$9,672 million at September 30, 2004 and December 31, 2003. The net carried
claim and claim adjustment expense reserves were $3,277 million and $3,737
million at September 30, 2004 and December 31, 2003. The net prior year development recorded for 2004 relates to commutation
agreements with several members of the Trenwick Group which resulted in
unfavorable net prior year development which was partially offset by a release
of a previously established allowance for uncollectible reinsurance. The following discusses net prior year development for the Corporate and Other
Non-Core Segment recorded for the nine months ended September 30, 2003. In addition to the net prior year development recorded in the third quarter of
2003 as discussed in the three month comparison, unfavorable net prior year
claim and allocated claim adjustment expense reserve development of
approximately $75 million was recorded related to an adverse arbitration
decision involving a single large property and business interruption loss. The
decision was rendered against a voluntary insurance pool in which the Company
was a participant. The loss was caused by a fire which occurred in 1995. The
Company no longer participates in this pool. Unfavorable net prior year claim and allocated claim adjustment expense reserve
development of approximately $25 million was recorded in CNA Re primarily for
directors and officers exposures. The reserve development was a result of a
claims review that was completed during the second quarter of 2003. The
unfavorable net prior year reserve development was primarily due to securities
class action cases related to certain known corporate malfeasance cases and
investment banking firms. The reserve development was recorded in accident
years 2000 and 2001. Offsetting this unfavorable development was a $10 million underwriting benefit
from cessions to corporate aggregate reinsurance treaties. The benefit was
comprised of $24 million of ceded losses and $14 million of ceded premiums for
accident years 2000 and 2001. See Note H in the Notes to the Condensed
Consolidated Financial Statements for further discussion. APMT Reserves CNAs property and casualty insurance subsidiaries have actual and potential
exposures related to APMT claims. Establishing reserves for APMT claim and claim adjustment expenses is subject
to uncertainties that are greater than those presented by other claims.
Traditional actuarial methods and techniques employed to estimate the ultimate
cost of claims for more traditional property and casualty exposures are less
precise in estimating claim and claim adjustment expense reserves for APMT,
particularly in an environment of emerging or potential claims and coverage
issues that arise from industry practices and legal, judicial, and 86




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued social conditions. Therefore, these traditional actuarial methods and
techniques are necessarily supplemented with additional estimating techniques
and methodologies, many of which involve significant judgments that are
required of management. Accordingly, a high degree of uncertainty remains for
the Companys ultimate liability for APMT claim and claim adjustment expenses. In addition to the difficulties described above, estimating the ultimate cost
of both reported and unreported APMT claims is subject to a higher degree of
variability due to a number of additional factors, including among others: the
number and outcome of direct actions against the Company; coverage issues,
including whether certain costs are covered under the policies and whether
policy limits apply; allocation of liability among numerous parties, some of
whom may be in bankruptcy proceedings, and in particular the application of
joint and several liability to specific insurers on a risk; inconsistent
court decisions and developing legal theories; increasingly aggressive tactics
of plaintiffs lawyers; the risks and lack of predictability inherent in major
litigation; increased filings of claims in certain states; enactment of
national federal legislation to address asbestos claims; a future increase in
asbestos and environmental pollution claims which cannot now be anticipated; a
future increase in number of mass tort claims relating to silica and
silica-containing products, and the outcome of ongoing disputes as to coverage
in relation to these claims; a further increase of claims and claims payments
that may exhaust underlying umbrella and excess coverages at accelerated rates;
and future developments pertaining to the Companys ability to recover
reinsurance for asbestos and environmental pollution claims. CNA regularly performs ground up reviews of all open APMT claims to evaluate
the adequacy of the Companys APMT reserves. In performing its comprehensive
ground up analysis, the Company considers input from its professionals with
direct responsibility for the claims, inside and outside counsel with
responsibility for representation of the Company, and its actuarial staff.
These professionals review, among many factors, the policyholders present and
predicted future exposures, including such factors as claims volume, trial
conditions, prior settlement history, settlement demands and defense costs; the
impact of asbestos defendant bankruptcies on the policyholder; the policies
issued by CNA, including such factors as aggregate or per occurrence limits,
whether the policy is primary, umbrella or excess, and the existence of
policyholder retentions and/or deductibles; the existence of other insurance;
and reinsurance arrangements. With respect to other court cases and how they might affect the Companys
reserves and reasonable possible losses, the following should be noted. State
and federal courts issue numerous decisions each year, which potentially impact
losses and reserves in both a favorable and unfavorable manner. Examples of
favorable developments include decisions to allocate defense and indemnity
payments in a manner so as to limit carriers obligations to damages taking
place during the effective dates of their policies; decisions holding that
injuries occurring after asbestos operations are completed are subject to the
completed operations aggregate limits of the policies; and decisions ruling
that carriers loss control inspections of their insureds premises do not give
rise to a duty to warn third parties to the dangers of asbestos. Examples of unfavorable developments include decisions limiting the application
of the absolute pollution exclusion and decisions holding carriers liable for
defense and indemnity of asbestos and pollution claims on a joint and several
basis. The Companys ultimate liability for its environmental pollution and mass tort
claims is impacted by several factors including ongoing disputes with
policyholders over scope and meaning of coverage terms and, in the area of
environmental pollution, court decisions that continue to restrict the scope
and applicability of the absolute pollution exclusion contained in policies
issued by the Company after 1989. Due to the inherent uncertainties described
above, including the inconsistency of court decisions, the number of waste
sites subject to cleanup, and in the area of environmental pollution, the
standards for 87




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued cleanup and liability, the ultimate liability of CNA for environmental
pollution and mass tort claims may vary substantially from the amount currently
recorded. Due to the inherent uncertainties in estimating reserves for APMT claim and
claim adjustment expenses and due to the significant uncertainties previously
described related to APMT claims, the ultimate liability for these cases, both
individually and in aggregate, may exceed the recorded reserves. Any such
potential additional liability, or any range of potential additional amounts,
cannot be reasonably estimated currently, but could be material to the
Companys business, results of operations, equity, and insurer financial
strength and debt ratings. Due to, among other things, the factors described
above, it may be necessary for the Company to record material changes in its
APMT claim and claim adjustment expense reserves in the future, should new
information become available or other developments emerge. The following table provides data related to CNAs APMT claim and claim
adjustment expense reserves. Asbestos and Environmental Pollution and Mass Tort Reserves September 30, 2004
    
    December 31, 2003Environmental
    
    
    
    
    
    EnvironmentalPollution and
    
    
    
    
    
    Pollution andAsbestos
    
    Mass Tort
    
    Asbestos
    
    Mass Tort(In millions)Gross reserves
    
    $
    3,221
    
    
    $
    787
    
    
    $
    3,347
    
    
    $
    839Ceded reserves
    
    
    (1,514
    )
    
    
    (279
    )
    
    
    (1,580
    )
    
    
    (262
    )Net reserves
    
    $
    1,707
    
    
    $
    508
    
    
    $
    1,767
    
    
    $
    577
 Asbestos CNAs property and casualty insurance subsidiaries have exposure to
asbestos-related claims. Estimation of asbestos-related claim and claim
adjustment expense reserves involves limitations such as inconsistency of court
decisions, specific policy provisions, allocation of liability among insurers
and insureds, and additional factors such as missing policies and proof of
coverage. Furthermore, estimation of asbestos-related claims is difficult due
to, among other reasons, the proliferation of bankruptcy proceedings and
attendant uncertainties, the targeting of a broader range of businesses and
entities as defendants, the uncertainty as to which other insureds may be
targeted in the future and the uncertainties inherent in predicting the number
of future claims. In the past several years, CNA has experienced, at certain points in time,
significant increases in claim counts for asbestos-related claims. The factors
that led to these increases included, among other things, intensive advertising
campaigns by lawyers for asbestos claimants, mass medical screening programs
sponsored by plaintiff lawyers, and the addition of new defendants such as the
distributors and installers of products containing asbestos. During the first
three quarters of 2004 the rate of new filings appears to have
decreased from the filing rates seen in the past several years.
Nevertheless, the Company continues to experience an overall increase
in total asbestos claim counts. The
majority of asbestos bodily injury claims are filed by persons exhibiting few,
if any, disease symptoms. Recent studies have concluded that the percentage of
unimpaired claimants to total claimants ranges between 66% and up to 90%. Some
courts, including the federal district court responsible for pre-trial
proceedings in all federal asbestos bodily injury actions, have ordered that
so-called unimpaired claimants may not recover unless at some point the
claimants condition worsens to the point of impairment. Several factors are, in managements view, negatively impacting asbestos claim
trends. Plaintiff attorneys who previously sued entities who are now bankrupt
are seeking other viable targets. As a result, companies with few or no
previous asbestos claims are becoming targets in asbestos litigation and,
although they may have little or no liability, nevertheless must be defended.
Additionally, plaintiff 88




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued attorneys and trustees for future claimants are demanding that policy limits be
paid lump-sum into the bankruptcy asbestos trusts prior to presentation of
valid claims and medical proof of these claims. The ultimate impact or success
of this tactic remains uncertain. Plaintiff attorneys and trustees for future
claimants are also attempting to devise claims payment procedures for
bankruptcy trusts that would allow asbestos claims to be paid under lax
standards for injury, exposure, and causation. This also presents the
potential for exhausting policy limits in an accelerated fashion. As a result of bankruptcies and insolvencies, management has observed an
increase in the total number of policyholders with current asbestos claims as
additional defendants are added to existing lawsuits and are named in new
asbestos bodily injury lawsuits. New asbestos bodily injury claims have also
increased substantially in 2003, but the rate of increase has moderated in the
first nine months of 2004. As of September 30, 2004 and December 31, 2003, CNA carried approximately
$1,707 million and $1,767 million of claim and claim adjustment expense
reserves, net of reinsurance recoverables, for reported and unreported
asbestos-related claims. The Company recorded $44 million of unfavorable
asbestos-related net claim and claim adjustment expense reserve development for
the nine months ended September 30, 2004 and $642 million of asbestos-related
net claim and claim adjustment expense development for the same period in 2003.
The unfavorable net prior year development was primarily related to a
commutation loss related to Trenwick. The Company paid asbestos-related
claims, net of reinsurance recoveries, of $104 million and $101 million for the
nine months ended September 30, 2004 and 2003. The Company has resolved a number of its large asbestos accounts by negotiating
settlement agreements. Structured settlement agreements provide for payments
over multiple years as set forth in each individual agreement. At September
30, 2004, CNA had eleven structured settlement agreements with a reserve net of
reinsurance of $179 million. As to the eleven structured settlement agreements
existing at September 30, 2004, payment obligations under those settlement
agreements are projected to terminate by 2016. At December 31, 2003, CNA had
structured settlement agreements with nine of its policyholders for which it
has future payment obligations with a reserve, net of reinsurance, of $188
million. In 1985, 47 asbestos producers and their insurers, including CIC, executed the
Wellington Agreement. The agreement intended to resolve all issues and
litigation related to coverage for asbestos exposures. Under this agreement,
signatory insurers committed scheduled policy limits and made the limits
available to pay asbestos claims based upon coverage blocks designated by the
policyholders in 1985, subject to extension by policyholders. CIC was a
signatory insurer to the Wellington Agreement. At September 30, 2004, CNA had
remaining payment obligations for four accounts. With respect to these four
remaining unpaid Wellington obligations, CNA has evaluated its exposure and the
expected reinsurance recoveries under these agreements and has a recorded
reserve of $19 million, net of reinsurance. At December 31, 2003, CNA had
fulfilled its Wellington Agreement obligations as to all but five accounts and
had a recorded reserve of $23 million, net of reinsurance. CNA has also used coverage in place agreements to resolve large asbestos
exposures. Coverage in place agreements are typically agreements between CNA
and its policyholders identifying the policies and the terms for payment of
asbestos related liabilities. Claims payments are contingent on presentation
of adequate documentation showing exposure during the policy periods and other
documentation supporting the demand for claims payment. Coverage in place
agreements may have annual payment caps. Coverage in place agreements are
evaluated based on claims filings trends and severities. As of September 30,
2004, CNA had negotiated thirty-one coverage in place agreements. The Company
has evaluated these commitments and the expected reinsurance recoveries under
these agreements and has recorded a reserve of $81 million, net of reinsurance
as of September 30, 2004. As of December 31, 2003, 89




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued CNA had negotiated thirty-two such agreements and had established a reserve of
$109 million, net of reinsurance. The Company categorizes active asbestos accounts as large or small accounts.
CNA defines a large account as an active account with more than $100,000 of
cumulative paid losses. The Company has made closing large accounts a
significant management priority. At September 30, 2004, the Company had 180
large accounts and had established reserves of $369 million, net of
reinsurance. At December 31, 2003, CNA had 160 large accounts with reserves of
$405 million, net of reinsurance. Large accounts are typically accounts that
have been long identified as significant asbestos exposures. In the 2003
ground up reserve study, the Company observed that underlying layers of
primary, umbrella and lower layer excess policies were exhausting at
accelerated rates due to increased claims volumes, claims severities and
increased defense expense incurred in litigating claims. Those accounts where
the Company had issued high excess policies were evaluated in the study to
determine potential impairment of the high excess layers of coverage.
Management concluded that high excess coverage previously thought not to be
exposed could potentially be exposed should current adverse claim trends
continue. Small accounts are defined as active accounts with $100,000 or less cumulative
paid losses. At September 30, 2004, the Company had 1,095 small accounts,
approximately 82% of its total active asbestos accounts, with reserves of $153
million, net of reinsurance. At December 31, 2003, CNA had 1,065 small
accounts and established reserves of $147 million, net of reinsurance. Small
accounts are typically representative of policyholders with limited connection
to asbestos. As entities which were historic targets in asbestos litigation
continue to file for bankruptcy protection, plaintiffs attorneys are seeking
other viable targets. As a result, companies with few or no previous asbestos
claims are becoming targets in asbestos litigation and nevertheless must be
defended by CNA under its policies. Bankruptcy filings and increased claims
filings in the last few years could potentially increase costs incurred in
defending small accounts. The Company also evaluates its asbestos liabilities arising from its assumed
reinsurance business and its participation in various pools. At September 30,
2004, CNAs reserve was $156 million, net of reinsurance, related to these
liabilities. At December 31, 2003, CNA had recorded a $157 million reserve
related to these asbestos liabilities arising from the Companys assumed
reinsurance obligations and CNAs participation in pools, including Excess &
Casualty Reinsurance Association (ECRA). At September 30, 2004, the unassigned IBNR reserve was $696 million, net of
reinsurance. At December 31, 2003, CNAs unassigned IBNR reserve for asbestos
was $684 million, net of reinsurance. This IBNR reserve relates to potential
development on accounts that have not settled and potential future claims from
unidentified policyholders. 90




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued The tables below depict CNAs overall pending asbestos accounts and associated
reserves at September 30, 2004 and December 31, 2003. Pending Asbestos Accounts and Associated ReservesSeptember 30, 2004 Net paid losses
    
    Net Asbestos
    
    Percent ofNumber of
    
    In 2004
    
    reserves
    
    Asbestospolicyholders
    
    (In millions)
    
    (In millions)
    
    Net ReservesPolicyholders with settlement agreementsStructured Settlements
    
    
    11
    
    
    $
    39
    
    
    $
    179
    
    
    
    11
    %Wellington
    
    
    4
    
    
    
    4
    
    
    
    19
    
    
    
    1Coverage in place
    
    
    31
    
    
    
    8
    
    
    
    81
    
    
    
    5Fibreboard
    
    
    1
    
    
    
    
    
    
    
    54
    
    
    
    3Total with settlement agreements
    
    
    47
    
    
    
    51
    
    
    
    333
    
    
    
    20Other policyholders with active accountsLarge asbestos accounts
    
    
    180
    
    
    
    35
    
    
    
    369
    
    
    
    21Small asbestos accounts
    
    
    1,095
    
    
    
    15
    
    
    
    153
    
    
    
    9Total other policyholders
    
    
    1,275
    
    
    
    50
    
    
    
    522
    
    
    
    30Assumed reinsurance and pools
    
    
    
    
    
    
    3
    
    
    
    156
    
    
    
    9Unassigned IBNR
    
    
    
    
    
    
    
    
    
    
    696
    
    
    
    41Total
    
    
    1,322
    
    
    $
    104
    
    
    $
    1,707
    
    
    
    100
    %
 Pending Asbestos Accounts and Associated ReservesDecember 31, 2003 Net paid losses
    
    Net Asbestos
    
    Percent ofNumber of
    
    In 2003
    
    reserves
    
    Asbestospolicyholders
    
    (In millions)
    
    (In millions)
    
    Net ReservesPolicyholders with settlement agreementsStructured Settlements
    
    
    9
    
    
    $
    20
    
    
    $
    188
    
    
    
    11
    %Wellington
    
    
    5
    
    
    
    2
    
    
    
    23
    
    
    
    1Coverage in place
    
    
    32
    
    
    
    40
    
    
    
    109
    
    
    
    6Fibreboard
    
    
    1
    
    
    
    1
    
    
    
    54
    
    
    
    3Total with settlement agreements
    
    
    47
    
    
    
    63
    
    
    
    374
    
    
    
    21Other policyholders with active accountsLarge asbestos accounts
    
    
    160
    
    
    
    35
    
    
    
    405
    
    
    
    23Small asbestos accounts
    
    
    1,065
    
    
    
    16
    
    
    
    147
    
    
    
    8Total other policyholders
    
    
    1,225
    
    
    
    51
    
    
    
    552
    
    
    
    31Assumed reinsurance and pools
    
    
    
    
    
    
    7
    
    
    
    157
    
    
    
    9Unassigned IBNR
    
    
    
    
    
    
    
    
    
    
    684
    
    
    
    39Total
    
    
    1,272
    
    
    $
    121
    
    
    $
    1,767
    
    
    
    100
    %
 Some asbestos-related defendants have asserted that their policies issued by
CNA are not subject to aggregate limits on coverage. CNA has such claims from
a number of insureds. Some of these claims involve insureds facing exhaustion
of products liability aggregate limits in their policies, who have 91




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued asserted that their asbestos-related claims fall within so-called
non-products liability coverage contained within their policies rather than
products liability coverage, and that the claimed non-products coverage is
not subject to any aggregate limit. It is difficult to predict the ultimate
size of any of the claims for coverage purportedly not subject to aggregate
limits or predict to what extent, if any, the attempts to assert non-products
claims outside the products liability aggregate will succeed. The Company has
attempted to manage its asbestos exposure by aggressively seeking to settle
claims on acceptable terms. There can be no assurance that any of these
settlement efforts will be successful, or that any such claims can be settled
on terms acceptable to CNA. Where CNA cannot settle a claim on acceptable
terms, the Company aggressively litigates the claim. Adverse developments with
respect to such matters could have a material adverse effect on CNAs results
of operations and/or equity. Certain asbestos litigation in which CNA is currently engaged is described
below: On February 13, 2003, CNA announced it had resolved asbestos related coverage
litigation and claims involving A.P. Green Industries, A.P. Green Services and
Bigelow  Liptak Corporation. Under the agreement, CNA is required to pay $74
million, net of reinsurance recoveries, over a ten year period. The settlement
resolves CNAs liabilities for all pending and future asbestos claims involving
A.P. Green Industries, Bigelow  Liptak Corporation and related subsidiaries,
including alleged non-products exposures. The settlement has received
initial bankruptcy court approval and CNA expects to procure confirmation of a
bankruptcy plan containing an injunction to protect CNA from any future claims. CNA is engaged in insurance coverage litigation with underlying plaintiffs who
have asbestos bodily injury claims against the former Robert A. Keasbey Company
(Keasbey) in New York state court (Continental Casualty Co. v. Nationwide
Indemnity Co. et al., No. 601037/03 (N.Y. County)). Keasbey, a currently
dissolved corporation, was a seller and installer of asbestos-containing
insulation products in New York and New Jersey. Thousands of plaintiffs have
filed bodily injury claims against Keasbey; however, Keasbeys involvement at a
number of work sites is a highly contested issue. Therefore, the defense
disputes the percentage of valid claims against Keasbey. CNA issued Keasbey
primary policies for 1970-1987 and excess policies for 1972-1978. CNA has paid
an amount substantially equal to the policies aggregate limits for products
and completed operations claims. Claimants against Keasbey allege, among other
things, that CNA owes coverage under sections of the policies not subject to
the aggregate limits, an allegation CNA vigorously contests in the lawsuit. CNA has insurance coverage disputes related to asbestos bodily injury claims
against Burns & Roe Enterprises, Inc. (Burns & Roe). Originally raised in
litigation, now stayed, these disputes are currently part of In re: Burns & Roe
Enterprises, Inc., pending in the U.S. Bankruptcy Court for the District of New
Jersey, No. 00-41610. Burns & Roe provided engineering and related services in
connection with construction projects. At the time of its bankruptcy filing,
Burns & Roe faced approximately 11,000 claims alleging bodily injury resulting
from exposure to asbestos as a result of construction projects in which Burns &
Roe was involved. CNA allegedly provided primary liability coverage to Burns &
Roe from 1956-1969 and 1971-1974, along with certain project-specific policies
from 1964-1970. CIC issued certain primary and excess policies to Bendix Corporation (Bendix),
now part of Honeywell International, Inc. (Honeywell). Honeywell faces
approximately 75,105 pending asbestos bodily injury claims resulting from
alleged exposure to Bendix friction products. CICs primary policies allegedly
covered the period from at least 1939 (when Bendix began to use asbestos in its
friction products) to 1983, although the parties disagree about whether CICs
policies provided product liability coverage before 1940 and from 1945 to 1956.
CIC asserts that it owes no further material obligations to Bendix under any
primary policy. Honeywell alleges that two primary policies issued by CIC
covering 1969-1975 contain occurrence limits but not product liability
aggregate limits for asbestos bodily injury claims. CIC has asserted, among
other things, even if Honeywells allegation is correct, which CNA denies, its 92




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued liability is limited to a single occurrence limit per policy or per year, and
in the alternative, a proper allocation of losses would substantially limit its
exposure under the 1969-1975 policies to asbestos claims. These and other
issues are being litigated in Continental Insurance Co., et al. v. Honeywell
International Inc., No. MRS-L-1523-00 (Morris County, New Jersey). Policyholders have also initiated litigation directly against CNA and other
insurers in four jurisdictions: Ohio, Texas, West Virginia and Montana. In the
two Ohio actions, plaintiffs allege the defendants negligently performed duties
undertaken to protect workers and the public from the effects of asbestos
(Varner v. Ford Motor Co., et al. (Cuyahoga County, Ohio) and Peplowski v. ACE
American Ins. Co., et al. (U.S. D. C. N.D. Ohio)). The state trial court
recently granted insurers, including CNA, summary judgment against a
representative group of plaintiffs, ruling that insurers had no duty to warn
plaintiffs about asbestos. Similar lawsuits have also been filed in Texas
against CNA, and other insurers and non-insurer corporate defendants asserting
liability for failing to warn of the dangers of asbestos (Boson v. Union
Carbide Corp., et al. (District Court of Nueces County, Texas)). Many of the
Texas claims have been dismissed as time-barred by the applicable statute of
limitations. In other claims, the Texas court recently ruled that the carriers
did not owe any duty to the plaintiffs or the general public to advise on the
effects of asbestos thereby dismissing these claims. The time period for
filing an appeal of this ruling has not expired and it remains uncertain
whether the plaintiffs will continue to pursue their causes of action. CNA has been named in
Adams v. Aetna, Inc., et al. (Circuit Court of Kanawha
County, West Virginia), a purported class action against CNA and other
insurers, alleging that the defendants violated West Virginias Unfair Trade
Practices Act in handling and resolving asbestos claims against their
policyholders. A direct action has also been filed in Montana (Pennock, et al.
v. Maryland Casualty, et al. First Judicial District Court of Lewis & Clark
County, Montana) by eight individual plaintiffs (all employees of W.R. Grace &
Co. (W.R. Grace)) and their spouses against CNA, Maryland Casualty and the
State of Montana. This action alleges that the carriers failed to warn of or
otherwise protect W.R. Grace employees from the dangers of asbestos at a W.R.
Grace vermiculite mining facility in Libby, Montana. The Montana direct action
is currently stayed because of W.R. Graces pending bankruptcy. CNA is vigorously defending these and other cases and believes that it has
meritorious defenses to the claims asserted. However, there are numerous
factual and legal issues to be resolved in connection with these claims, and it
is extremely difficult to predict the outcome or ultimate financial exposure
represented by these matters. Adverse developments with respect to any of
these matters could have a material adverse effect on CNAs business, insurer
financial strength and debt ratings, and results of operations and/or equity. As a result of the uncertainties and complexities involved, reserves for
asbestos claims cannot be estimated with traditional actuarial techniques that
rely on historical accident year loss development factors. In establishing
asbestos reserves, CNA evaluates the exposure presented by each insured. As
part of this evaluation, CNA considers the available insurance coverage; limits
and deductibles; the potential role of other insurance, particularly underlying
coverage below any CNA excess liability policies; and applicable coverage
defenses, including asbestos exclusions. Estimation of asbestos-related claim
and claim adjustment expense reserves involves a high degree of judgment on the
part of management and consideration of many complex factors, including:  
    
    inconsistency of court decisions, jury attitudes and future court decisions
    
    specific policy provisions
    
    allocation of liability among insurers and insureds 93




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued  
    
    missing policies and proof of coverage
    
    the proliferation of bankruptcy proceedings and attendant uncertainties
    
    novel theories asserted by policyholders and their counsel
    
    the targeting of a broader range of businesses and entities as defendants
    
    the uncertainty as to which other insureds may be targeted in the
future and the uncertainties inherent in predicting the number of
future claims
    
    volatility in claim numbers and settlement demands
    
    increases in the number of non-impaired claimants and the extent to
which they can be precluded from making claims
    
    the efforts by insureds to obtain coverage not subject to aggregate
limits
    
    long latency period between asbestos exposure and disease
manifestation and the resulting potential for involvement of multiple
policy periods for individual claims
    
    medical inflation trends
    
    the mix of asbestos-related diseases presented, and
    
    the ability to recover reinsurance. The Company is also monitoring possible legislative reforms, including
possible federal legislation to create a national privately financed trust
financed by contributions from insurers such as CNA, industrial companies and
others, which if established, could replace litigation of asbestos claims with
payments to claimants from the trust. It is uncertain at the present time
whether such legislation will be enacted or, if it is, its impact on the
Company. Environmental Pollution and Mass Tort Environmental pollution cleanup is the subject of both federal and state
regulation. By some estimates, there are thousands of potential waste sites
subject to cleanup. The insurance industry is involved in extensive litigation
regarding coverage issues. Judicial interpretations in many cases have
expanded the scope of coverage and liability beyond the original intent of the
policies. The Comprehensive Environmental Response Compensation and Liability
Act of 1980 (Superfund) and comparable state statutes (mini-Superfunds) govern
the cleanup and restoration of toxic waste sites and formalize the concept of
legal liability for cleanup and restoration by Potentially Responsible
Parties (PRPs). Superfund and the mini-Superfunds establish mechanisms to pay
for cleanup of waste sites if PRPs fail to do so and assign liability to PRPs.
The extent of liability to be allocated to a PRP is dependent upon a variety of
factors. Further, the number of waste sites subject to cleanup is unknown. To
date, approximately 1,400 cleanup sites have been identified by the
Environmental Protection Agency (EPA) and included on its National Priorities
List (NPL). State authorities have designated many cleanup sites as well. 94




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued Many policyholders have made claims against various CNA insurance subsidiaries
for defense costs and indemnification in connection with environmental
pollution matters. The vast majority of these claims relate to accident years
1989 and prior, which coincides with CNAs adoption of the Simplified
Commercial General Liability coverage form, which includes what is referred to
in the industry as an absolute pollution exclusion. CNA and the insurance
industry are disputing coverage for many such claims. Key coverage issues
include whether cleanup costs are considered damages under the policies,
trigger of coverage, allocation of liability among triggered policies,
applicability of pollution exclusions and owned property exclusions, the
potential for joint and several liability and the definition of an occurrence.
To date, courts have been inconsistent in their rulings on these issues. A number of proposals to modify Superfund have been made by various parties.
However, no modifications were enacted by Congress during 2003 or in the first
three quarters of 2004, and it is unclear what positions Congress or the Administration
will take and what legislation, if any, will result in the future. If there is
legislation, and in some circumstances even if there is no legislation, the
federal role in environmental cleanup may be significantly reduced in favor of
state action. Substantial changes in the federal statute or the activity of
the EPA may cause states to reconsider their environmental cleanup statutes and
regulations. There can be no meaningful prediction of the pattern of
regulation that would result or the possible effect upon CNAs results of
operations or equity. As of September 30, 2004 and December 31, 2003, CNA carried approximately $508
million and $577 million of claim and claim adjustment expense reserves, net of
reinsurance recoverables, for reported and unreported environmental pollution
and mass tort claims. There was no environmental pollution and mass tort net
claim and claim adjustment expense reserve development for the nine months
ended September 30, 2004 and $153 million unfavorable development in the same
period of 2003. The Company paid environmental pollution-related claims and
mass tort-related claims, net of reinsurance recoveries, of $79 million and $68
million for the nine months ended September 30, 2004 and 2003. Additionally,
the Company recorded $10 million of current accident year losses related to
mass tort in 2004. CNA has made resolution of large environmental pollution exposures a management
priority. The Company has resolved a number of its large environmental
accounts by negotiating settlement agreements. In its settlements, CNA sought
to resolve those exposures and obtain the broadest release language to avoid
future claims from the same policyholders seeking coverage for sites or claims
that had not emerged at the time CNA settled with its policyholder. While the
terms of each settlement agreement vary, CNA sought to obtain broad
environmental releases that include known and unknown sites, claims and
policies. The broad scope of the release provisions contained in those
settlement agreements should, in many cases, prevent future exposure from
settled policyholders. It remains uncertain, however, whether a court
interpreting the language of the settlement agreements will adhere to the
intent of the parties and uphold the broad scope of language of the agreements. In 2003, CNA observed a
marked increase in silica claims frequency in Mississippi, where
plaintiff attorneys appear to have filed claims to avoid the effect
of tort reform. In 2004, silica
claims frequency in Mississippi has moderated notably due to
implementation of tort reform
measures and favorable court decisions. To date, the most significant
silica exposures identified
included a relatively small number of accounts with significant
numbers of new claims reported
in 2003 and continuing in 2004. Establishing claim and claim
adjustment expense reserves for
silica claims is subject to uncertainties because of disputes
concerning medical causation with
respect to certain diseases, including lung cancer, geographical
concentration of the lawsuits
asserting the claims, and the large rise in the total number of
claims without underlying
epidemiological developments suggesting an increase in disease rates
or plaintiffs. Moreover,
judicial interpretations regarding application of various tort
defenses, including application of
various theories of joint and several liabilities, impede the
Company's ability to estimate its
ultimate liability for such claims. The Company classifies its environmental pollution accounts into several
categories, which include structured settlements, coverage in place agreements
and active accounts. Structured settlement agreements provide for payments
over multiple years as set forth in each individual agreement. At September
30, 2004, CNA had two structured settlement agreements and has established
reserves of $7 million, net of reinsurance, to fund future payment obligations
under the agreements. At December 31, 2003, CNA had a structured settlement
agreement with one of its policyholders for which it has future payment
obligations with a recorded reserve of $12 million, net of reinsurance. CNA has also used coverage in place agreements to resolve pollution exposures.
Coverage in place agreements are typically agreements between CNA and its
policyholders identifying the policies and the 95




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued terms for payment of pollution related liabilities. Claims payments are
contingent on presentation of adequate documentation of damages during the
policy periods and other documentation supporting the demand for claims
payment. Coverage in place agreements may have annual payment caps. At
September 30, 2004, CNA had negotiated thirteen coverage in place agreements
and had established a reserve of $9 million, net of reinsurance. At December
31, 2003, CNA had six such agreements in which CNA committed coverage for
payment of claims and claim related adjustment expenses subject to
documentation requirements as set forth in the terms of each specific
agreement. At December 31, 2003, CNA had a recorded reserve of $8 million, net
of reinsurance, related to coverage in place agreements. The Company categorizes active accounts as large or small accounts in the
pollution area. CNA defines a large account as an active account with more
than $100,000 cumulative paid losses. At September 30, 2004, the Company had
133 large accounts with a collective reserve of $84 million, net of
reinsurance. The Company has made closing large accounts a significant
management priority. CNA had 144 large accounts with a collective reserve of
$86 million, net of reinsurance, at December 31, 2003. Small accounts are
defined as active accounts with $100,000 or less cumulative paid losses. At
September 30, 2004, CNA had 396 small accounts with a collective reserve of $48
million, net of reinsurance. CNA had 432 small accounts with a collective
reserve of $53 million, net of reinsurance, at December 31, 2003. The Company also evaluates its environmental pollution exposures arising from
its assumed reinsurance and its participation in various pools, including
Excess and Casualty Reinsurance Association (ECRA). CNA has a reserve of $37
million and $38 million related to these liabilities at September 30, 2004 and
December 31, 2003. At September 30, 2004, the Companys unassigned IBNR reserve was $169 million,
net of reinsurance. At December 31, 2003, CNAs unassigned IBNR reserve for
environmental pollution was $197 million, net of reinsurance. This IBNR
reserve relates to potential development on accounts that have not settled and
potential future claims from unidentified policyholders. 96




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued The charts below depict CNAs overall pending environmental pollution accounts
and associated reserves at September 30, 2004 and December 31, 2003. At September 30, 2004 Percent ofNet Paid Losses
    
    Net Environmental
    
    EnvironmentalNumber of
    
    in 2004
    
    Pollution Reserves
    
    Pollution NetPolicyholders
    
    (In millions)
    
    (In millions)
    
    ReservePolicyholders with Settlement AgreementsStructured Settlements
    
    
    2
    
    
    $
    12
    
    
    $
    7
    
    
    
    2
    %Coverage In Place
    
    
    13
    
    
    
    4
    
    
    
    9
    
    
    
    2Total with Settlement Agreements
    
    
    15
    
    
    
    16
    
    
    
    16
    
    
    
    4Other Policyholders with Active AccountsLarge Pollution Accounts
    
    
    133
    
    
    
    13
    
    
    
    84
    
    
    
    24Small Pollution Accounts
    
    
    396
    
    
    
    10
    
    
    
    48
    
    
    
    14Total Other Policyholders
    
    
    529
    
    
    
    23
    
    
    
    132
    
    
    
    38Assumed Reinsurance & Pools
    
    
    
    
    
    
    1
    
    
    
    37
    
    
    
    10Unassigned IBNR
    
    
    
    
    
    
    
    
    
    
    169
    
    
    
    48Total
    
    
    544
    
    
    $
    40
    
    
    $
    354
    
    
    
    100
    %
 At December 31, 2003 Percent ofNet Paid Losses
    
    Net Environmental
    
    EnvironmentalNumber of
    
    in 2003
    
    Pollution Reserves
    
    Pollution NetPolicyholders
    
    (In millions)
    
    (In millions)
    
    ReservePolicyholders with Settlement AgreementsStructured Settlements
    
    
    1
    
    
    $
    17
    
    
    $
    12
    
    
    
    3
    %Coverage In Place
    
    
    6
    
    
    
    3
    
    
    
    8
    
    
    
    2Total with Settlement Agreements
    
    
    7
    
    
    
    20
    
    
    
    20
    
    
    
    5Other Policyholders with Active AccountsLarge Pollution Accounts
    
    
    144
    
    
    
    21
    
    
    
    86
    
    
    
    22Small Pollution Accounts
    
    
    432
    
    
    
    14
    
    
    
    53
    
    
    
    13Total Other Policyholders
    
    
    576
    
    
    
    35
    
    
    
    139
    
    
    
    35Assumed Reinsurance & Pools
    
    
    
    
    
    
    2
    
    
    
    38
    
    
    
    10Unassigned IBNR
    
    
    
    
    
    
    
    
    
    
    197
    
    
    
    50Total
    
    
    583
    
    
    $
    57
    
    
    $
    394
    
    
    
    100
    %
 97




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued INVESTMENTS CNA adopted Statement of
Position 03-01, Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate
Accounts (SOP 03-01) as of January 1, 2004. The assets and liabilities of
certain guaranteed investment contracts and indexed group annuity contracts
that were previously segregated and reported as separate accounts no longer
qualify for separate account presentation. Prior to the adoption of SOP 03-01,
the asset and liability presentation of these affected contracts were
categorized as separate account assets and liabilities within the Condensed
Consolidated Balance Sheet. The results of operations from separate account
business were primarily classified as other revenue in the Condensed
Consolidated Statement of Operations. In accordance with the provisions of SOP
03-01, the classification and presentation of certain balance sheet and income
statement items have been modified. Accordingly, certain investment
securities previously classified as separate account assets have now been
reclassified on the balance sheet to the general account and are reported as
available-for-sale or trading securities. The investment portfolio supporting
the indexed group annuity contracts is classified as held for trading purposes,
and is carried at fair value, with both the net realized and unrealized gains
(losses) included within net investment income in the Condensed Consolidated
Statement of Operations. Consistent with the requirements of SOP 03-01, prior
year amounts have not been conformed to the current year presentation. Net Investment Income The significant components of net investment income are presented in the
following table. Net Investment Income Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Fixed maturity securities
    
    $
    396
    
    
    $
    412
    
    
    $
    1,189
    
    
    $
    1,254Short term investments
    
    
    14
    
    
    
    14
    
    
    
    39
    
    
    
    46Limited partnerships
    
    
    26
    
    
    
    61
    
    
    
    131
    
    
    
    159Equity securities
    
    
    3
    
    
    
    4
    
    
    
    11
    
    
    
    13Income (loss) from trading portfolio (a)
    
    
    (21
    )
    
    
    
    
    
    
    13
    
    
    
    Interest on funds withheld and other deposits
    
    
    (55
    )
    
    
    (148
    )
    
    
    (161
    )
    
    
    (288
    )Other
    
    
    4
    
    
    
    20
    
    
    
    15
    
    
    
    63Gross investment income
    
    
    367
    
    
    
    363
    
    
    
    1,237
    
    
    
    1,247Investment expense
    
    
    (8
    )
    
    
    (11
    )
    
    
    (25
    )
    
    
    (36
    )Net investment income
    
    $
    359
    
    
    $
    352
    
    
    $
    1,212
    
    
    $
    1,211
   (a)
    
    The change in net unrealized gains (losses) on trading securities, included
in net investment income, was $(4) million and $(2) million for the three and
nine months ended September 30, 2004. The Company experienced slightly higher net investment income for the three and
nine months ended September 30, 2004 as compared with the same periods in 2003.
This increase was due primarily to reduced interest expense on funds withheld
and other deposits. The higher interest expense on funds withheld and other
deposits in third quarter of 2003 was due to additional premiums ceded to the
corporate aggregate and other finite reinsurance treaties. This improvement
was partially offset by decreases in net investment income for Limited
Partnerships and Fixed Maturities. The net investment income of the trading
portfolio negatively impacted results for the third quarter and positively
impacted results for the nine months ended September 30, 2004. The bond segment of the investment portfolio yielded 4.7% and 5.3% for the nine
months ended September 30, 2004 and 2003. 98




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued Realized Investment Gains (Losses) The components of realized investment results from available-for-sale
securities are presented in the following table. Realized Investment Gains (Losses) Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Realized investment gains (losses):Fixed maturity securities:U.S. Government bonds
    
    $
    4
    
    
    $
    (145
    )
    
    $
    13
    
    
    $
    (70
    )Corporate and other taxable bonds
    
    
    (35
    )
    
    
    177
    
    
    
    (2
    )
    
    
    303Tax-exempt bonds
    
    
    42
    
    
    
    (16
    )
    
    
    23
    
    
    
    79Asset-backed bonds
    
    
    9
    
    
    
    17
    
    
    
    44
    
    
    
    58Redeemable preferred stock
    
    
    6
    
    
    
    (4
    )
    
    
    11
    
    
    
    (14
    )Total fixed maturity securities
    
    
    26
    
    
    
    29
    
    
    
    89
    
    
    
    356Equity securities
    
    
    10
    
    
    
    31
    
    
    
    187
    
    
    
    89Derivative securities
    
    
    (105
    )
    
    
    85
    
    
    
    (88
    )
    
    
    8Short term investments
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    13Other, including disposition of individual life insurance
business net of participating policyholders interest
    
    
    10
    
    
    
    18
    
    
    
    (594
    )
    
    
    1Realized investment gains (losses) before allocation to
participating policyholders and minority interests
    
    
    (59
    )
    
    
    166
    
    
    
    (406
    )
    
    
    467Allocated to participating policyholders and minority interest
    
    
    (3
    )
    
    
    (2
    )
    
    
    (9
    )
    
    
    (1
    )Realized investment gains (losses), net of participating
policyholders and minority interests
    
    $
    (62
    )
    
    $
    164
    
    
    $
    (415
    )
    
    $
    466
 Realized investment losses were $62 million as compared to realized investment
gains of $164 million for the three months ended September 30, 2004 and 2003.
The decline was primarily due to losses related to derivative securities held
to mitigate the effect of changes in long term interest rates on the value of
the fixed maturity portfolio. While a decrease in long term interest rates
during the third quarter of 2004 resulted in a realized loss related to these
derivatives, the fair value of the Companys fixed maturity portfolio benefited
from the interest rate movements resulting in a substantial increase in
Accumulated Other Comprehensive Income and Stockholders Equity. Realized investment losses were $415 million for the nine months ended
September 30, 2004 as compared to realized investment gains of $466 million for
the nine months ended September 30, 2003. The decrease in the pretax
investment results was primarily due to a $622 million pretax loss on the sale
of the individual life insurance business, losses related to derivative
securities and decreased realized gains on the sale of fixed maturity
securities. These decreases were partially offset by a $162 million pretax
gain on the disposition of the Companys equity holdings of Canary Wharf Group
PLC (Canary Wharf), a London-based real estate company. Impairment losses were $19 million pretax for other-than-temporary declines in
fair value for fixed maturity and equity securities for the three and nine
months ended September 30, 2004. Realized investment gains for the three and
nine months ended September 30, 2003 included $16 million and $302 million of
pretax impairment losses for other-than-temporary declines in fair values for
fixed maturity and equity securities. These impairment losses were for
securities across several market sectors, including the airline, healthcare and
energy industries. 99




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued A primary objective in the management of the fixed maturity and equity
portfolios is to maximize total return relative to underlying liabilities and
respective liquidity needs. In achieving this goal, assets may be sold to take
advantage of market conditions or other investment opportunities or for credit
or tax considerations. This activity will produce realized gains and losses. CNA classifies substantially all its fixed maturity securities (bonds and
redeemable preferred stocks) and its equity securities as either
available-for-sale or trading, and as such, they are carried at fair value.
The amortized cost of fixed maturity securities is adjusted for amortization of
premiums and accretion of discounts to maturity, which is included in net
investment income. Changes in fair value related to available-for-sale
securities are reported as a component of other comprehensive income. The following table provides further detail of gross realized gains and gross
realized losses on fixed maturity securities and equity securities
available-for-sale. Realized Gains and Losses Three Months
    
    Nine MonthsPeriod ended September 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Net realized gains on fixed maturity securities and equity securities:Fixed maturity securities:Gross realized gains
    
    $
    130
    
    
    $
    361
    
    
    $
    443
    
    
    $
    1,056Gross realized losses
    
    
    (104
    )
    
    
    (332
    )
    
    
    (354
    )
    
    
    (700
    )Net realized gains on fixed maturity securities
    
    
    26
    
    
    
    29
    
    
    
    89
    
    
    
    356Equity securities:Gross realized gains
    
    
    16
    
    
    
    43
    
    
    
    198
    
    
    
    113Gross realized losses
    
    
    (6
    )
    
    
    (12
    )
    
    
    (11
    )
    
    
    (24
    )Net realized gains on equity securities
    
    
    10
    
    
    
    31
    
    
    
    187
    
    
    
    89Net realized gains on fixed maturity and equity securities
    
    $
    36
    
    
    $
    60
    
    
    $
    276
    
    
    $
    445
 100




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued The following table provides details of the largest realized losses from sales
of securities aggregated by issuer for the nine months ended September 30,
2004, including: the fair value of the securities at sales date, the amount of
the loss recorded and the period of time that the security had been in an
unrealized loss position prior to sale. The period of time that the security
had been in an unrealized loss position prior to sale can vary due to the
timing of individual security purchases. Also included is a narrative
providing the industry sector along with the facts and circumstances giving
rise to the loss. Largest Realized Losses from Securities Sold at a Loss Nine Months Ended September 30, 2004Fair
    
    
    
    
    
    Months inValue at
    
    
    
    
    
    UnrealizedDate of
    
    Loss
    
    Loss PriorIssuer Description and Discussion
    
    Sale
    
    On Sale
    
    To Sale(In millions)Issues and sells mortgage backed securities. Issuer
was chartered by United States Congress to facilitate
housing ownership for low to middle income Americans.
Loss was incurred as a result of unfavorable
interest rate change.
    
    $
    3,469
    
    
    $
    18
    
    
    
    0-12Municipal issuer of revenue bonds that authorizes the
financing of water facilities. Loss was incurred as a
result of unfavorable interest rate change.
    
    
    291
    
    
    
    13
    
    
    
    0-6Company provides networking telecommunications
services worldwide. The company is under price/profit
pressure as a result of excess capacity in the
industry.
    
    
    100
    
    
    
    11
    
    
    
    0-6Various notes and bonds issued by the United States
Treasury. Volatility of interest rates prompted
movement to other asset classes.
    
    
    2,522
    
    
    
    8
    
    
    
    0-6Municipal issuer of special obligation bonds for
school financing. Loss was incurred as a result of
unfavorable interest rate change.
    
    
    152
    
    
    
    8
    
    
    Various, 0-24Municipal issuer of revenue bonds that support
transportation services. Loss was incurred as a
result of unfavorable interest rate change.
    
    
    268
    
    
    
    7
    
    
    
    0-12Municipal issuer of revenue bonds that authorizes the
financing of sewer facilities. Loss was incurred as a
result of unfavorable interest rate change.
    
    
    113
    
    
    
    7
    
    
    
    0-6Municipal issuer of revenue bonds that authorizes the
financing of water facilities. Loss was incurred as a
result of unfavorable interest rate change.
    
    
    180
    
    
    
    6
    
    
    
    0-6Air transportation carrier for passengers, freight,
and mail both domestic and international. Company
was subject to higher fuel costs and union
negotiations.
    
    
    24
    
    
    
    6
    
    
    
    0-6Company acquires, sells, and operates power
generation facility. The loss reflects intense
competition and price pressure in the sector.
    
    
    57
    
    
    
    6
    
    
    
    0-12Municipal issuer of revenue bonds that authorizes
bridge and tunnel facilities. Loss was incurred as a
result of unfavorable interest rate change.
    
    
    103
    
    
    
    6
    
    
    
    0-12Total
    
    $
    7,279
    
    
    $
    96
 101




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##### Table of Contents



CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued Valuation and Impairment of Investments The following table details the carrying value of CNAs general account
investment portfolios. Carrying Value of Investments September 30,
    
    
    
    
    
    December 31,2004
    
    %
    
    2003
    
    %(In millions)General account investments:Fixed maturity securities available-for-sale:U.S. Treasury securities and obligations of government agencies
    
    $
    1,999
    
    
    
    5
    %
    
    $
    1,900
    
    
    
    5
    %Asset-backed securities
    
    
    9,458
    
    
    
    25
    
    
    
    8,757
    
    
    
    23States, municipalities and political subdivisions  tax-exempt
    
    
    9,022
    
    
    
    24
    
    
    
    7,970
    
    
    
    21Corporate securities
    
    
    7,104
    
    
    
    19
    
    
    
    6,482
    
    
    
    17Other debt securities
    
    
    3,467
    
    
    
    9
    
    
    
    3,264
    
    
    
    9Redeemable preferred stock
    
    
    151
    
    
    
    
    
    
    
    104
    
    
    
    Options embedded in convertible debt securities
    
    
    202
    
    
    
    1
    
    
    
    201
    
    
    
    Total fixed maturity securities available-for-sale
    
    
    31,403
    
    
    
    83
    
    
    
    28,678
    
    
    
    75Fixed maturity trading securities:U.S. Treasury securities and obligations of government agencies
    
    
    41
    
    
    
    
    
    
    
    
    
    
    
    Asset-backed securities
    
    
    87
    
    
    
    
    
    
    
    
    
    
    
    Corporate securities
    
    
    151
    
    
    
    1
    
    
    
    
    
    
    
    Other debt securities
    
    
    34
    
    
    
    
    
    
    
    
    
    
    
    Redeemable preferred stock
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    Total fixed maturity trading securities
    
    
    317
    
    
    
    1
    
    
    
    
    
    
    
    Equity securities:Common stock
    
    
    251
    
    
    
    1
    
    
    
    383
    
    
    
    1Non-redeemable preferred stock
    
    
    92
    
    
    
    
    
    
    
    144
    
    
    
    Total equity securities
    
    
    343
    
    
    
    1
    
    
    
    527
    
    
    
    1Short term investments available-for-sale
    
    
    3,767
    
    
    
    10
    
    
    
    7,538
    
    
    
    20Short term trading securities
    
    
    375
    
    
    
    1
    
    
    
    
    
    
    
    Limited partnerships
    
    
    1,715
    
    
    
    4
    
    
    
    1,117
    
    
    
    3Other investments
    
    
    30
    
    
    
    
    
    
    
    240
    
    
    
    1Total general account investments
    
    $
    37,950
    
    
    
    100
    %
    
    $
    38,100
    
    
    
    100
    %
 The Companys general account investment portfolio consists primarily of
asset-backed and mortgage-backed securities, municipal bonds and corporate
bonds. Investments in the general account had a total net unrealized gain of $1,143
million at September 30, 2004 compared with $1,348 million at December 31,
2003. The net unrealized position at September 30, 2004 was composed of a net
unrealized gain of $1,053 million for fixed maturities and a net unrealized
gain of $90 million for equity securities. The net unrealized position at
December 31, 2003 was composed of a net unrealized gain of $1,114 million for
fixed maturities and a net unrealized gain of $234 million for equity
securities. 102




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued Unrealized Gains (Losses) on Fixed Maturity and Equity Securities Cost or
    
    Gross
    
    Gross Unrealized Losses
    
    NetAmortized
    
    Unrealized
    
    Less than
    
    Greater than
    
    UnrealizedSeptember 30, 2004
    
    Cost
    
    Gains
    
    12 Months
    
    12 Months
    
    Gain/(Loss)(In millions)Fixed maturity securities available-for-sale:U.S. Treasury securities and obligations
of government agencies
    
    $
    1,889
    
    
    $
    123
    
    
    $
    10
    
    
    $
    3
    
    
    $
    110Asset-backed securities
    
    
    9,349
    
    
    
    133
    
    
    
    20
    
    
    
    4
    
    
    
    109States, municipalities and political
subdivisions  tax-exempt
    
    
    8,840
    
    
    
    215
    
    
    
    29
    
    
    
    4
    
    
    
    182Corporate securities
    
    
    6,730
    
    
    
    443
    
    
    
    55
    
    
    
    14
    
    
    
    374Other debt securities
    
    
    3,192
    
    
    
    304
    
    
    
    22
    
    
    
    7
    
    
    
    275Redeemable preferred stock
    
    
    148
    
    
    
    6
    
    
    
    1
    
    
    
    2
    
    
    
    3Options embedded in convertible debt
securities
    
    
    202
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total fixed maturity securities
available-for-sale
    
    
    30,350
    
    
    
    1,224
    
    
    
    137
    
    
    
    34
    
    
    
    1,053Total fixed maturity trading securities
    
    
    317
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Equity securities:Common stock
    
    
    175
    
    
    
    78
    
    
    
    1
    
    
    
    1
    
    
    
    76Non-redeemable preferred stock
    
    
    78
    
    
    
    14
    
    
    
    
    
    
    
    
    
    
    
    14Total equity securities
    
    
    253
    
    
    
    92
    
    
    
    1
    
    
    
    1
    
    
    
    90Total fixed maturity and equity securities
    
    $
    30,920
    
    
    $
    1,316
    
    
    $
    138
    
    
    $
    35
    
    
    $
    1,143
 Unrealized Gains (Losses) on Fixed Maturity and Equity Securities Cost or
    
    Gross
    
    Gross Unrealized Losses
    
    NetAmortized
    
    Unrealized
    
    Less than
    
    Greater than
    
    UnrealizedDecember 31, 2003
    
    Cost
    
    Gains
    
    12 Months
    
    12 Months
    
    Gain/(Loss)(In millions)Fixed maturity securities:U.S. Treasury securities and obligations of government agencies
    
    $
    1,823
    
    
    $
    91
    
    
    $
    10
    
    
    $
    4
    
    
    $
    77Asset-backed securities
    
    
    8,634
    
    
    
    146
    
    
    
    22
    
    
    
    1
    
    
    
    123States, municipalities and political subdivisions  tax-exempt
    
    
    7,787
    
    
    
    207
    
    
    
    22
    
    
    
    2
    
    
    
    183Corporate securities
    
    
    6,061
    
    
    
    475
    
    
    
    40
    
    
    
    14
    
    
    
    421Other debt securities
    
    
    2,961
    
    
    
    311
    
    
    
    4
    
    
    
    4
    
    
    
    303Redeemable preferred stock
    
    
    97
    
    
    
    7
    
    
    
    
    
    
    
    
    
    
    
    7Options embedded in convertible debt securities
    
    
    201
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total fixed maturity securities
    
    
    27,564
    
    
    
    1,237
    
    
    
    98
    
    
    
    25
    
    
    
    1,114Equity securities:Common stock
    
    
    163
    
    
    
    222
    
    
    
    2
    
    
    
    
    
    
    
    220Non-redeemable preferred stock
    
    
    130
    
    
    
    16
    
    
    
    2
    
    
    
    
    
    
    
    14Total equity securities
    
    
    293
    
    
    
    238
    
    
    
    4
    
    
    
    
    
    
    
    234Total fixed maturity and equity securities
    
    $
    27,857
    
    
    $
    1,475
    
    
    $
    102
    
    
    $
    25
    
    
    $
    1,348
 103




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued The Companys investment policies for the general account emphasize high credit
quality and diversification by industry, issuer and issue. Assets supporting
interest rate sensitive liabilities are segmented within the general account to
facilitate asset/liability duration management. At September 30, 2004, the carrying value of the general account fixed
maturities available-for-sale was $31,403 million, representing 83% of the
total investment portfolio. The net unrealized gain related to this fixed
maturity portfolio was $1,053 million, comprised of $1,224 million in gross
unrealized gains and $171 million in gross unrealized losses. Corporate bonds
represented 40%, municipal securities represented 19%, asset-backed securities
represented 14%, and all other fixed maturity securities represented 27% of the
gross unrealized losses. Within corporate bonds, the largest industry sectors
were consumer cyclical, financial and communications, which represented 33%,
26%, and 15% of the gross unrealized losses. Gross unrealized losses in any
single issuer were less than 0.1% of the carrying value of the total general
account fixed maturity portfolio. The following table provides the composition of fixed maturity securities
available-for-sale with an unrealized loss at September 30, 2004 in relation to
the total of all fixed maturity securities available-for-sale with an
unrealized loss by contractual maturities. Contractual Maturity Percent of
    
    Percent ofMarket
    
    UnrealizedValue
    
    LossDue in one year or less
    
    
    1
    %
    
    
    4
    %Due after one year through five years
    
    
    87
    
    
    
    80Due after five years through ten years
    
    
    5
    
    
    
    9Due after ten years
    
    
    4
    
    
    
    6Asset-backed securities
    
    
    3
    
    
    
    1Total
    
    
    100
    %
    
    
    100
    %
 104




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued The following table summarizes, for fixed maturity and equity securities
available-for-sale in an unrealized loss position at September 30, 2004 and
December 31, 2003, the aggregate fair value and gross unrealized loss by length
of time, for securities that have been continuously in an unrealized loss
position. Gross Unrealized Loss Aging September 30, 2004
    
    December 31, 2003Gross
    
    
    
    
    
    GrossEstimated
    
    Unrealized
    
    Estimated
    
    UnrealizedFair Value
    
    Loss
    
    Fair Value
    
    Loss(In millions)Fixed maturity securities:Investment grade:0-6 months
    
    $
    6,096
    
    
    $
    55
    
    
    $
    4,138
    
    
    $
    507-12 months
    
    
    2,093
    
    
    
    55
    
    
    
    834
    
    
    
    3613-24 months
    
    
    377
    
    
    
    21
    
    
    
    76
    
    
    
    11Greater than 24 months
    
    
    
    
    
    
    
    
    
    
    51
    
    
    
    3Total investment grade
    
    
    8,566
    
    
    
    131
    
    
    
    5,099
    
    
    
    100Non-investment grade:0-6 months
    
    
    425
    
    
    
    9
    
    
    
    134
    
    
    
    57-12 months
    
    
    170
    
    
    
    18
    
    
    
    60
    
    
    
    713-24 months
    
    
    35
    
    
    
    3
    
    
    
    16
    
    
    
    1Greater than 24 months
    
    
    56
    
    
    
    10
    
    
    
    105
    
    
    
    10Total non-investment grade
    
    
    686
    
    
    
    40
    
    
    
    315
    
    
    
    23Total fixed maturity securities
    
    
    9,252
    
    
    
    171
    
    
    
    5,414
    
    
    
    123Equity securities:0-6 months
    
    
    23
    
    
    
    1
    
    
    
    23
    
    
    
    27-12 months
    
    
    1
    
    
    
    
    
    
    
    10
    
    
    
    213-24 months
    
    
    2
    
    
    
    1
    
    
    
    3
    
    
    
    Greater than 24 months
    
    
    6
    
    
    
    
    
    
    
    6
    
    
    
    Total equity securities
    
    
    32
    
    
    
    2
    
    
    
    42
    
    
    
    4Total fixed maturity and equity securities
    
    $
    9,284
    
    
    $
    173
    
    
    $
    5,456
    
    
    $
    127
 The Companys non-investment grade fixed maturity securities available-for-sale
as of September 30, 2004 that were in a gross unrealized loss position had a
fair value of $686 million. A significant judgment in the valuation of
investments is the determination of when an other-than-temporary impairment has
occurred. The Companys Impairment Committee analyzes securities placed on the
watch list on at least a quarterly basis. Part of this analysis is to monitor
the length of time and severity of the decline below book value of the watch
list securities. The following tables summarize the fair value and gross
unrealized loss of non-investment grade securities categorized by the length of
time those securities have been in a continuous unrealized loss position and
further categorized by the severity of the unrealized loss position in 10%
increments as of September 30, 2004 and December 31, 2003. 105




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued Unrealized Loss Aging for Non-investment Grade Securities Fair Value as a Percentage of Book Value
    
    GrossEstimated
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    UnrealizedSeptember 30, 2004
    
    Fair Value
    
    90-99%
    
    80-89%
    
    70-79%
    
    <70%
    
    Loss(In millions)Fixed maturity securities:Non-investment grade:0-6 months
    
    $
    425
    
    
    $
    7
    
    
    $
    2
    
    
    $
    
    
    
    $
    
    
    
    $
    97-12 months
    
    
    170
    
    
    
    3
    
    
    
    15
    
    
    
    
    
    
    
    
    
    
    
    1813-24 months
    
    
    35
    
    
    
    1
    
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    3Greater than 24 months
    
    
    56
    
    
    
    1
    
    
    
    4
    
    
    
    5
    
    
    
    
    
    
    
    10Total non-investment grade
    
    $
    686
    
    
    $
    12
    
    
    $
    22
    
    
    $
    6
    
    
    $
    
    
    
    $
    40
 Unrealized Loss Aging for Non-investment Grade Securities Fair Value as a Percentage of Book Value
    
    GrossEstimated
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    UnrealizedDecember 31, 2003
    
    Fair Value
    
    90-99%
    
    80-89%
    
    70-79%
    
    <70%
    
    Loss(In millions)Fixed maturity securities:Non-investment grade:0-6 months
    
    $
    134
    
    
    $
    2
    
    
    $
    1
    
    
    $
    
    
    
    $
    2
    
    
    $
    57-12 months
    
    
    60
    
    
    
    1
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    713-24 months
    
    
    16
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1Greater than 24 months
    
    
    105
    
    
    
    4
    
    
    
    1
    
    
    
    5
    
    
    
    
    
    
    
    10Total non-investment grade
    
    $
    315
    
    
    $
    8
    
    
    $
    8
    
    
    $
    5
    
    
    $
    2
    
    
    $
    23
 Invested assets are exposed to various risks, such as interest rate, market and
credit risk. Due to the level of risk associated with certain invested assets
and the level of uncertainty related to changes in the value of these assets,
it is possible that changes in risks in the near term could have an adverse
material impact on the Companys results of operations or equity. A significant judgment in the valuation of investments is the determination of
when an other-than-temporary decline in value has occurred. The Company
follows a consistent and systematic process for impairing securities that
sustain other-than-temporary declines in value. The Company has established a
committee responsible for the impairment process. This committee, referred to
as the Impairment Committee, is made up of three officers appointed by the
Companys Chief Financial Officer. The committee is responsible for analyzing
watch list securities on at least a quarterly basis. The watch list includes
individual securities that fall below certain thresholds or that exhibit
evidence of impairment indicators including, but not limited to, a significant
adverse change in the financial condition and near term prospects of the
investment or a significant adverse change in legal factors, the business
climate or credit ratings. When a security is placed on the watch list, it is monitored for further fair
value changes and additional news related to the issuers financial condition.
The focus is on objective evidence that may influence the evaluation of
impairment factors. 106




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued The decision to impair a security incorporates both quantitative criteria and
qualitative information. The committee considers a number of factors
including, but not limited to: (1) the length of time and the extent to which
the fair value has been less than book value, (2) the financial condition and
near term prospects of the issuer, (3) the intent and ability of the Company to
retain its investment for a period of time sufficient to allow for any
anticipated recovery in value, (4) whether the debtor is current on interest
and principal payments and (5) general market conditions and industry or sector
specific factors. The committees decision to impair a security is primarily
based on whether the securitys fair value is likely to remain significantly
below its book value in light of all of the factors considered above. For
securities that are impaired, the security is written down to fair value and
the resulting losses are recognized in realized gains/losses in the Condensed
Consolidated Statements of Operations. As part of the ongoing impairment monitoring process, the Impairment Committee
has evaluated the facts and circumstances based on available information for
each of the non-investment grade securities and determined that no further
impairments were appropriate at September 30, 2004. This determination was
based on a number of factors that the Impairment Committee regularly considers
including, but not limited to: the issuers ability to meet current and future
interest and principal payments, an evaluation of the issuers financial
condition and near term prospects, the Companys sector outlook and estimates
of the fair value of any underlying collateral. In all cases where a decline
in value is judged to be temporary, the Company had the intent and ability to
hold these securities for a period of time sufficient to recover the book value
of its investment through a recovery in the fair value of such securities or by
holding the securities to maturity. In many cases, the securities held are
matched to liabilities as part of ongoing asset/liability duration management.
As such, the Impairment Committee continually assesses its ability to hold
securities for a time sufficient to recover any temporary loss in value or
until maturity. The Company maintains sufficient levels of liquidity so as to
not impact the asset/liability management process. The fair value of securities held by the Company may deteriorate in the future
which may have an adverse impact on the Companys results of operations and/or
equity. The Companys equity securities available-for-sale as of September 30, 2004
that were in a gross unrealized loss position had a fair value of $32 million.
The Companys Impairment Committee, under the same process as fixed maturity
securities, monitors the equity securities for other-than-temporary declines in
value. In all cases where a decline in value is judged to be temporary, the
Company expects to recover the book value of its investment through a recovery
in the fair value of the security. The general account portfolio consists primarily of high quality (rated BBB or
higher) bonds, 91% and 93% of which were rated as investment grade at September
30, 2004 and December 31, 2003. The following table summarizes the ratings of
CNAs general account bond portfolio at carrying value. General Account Bond Ratings September 30,
    
    
    
    
    
    December 31,2004
    
    %
    
    2003
    
    %(In millions)U.S. Government and affiliated agency securities
    
    $
    2,333
    
    
    
    7
    %
    
    $
    2,818
    
    
    
    10
    %Other AAA rated
    
    
    15,984
    
    
    
    51
    
    
    
    12,779
    
    
    
    45AA and A rated
    
    
    5,952
    
    
    
    19
    
    
    
    6,329
    
    
    
    22BBB rated
    
    
    4,317
    
    
    
    14
    
    
    
    4,631
    
    
    
    16Below investment-grade
    
    
    2,979
    
    
    
    9
    
    
    
    2,017
    
    
    
    7Total
    
    $
    31,565
    
    
    
    100
    %
    
    $
    28,574
    
    
    
    100
    %
 At September 30, 2004 and at December 31, 2003, approximately 98% and 97% of
the general account portfolio was U.S. Government and affiliated agency
securities or was rated by Standard & Poors (S&P) 107




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued or Moodys Investors Service (Moodys). The remaining bonds were rated by
other rating agencies or Company management. Non-investment grade bonds, as presented in the table above, are high-yield
securities rated below BBB by bond rating agencies, as well as other unrated
securities that, in the opinion of management, are below investment-grade.
High-yield securities generally involve a greater degree of risk than
investment-grade securities. However, expected returns should compensate for
the added risk. This risk is also considered in the interest rate assumptions
for the underlying insurance products. The carrying value of non-traded securities at September 30, 2004 was $309
million which represents 0.8% of the Companys total investment portfolio.
These securities were in a net unrealized gain position of $103 million at
September 30, 2004. Of the non-traded securities, 46% are priced by unrelated
third party sources. Included in CNAs general account fixed maturity securities at September 30,
2004 were $9,545 million of asset-backed securities, at fair value, consisting
of approximately 61% in collateralized mortgage obligations (CMOs), 7% in
corporate asset-backed obligations, 4% in U.S. Government agency issued
pass-through certificates and 28% in corporate mortgage-backed pass-through
certificates. The majority of CMOs held are actively traded in liquid markets
and are priced by broker-dealers. The carrying value of the components of the general account short-term
investment portfolio is presented in the following table. Short-term Investments September 30,
    
    December 31,2004
    
    2003(In millions)Short-term investments available-for-sale:Commercial paper
    
    $
    2,731
    
    
    $
    4,458U.S. Treasury securities
    
    
    364
    
    
    
    1,068Money market funds
    
    
    301
    
    
    
    1,230Other
    
    
    371
    
    
    
    782Total short-term investments available-for-sale
    
    
    3,767
    
    
    
    7,538Short-term trading securities:Commercial paper
    
    
    15
    
    
    
    U.S. Treasury securities
    
    
    60
    
    
    
    Money market funds
    
    
    291
    
    
    
    Other
    
    
    9
    
    
    
    Total short-term trading securities
    
    
    375
    
    
    
    Total short-term investments
    
    $
    4,142
    
    
    $
    7,538
 CNA invests in certain derivative financial instruments primarily to reduce its
exposure to market risk (principally interest rate, equity price and foreign
currency risk) and credit risk (risk of non-performance of underlying obligor).
Derivative securities are recorded at fair value at the reporting date. The
Company also uses derivatives to mitigate market risk by purchasing
S&P 500®
index futures in a notional amount equal to the contract liability relating to
Life and Group Non-Core indexed group annuity contracts. 108




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##### Table of Contents



CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued LIQUIDITY AND CAPITAL RESOURCES Cash Flow The principal operating cash flow sources of CNAs insurance subsidiaries are
premiums and investment income. The primary operating cash flow uses are
payments for claims, policy benefits and operating expenses. For the nine months ended September 30, 2004, net cash provided by operating
activities was $1,259 million as compared with $1,482 million for the same
period in 2003. The decrease in cash provided by operating activities related
primarily to decreased net premium collections in 2004 as compared with 2003.
The decrease in net premium collections is primarily due to the sale of the
individual life and group benefits businesses and the sale of the CNA Re
renewal rights. Cash flows from investing activities include the purchase and sale of financial
instruments, as well as the purchase and sale of land, buildings, equipment and
other assets not generally held for resale. For the nine months ended September 30, 2004, net cash used by investing
activities was $1,149 million as compared with $1,270 million for the same
period in 2003. Cash flows used for investing activities related principally
to purchases of fixed maturity securities. Cash flows from financing activities include proceeds from the issuance of debt
or equity securities, outflows for dividends or repayment of debt and outlays
to reacquire equity instruments. For the nine months ended September 30, 2004, net cash used by financing
activities was $178 million as compared with $160 million for the same period
in 2003. Cash flows used for financing activities were related principally to
the repayment of debt. The Company has an existing shelf registration statement under which it may
issue an aggregate of $549 million of debt or equity securities, declared
effective by the Securities and Exchange Commission (SEC). Debt and Other Commitments See Note I of the Notes to the Condensed Consolidated Financial Statements for
a detailed discussion of the Companys debt. The Company paid the $250 million
three-year bank credit facility on April 20, 2004. See Note O of the Notes to the Condensed Consolidated Financial Statements for
information related to CNA Suretys related party transactions with CNAF. The
impact of these transactions should be considered when evaluating the Companys
liquidity and capital resources. See Note K of the Notes to the Condensed Consolidated Financial Statements for
information related to the Companys commitments and contingencies. The impact
of these commitments and contingencies should be considered when evaluating the
Companys liquidity and capital resources. 109




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##### Table of Contents



CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued A summary of the Companys commitments as of September 30, 2004 is presented in
the following table. Commitments 2009 andSeptember 30, 2004
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Beyond
    
    Total(In millions)Debt (a)
    
    $
    
    
    
    $
    528
    
    
    $
    251
    
    
    $
    8
    
    
    $
    350
    
    
    $
    552
    
    
    $
    1,689Capital leases
    
    
    1
    
    
    
    3
    
    
    
    3
    
    
    
    4
    
    
    
    4
    
    
    
    16
    
    
    
    31Lease obligations
    
    
    18
    
    
    
    65
    
    
    
    58
    
    
    
    48
    
    
    
    39
    
    
    
    94
    
    
    
    322Guaranteed payment contracts
    
    
    2
    
    
    
    7
    
    
    
    4
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    15Total
    
    $
    21
    
    
    $
    603
    
    
    $
    316
    
    
    $
    62
    
    
    $
    393
    
    
    $
    662
    
    
    $
    2,057
   (a)
    
    Does not include original issue discount of $7 million. The Company may consider refinancing alternatives or seek approval for
dividends to fund CNAFs 2005 debt service and principal repayment
requirements. See the Dividends from Subsidiaries section of this MD&A for
further information. Regulatory Matters The Company has established a plan to reorganize and streamline its U.S.
property and casualty insurance legal entity structure. One phase of this
multi-year plan was completed during 2003. This phase served to consolidate
the Companys U.S. property and casualty insurance risks into CCC, as well as
realign the capital supporting these risks. As part of this phase, the Company
implemented in the fourth quarter of 2003 a 100% quota share reinsurance
agreement, effective January 1, 2003, ceding all of the net insurance risks of
The Continental Insurance Company (CIC) and its 14 affiliated insurance
companies (CIC Group) to CCC. Additionally, the ownership of the CIC Group was
transferred to CCC in the fourth quarter of 2003 in order to align the
insurance risks with the supporting capital. In subsequent phases of this
plan, the Company will continue its efforts to reduce both the number of U.S.
property and casualty insurance entities it maintains and the number of states
in which such entities are domiciled. In order to facilitate the execution of
this plan, the Company, CCC and CIC have agreed to participate in a working
group consisting of several states of the National Association of Insurance
Commissioners. In connection with the approval process for aspects of the reorganization plan,
the Company agreed to undergo a state regulatory financial examination of CCC
and CIC as of December 31, 2003, including a review of insurance reserves by an
independent actuarial firm. These state regulatory financial examinations are
currently underway. The Company is presently engaged in discussions related to
the examination with state regulatory agencies and is exchanging information
with the independent actuarial firm. No date has been set for the issuance of
an examination report by the state authorities. Pursuant to its participation in the working group referenced above, the
Company has agreed to certain time frames and informational provisions in
relation to the reorganization plan. The Company has also agreed that any
proceeds from the sale of any member of the CIC pool, net of transaction
expenses, will be retained in CIC or one of its subsidiaries until the dividend
stipulation discussed below expires. Along with other companies in the industry, the Company has received subpoenas
and interrogatories from the New York and Connecticut State Attorney Generals
Offices concerning contingent compensation arrangements and fictitious quotes.
The Company is responding as required by law. Dividends from Subsidiaries CNAFs ability to pay dividends and other credit obligations is significantly
dependent on receipt of dividends from its subsidiaries. The payment of
dividends to CNAF by its insurance subsidiaries without 110




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CNA FINANCIAL CORPORATIONMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued prior approval of the insurance department of each subsidiarys domiciliary
jurisdiction is limited by formula. Dividends in excess of these amounts are
subject to prior approval by the respective state insurance departments. Dividends from CCC are subject to the insurance holding company laws of the
State of Illinois, the domiciliary state of CCC. Under these laws, ordinary
dividends, or dividends that do not require prior approval of the Illinois
Department of Insurance (the Department), may be paid only from earned surplus,
which is calculated by removing unrealized gains from unassigned surplus. As
of September 30, 2004, CCC is in a negative earned surplus position. Until CCC
is in a positive earned surplus position, all dividends require prior approval
of the Department. In January of 2004, the Department approved extraordinary
dividends in the amount of approximately $312 million to be used to fund the
CNAFs 2004 debt service and principal repayment requirements. As of September
30, 2004, there is approximately $41 million of this extraordinary dividend
capacity available for payment to CNAF. CCC intends to request approval for extraordinary dividends in 2005 to fund
CNAFs debt service and principal repayment requirements. By agreement with the
New Hampshire Insurance Department, the CIC Group may not pay dividends to CCC
until after January 1, 2006. Loews The Company has received substantial capital support from Loews. For further
information regarding the support received related to the November of 2003
capital plan see the Capital Plan section of this MD&A. Ratings Ratings are an important factor in establishing the competitive position of
insurance companies. CNAs insurance company subsidiaries are rated by major
rating agencies, and these ratings reflect the rating agencys opinion of the
insurance companys financial strength, operating performance, strategic
position and ability to meet its obligations to policyholders. Agency ratings
are not a recommendation to buy, sell or hold any security, and may be revised
or withdrawn at any time by the issuing organization. Each agencys rating
should be evaluated independently of any other agencys rating. One or more of
these agencies could take action in the future to change the ratings of CNAs
insurance subsidiaries. The actions that can be taken by rating agencies are changes in ratings or
modifiers. On Review, Credit Watch and Rating Watch are modifiers used
by the ratings agencies to alert those parties relying on the Companys ratings
of the possibility of a rating change in the near term. Modifiers are utilized
when the agencies are uncertain as to the impact of a Company action or
initiative, which could prove to be material to the current rating level.
Modifiers are generally used to indicate a possible change in rating within 90
days. Outlooks accompanied with ratings are additional modifiers used by the
rating agencies to alert those parties relying on the Companys ratings of the
possibility of a rating change in the longer term. The time frame referenced
in an outlook is not necessarily limited to ninety days as defined in the
Credit-Watch category. 111




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued The table below reflects the various group ratings issued by A.M. Best, Fitch,
Moodys and S&P as of October 12, 2004 for the Property and Casualty and Life
companies. The table also includes the ratings for CNAFs senior debt and
Continental senior debt. Insurance Financial Strength Ratings
    
    Debt RatingsProperty & Casualty (a)
    
    Life
    
    CNAF
    
    ContinentalCCC
    
    CIC
    
    
    
    Senior
    
    SeniorGroup
    
    Group
    
    CAC (b)
    
    Debt
    
    DebtA.M. Best
    
    A
    
    A
    
    A-
    
    bbb
    
    bbb-Fitch
    
    A-
    
    A-
    
    A-
    
    BBB-
    
    BBB-Moodys
    
    A3
    
    A3
    
    Baa1
    
    Baa3
    
    Baa3S&P
    
    A-
    
    A-
    
    BBB+
    
    BBB-
    
    BBB-
   (a)
    
    All outlooks for the Property & Casualty companies financial
strength and holding company debt ratings are negative.(b)
    
    A.M. Best and Moodys have a stable outlook while Fitch and S&P have
negative outlooks on the CAC rating. If CNAs property and casualty insurance financial strength ratings were
downgraded below current levels, CNAs business and results of operations could
be materially adversely affected. The severity of the impact on CNAs business
is dependent on the level of downgrade and, for certain products, which rating
agency takes the rating action. Among the adverse effects in the event of such
downgrades would be the inability to obtain a material volume of business from
certain major insurance brokers, the inability to sell a material volume of the
Companys insurance products to certain markets, and the required
collateralization of certain future payment obligations or reserves. In addition, the Company believes that a lowering of the debt ratings of Loews
by certain of these agencies could result in an adverse impact on CNAs
ratings, independent of any change in circumstances at CNA. Each of the major
rating agencies which rates Loews currently maintains a negative outlook, but
none currently has Loews on negative Credit Watch. The Company has entered into several settlement agreements and assumed
reinsurance contracts that require collateralization of future payment
obligations and assumed reserves if the Companys ratings or other specific
criteria fall below certain thresholds. The ratings triggers are generally
more than one level below the Companys current ratings. FORWARD-LOOKING STATEMENTS This quarterly report includes a number of statements which relate to
anticipated future events (forward-looking statements) rather than actual
present conditions or historical events. You can identify forward-looking
statements because generally they include words such as believes, expects,
intends, anticipates, estimates, and similar expressions.
Forward-looking statements in this report include expected developments in the
Companys insurance business, including losses and loss reserves for APMT
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 being conducted by the
Company; the ongoing state regulatory examinations of the Companys primary
insurance company subsidiaries, and the Companys responses to the results of
those reviews and examinations; the Companys expectations concerning its
revenues, earnings, expenses and investment activities; expected cost savings
and other results from the Companys expense reduction and restructuring
activities; and the Companys proposed actions in response to trends in its
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. Many of these risks and uncertainties
cannot be controlled by the Company. Some examples of these risks and
uncertainties are:  
    
    general economic and business conditions, including inflationary
pressures on medical care costs, construction costs and other economic
sectors that increase the severity of claims; 112




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued  
    
    changes in financial markets such as fluctuations in interest rates,
long-term periods of low interest rates, credit conditions and currency,
commodity and stock prices;  
    
    the effects of corporate bankruptcies, such as Enron and WorldCom, on
surety bond claims, as well as on capital markets, and on the markets for
directors and officers and errors and omissions coverages;  
    
    changes in foreign or domestic political, social and economic conditions;  
    
    regulatory initiatives and compliance with governmental regulations,
judicial decisions, including interpretation of policy provisions,
decisions regarding coverage and theories of liability, trends in
litigation and the outcome of any litigation involving the Company, and
rulings and changes in tax laws and regulations;  
    
    the effects upon insurance markets and upon industry business practices
and relationships of current litigation, investigations and regulatory
activity by the New York State Attorney Generals office and other
authorities concerning contingent commission arrangements with brokers and
bid solicitation activities;  
    
    regulatory limitations, impositions and restrictions upon the Company,
including the effects of assessments and other surcharges for guaranty
funds and second-injury funds and other mandatory pooling arrangements;  
    
    the impact of competitive products, policies and pricing and the
competitive environment in which the Company operates, including changes
in the Companys books 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 underpriced accounts, to achieve premium targets and
profitability and to realize growth and retention estimates;  
    
    development of claims and the impact on loss reserves, including changes
in claim settlement practices;  
    
    the effectiveness of current initiatives by claims management to reduce
loss and expense ratio through more efficacious claims handling
techniques;  
    
    the performance of reinsurance companies under reinsurance contracts with the Company;  
    
    results of financing efforts, including the availability of bank credit facilities;  
    
    changes in the Companys composition of operating segments;  
    
    weather and other natural physical events, including the severity and
frequency of storms, hail, snowfall and other winter conditions, as well
as of natural disasters such as hurricanes and earthquakes;  
    
    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 possibility that the Terrorism Risk Insurance Act of 2002 will not be
extended beyond the end of 2005, as a result of which the Company could
incur substantial additional exposure to losses resulting from terrorist
attacks, which could be increased by current state regulatory restrictions
on terrorism policy exclusions and by regulatory unwillingness to approve
such exclusions prospectively;  
    
    the occurrence of epidemics;  
    
    exposure to liabilities due to claims made by insureds and others
relating to asbestos remediation and health-based asbestos impairments, as
well as exposure to liabilities for environmental pollution, mass tort,
and construction defect claims; 113




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CNA FINANCIAL CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS, Continued  
    
    whether a national privately financed trust to replace litigation of
asbestos claims with payments to claimants from the trust will be
established or approved through federal legislation, or, if established
and approved, whether it will contain funding requirements in excess of
the Companys established loss reserves or carried loss reserves;  
    
    the sufficiency of the Companys loss reserves and the possibility of
future increases in reserves;  
    
    the risks and uncertainties associated with the Companys loss reserves
as outlined in the Reserves  Estimates and Uncertainties section of this
MD&A;  
    
    the level of success in integrating acquired businesses and operations,
and in consolidating, or selling existing ones;  
    
    the possibility of further changes in the Companys ratings by ratings
agencies, including the inability to access certain markets or
distribution channels and the required collateralization of future payment
obligations as a result of such changes, and changes in rating agency
policies and practices; and  
    
    the actual closing of contemplated transactions and agreements. Any forward-looking statements made in this report are made by the Company as
of the date of this quarterly report. The Company does not have any obligation
to update or revise any forward-looking statement contained in this quarterly
report, even if the Companys expectations or any related events, conditions or
circumstances change. 114




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CNA FINANCIAL CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk Market risk is a broad term related to changes in the fair value of a financial
instrument. Discussions herein regarding market risk focus on only one element
of market risk  price risk. Price risk relates to changes in the level of
prices due to changes in interest rates, equity prices, foreign exchange rates
or other factors that relate to market volatility of the rate, index or price
underlying the financial instrument. The Companys primary market risk
exposures are due to changes in interest rates, although the Company has
certain exposures to changes in equity prices and foreign currency exchange
rates. The fair value of the financial instruments is adversely affected when
interest rates rise, equity markets decline and the dollar strengthens against
foreign currency. Active management of market risk is integral to the Companys operations. The
Company may use the following tools to manage its exposure to market risk
within defined tolerance ranges: (1) change the character of future
investments purchased or sold, (2) use derivatives to offset the market
behavior of existing assets and liabilities or assets expected to be purchased
and liabilities to be incurred, or (3) rebalance its existing asset and
liability portfolios. For purposes of this disclosure, market risk sensitive instruments are divided
into two categories: (1) instruments entered into for trading purposes and (2)
instruments entered into for purposes other than trading. The Companys
general account market risk sensitive instruments presented are classified as
held for purposes other than trading. In accordance with the provisions of SOP 03-01, the classification and
presentation of certain balance sheet and income statement items have been
modified. Accordingly, the investment securities previously classified as
separate account assets have now been reclassified to the general account and
will be reported based on their investment classification whether
available-for-sale or trading securities. The investment portfolio for the
indexed group annuity contracts is classified as held for trading purposes and
is carried at fair value, with both the net realized and unrealized gains
(losses) included within net investment income in the Condensed Consolidated
Statement of Operations. Consistent with the requirements of SOP 03-01, prior
year amounts have not been conformed to the current year presentation. Sensitivity Analysis CNA monitors its sensitivity to interest rate risk by evaluating the change in
the value of financial assets and liabilities due to fluctuations in interest
rates. The evaluation is performed by applying an instantaneous change in
interest rates of varying magnitudes on a static balance sheet to determine the
effect such a change in rates would have on the Companys fair value at risk
and the resulting effect on stockholders equity. The analysis presents the
sensitivity of the fair value of the Companys financial instruments to
selected changes in market rates and prices. The range of change chosen
reflects the Companys view of changes that are reasonably possible over a
one-year period. The selection of the range of values chosen to represent
changes in interest rates should not be construed as the Companys prediction
of future market events, but rather an illustration of the impact of such
events. The sensitivity analysis estimates the decline in the fair value of the
Companys interest sensitive assets and liabilities that were held on September
30, 2004 and December 31, 2003 due to instantaneous parallel increases in the
period end yield curve of 100 and 150 basis points. 115




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CNA FINANCIAL CORPORATIONITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, Continued

The sensitivity analysis also assumes an instantaneous 10% and 20% decline in
the foreign currency exchange rates versus the United States dollar from their
levels at September 30, 2004 and December 31, 2003, with all other variables
held constant.

Equity price risk was measured assuming an instantaneous 10% and 25% decline in
the S&P 500 Index (Index) from its level at September 30, 2004 and December 31,
2003, with all other variables held constant. The Companys equity holdings
were assumed to be highly and positively correlated with the Index. At
September 30, 2004, a 10% and 25% decrease in the Index would result in a $206
million and $516 million decrease compared to $245 million and $612 million
decrease at December 31, 2003, in the fair value of the Companys equity
investments.

116



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CNA FINANCIAL CORPORATIONITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, Continued

Of these amounts, under the 10% and 25% scenarios, $5 million and $13 million
at September 30, 2004 and $168 million and $418 million at December 31, 2003
pertained to decreases in the fair value of the separate account investments.
These decreases would substantially be offset by decreases in related separate
account liabilities to customers. Similarly, increases in the fair value of
the separate account equity investments would also be offset by increases in
the same related separate account liabilities by the same approximate amounts.

The following tables present the estimated effects on the fair value of the
Companys financial instruments at September 30, 2004 and December 31, 2003,
due to an increase in interest rates of 100 basis points, a 10% decline in
foreign currency exchange rates and a 10% decline in the Index.

Market Risk Scenario 1

Increase (Decrease)Market
    
    Interest
    
    Currency
    
    EquitySeptember 30, 2004
    
    Value
    
    Rate Risk
    
    Risk
    
    Risk(In millions)General account:Fixed maturity securities available-for-sale
    
    $
    31,403
    
    
    $
    (1,929
    )
    
    $
    (85
    )
    
    $
    (36
    )Fixed maturity trading securities
    
    
    317
    
    
    
    (3
    )
    
    
    
    
    
    
    (5
    )Equity securities available-for-sale
    
    
    343
    
    
    
    
    
    
    
    (7
    )
    
    
    (34
    )Short term investments available-for-sale
    
    
    3,767
    
    
    
    (3
    )
    
    
    (2
    )
    
    
    Short term trading securities
    
    
    375
    
    
    
    
    
    
    
    
    
    
    
    Limited partnerships
    
    
    1,715
    
    
    
    7
    
    
    
    
    
    
    
    (20
    )Other invested assets
    
    
    27
    
    
    
    
    
    
    
    
    
    
    
    Interest rate swaps
    
    
    3
    
    
    
    180
    
    
    
    
    
    
    
    Equity indexed futures for trading securities
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    (106
    )Other derivative securities
    
    
    
    
    
    
    (27
    )
    
    
    1
    
    
    
    Total general account
    
    
    37,950
    
    
    
    (1,773
    )
    
    
    (93
    )
    
    
    (201
    )Separate accounts:Fixed maturity securities
    
    
    487
    
    
    
    (23
    )
    
    
    
    
    
    
    Equity securities
    
    
    52
    
    
    
    
    
    
    
    
    
    
    
    (5
    )Short term investments
    
    
    18
    
    
    
    
    
    
    
    
    
    
    
    Other invested assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total separate accounts
    
    
    557
    
    
    
    (23
    )
    
    
    
    
    
    
    (5
    )Total securities
    
    $
    38,507
    
    
    $
    (1,796
    )
    
    $
    (93
    )
    
    $
    (206
    )Debt (carrying value)
    
    $
    1,713
    
    
    $
    (60
    )
    
    $
    
    
    
    $
    


117



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CNA FINANCIAL CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, Continued

Market Risk Scenario 1

Increase (Decrease)Fair
    
    Interest
    
    Currency
    
    EquityDecember 31, 2003
    
    Value
    
    Rate Risk
    
    Risk
    
    Risk(In millions)Held for Other Than Trading Purposes:General account:Fixed maturity securities
    
    $
    28,678
    
    
    $
    (1,979
    )
    
    $
    (35
    )
    
    $
    (13
    )Equity securities
    
    
    527
    
    
    
    
    
    
    
    (26
    )
    
    
    (51
    )Short term investments
    
    
    7,538
    
    
    
    (5
    )
    
    
    (16
    )
    
    
    Limited partnerships
    
    
    1,117
    
    
    
    5
    
    
    
    
    
    
    
    (13
    )Other invested assets
    
    
    233
    
    
    
    
    
    
    
    
    
    
    
    Interest rate swaps
    
    
    (5
    )
    
    
    3
    
    
    
    
    
    
    
    Other derivative securities
    
    
    12
    
    
    
    (108
    )
    
    
    1
    
    
    
    Total general account
    
    
    38,100
    
    
    
    (2,084
    )
    
    
    (76
    )
    
    
    (77
    )Separate accounts:Fixed maturity securities
    
    
    1,809
    
    
    
    (113
    )
    
    
    
    
    
    
    Equity securities
    
    
    117
    
    
    
    
    
    
    
    
    
    
    
    (12
    )Short term investments
    
    
    82
    
    
    
    
    
    
    
    
    
    
    
    Other invested assets
    
    
    415
    
    
    
    
    
    
    
    
    
    
    
    (41
    )Total separate accounts
    
    
    2,423
    
    
    
    (113
    )
    
    
    
    
    
    
    (53
    )Total securities held for other than trading purposes
    
    
    40,523
    
    
    
    (2,197
    )
    
    
    (76
    )
    
    
    (130
    )Held for Trading Purposes:Separate accounts:Fixed maturity securities
    
    
    304
    
    
    
    (4
    )
    
    
    
    
    
    
    (1
    )Short term investments
    
    
    414
    
    
    
    
    
    
    
    
    
    
    
    Limited partnerships
    
    
    419
    
    
    
    2
    
    
    
    
    
    
    
    (3
    )Equity indexed futures
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    (111
    )Other derivative securities
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    Total securities held for trading purposes
    
    
    1,137
    
    
    
    (1
    )
    
    
    
    
    
    
    (115
    )Total securities
    
    $
    41,660
    
    
    $
    (2,198
    )
    
    $
    (76
    )
    
    $
    (245
    )Debt (carrying value)
    
    $
    1,904
    
    
    $
    (70
    )
    
    $
    
    
    
    $
    


118



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CNA FINANCIAL CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, Continued

The following tables present the estimated effects on the fair value of the
Companys financial instruments at September 30, 2004 and December 31, 2003,
due to an increase in interest rates of 150 basis points, a 20% decline in
foreign currency exchange rates and a 25% decline in the Index.

Market Risk Scenario 2

Increase (Decrease)Market
    
    Interest
    
    Currency
    
    EquitySeptember 30, 2004
    
    Value
    
    Rate Risk
    
    Risk
    
    Risk(In millions)General account:Fixed maturity securities available-for-sale
    
    $
    31,403
    
    
    $
    (2,869
    )
    
    $
    (170
    )
    
    $
    (91
    )Fixed maturity trading securities
    
    
    317
    
    
    
    (5
    )
    
    
    
    
    
    
    (11
    )Equity securities available-for-sale
    
    
    343
    
    
    
    
    
    
    
    (14
    )
    
    
    (85
    )Short term investments available-for-sale
    
    
    3,767
    
    
    
    (4
    )
    
    
    (4
    )
    
    
    Short term trading securities
    
    
    375
    
    
    
    
    
    
    
    
    
    
    
    Limited partnerships
    
    
    1,715
    
    
    
    10
    
    
    
    
    
    
    
    (51
    )Other invested assets
    
    
    27
    
    
    
    
    
    
    
    
    
    
    
    Interest rate swaps
    
    
    3
    
    
    
    266
    
    
    
    
    
    
    
    Equity indexed futures for trading securities
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    (265
    )Other derivative securities
    
    
    
    
    
    
    (47
    )
    
    
    1
    
    
    
    Total general account
    
    
    37,950
    
    
    
    (2,646
    )
    
    
    (187
    )
    
    
    (503
    )Separate accounts:Fixed maturity securities
    
    
    487
    
    
    
    (35
    )
    
    
    
    
    
    
    Equity securities
    
    
    52
    
    
    
    
    
    
    
    
    
    
    
    (13
    )Short term investments
    
    
    18
    
    
    
    
    
    
    
    
    
    
    
    Other invested assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total separate accounts
    
    
    557
    
    
    
    (35
    )
    
    
    
    
    
    
    (13
    )Total securities
    
    $
    38,507
    
    
    $
    (2,681
    )
    
    $
    (187
    )
    
    $
    (516
    )Debt (carrying value)
    
    $
    1,713
    
    
    $
    (87
    )
    
    $
    
    
    
    $
    


119



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CNA FINANCIAL CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, Continued

Market Risk Scenario 2

Increase (Decrease)Fair
    
    Interest
    
    Currency
    
    EquityDecember 31, 2003
    
    Value
    
    Rate Risk
    
    Risk
    
    Risk(In millions)Held for Other Than Trading Purposes:General account:Fixed maturity securities
    
    $
    28,678
    
    
    $
    (2,896
    )
    
    $
    (71
    )
    
    $
    (32
    )Equity securities
    
    
    527
    
    
    
    
    
    
    
    (52
    )
    
    
    (129
    )Short term investments
    
    
    7,538
    
    
    
    (7
    )
    
    
    (32
    )
    
    
    Limited partnerships
    
    
    1,117
    
    
    
    7
    
    
    
    
    
    
    
    (33
    )Other invested assets
    
    
    233
    
    
    
    
    
    
    
    
    
    
    
    Interest rate caps
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    Interest rate swaps
    
    
    (5
    )
    
    
    4
    
    
    
    
    
    
    
    Other derivative securities
    
    
    12
    
    
    
    (184
    )
    
    
    3
    
    
    
    Total general account
    
    
    38,100
    
    
    
    (3,075
    )
    
    
    (152
    )
    
    
    (194
    )Separate accounts:Fixed maturity securities
    
    
    1,809
    
    
    
    (165
    )
    
    
    
    
    
    
    Equity securities
    
    
    117
    
    
    
    
    
    
    
    
    
    
    
    (29
    )Short term investments
    
    
    82
    
    
    
    
    
    
    
    
    
    
    
    Other invested assets
    
    
    415
    
    
    
    
    
    
    
    
    
    
    
    (103
    )Total separate accounts
    
    
    2,423
    
    
    
    (165
    )
    
    
    
    
    
    
    (132
    )Total securities held for other than trading purposes
    
    
    40,523
    
    
    
    (3,240
    )
    
    
    (152
    )
    
    
    (326
    )Held for Trading Purposes:Separate accounts:Fixed maturity securities
    
    
    304
    
    
    
    (6
    )
    
    
    
    
    
    
    (2
    )Short term investments
    
    
    414
    
    
    
    (1
    )
    
    
    
    
    
    
    Limited partnerships
    
    
    419
    
    
    
    3
    
    
    
    
    
    
    
    (7
    )Equity indexed futures
    
    
    
    
    
    
    4
    
    
    
    
    
    
    
    (277
    )Other derivative securities
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    Total securities held for trading purposes
    
    
    1,137
    
    
    
    (1
    )
    
    
    
    
    
    
    (286
    )Total securities
    
    $
    41,660
    
    
    $
    (3,241
    )
    
    $
    (152
    )
    
    $
    (612
    )Debt (carrying value)
    
    $
    1,904
    
    
    $
    (102
    )
    
    $
    
    
    
    $
    


120



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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, 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.

The Companys principal executive officer and its principal financial officer
undertook an evaluation of the Companys disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the
period covered by this report and concluded that the Companys controls and
procedures were effective.

There were no significant changes in the Companys internal control over
financial reporting identified in connection with the foregoing evaluation that
occurred during the Companys last fiscal quarter that have materially
affected, or are reasonably likely to materially affect, the Companys internal
control over financial reporting.

121



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CNA FINANCIAL CORPORATION
PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings Information on CNAs legal proceedings is set forth in Notes F and G of the
Condensed Consolidated Financial Statements included under Part I, Item 1. 
 Item 6. Exhibits (a) Exhibits Description of Exhibit
    
    Exhibit NumberCertification of Chief Executive Officer pursuant to 18 U.S.C. 1350,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
    
    
    31.1Certification of Acting Chief Financial Officer pursuant to 18 U.S.C. 1350,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
    
    
    31.2Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
    
    
    32.1
    *Certification of Acting Chief Financial Officer pursuant to 18 U.S.C. 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
    
    
    32.2
    *
   *
    
    Exhibits 32.1 and 32.2 are being furnished and shall not be deemed
filed for the purpose of Section 18 of the Securities Exchange Act of
1934, as amended, or otherwise subject to the liabilities of that Section.
These Exhibits shall not be incorporated by reference into any
registration statement or other document pursuant to the Securities Act of
1933, as amended. 122




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CNA FINANCIAL CORPORATION
PART II. OTHER INFORMATION 
 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 CorporationDated: October 29, 2004
    By
    /s/ Lawrence J. BoysenLawrence J. BoysenActing Chief Financial Officer 123