##### Table of Contents



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
 
 o
    
    
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
 Commission File Number 1-5823   CNA FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) Delaware
(State or other jurisdiction of
incorporation or organization)
    
    36-6169860
(I.R.S. Employer
Identification No.)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 ü No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes ü 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 July 27, 2004Common Stock, Par value $2.50
    
    
    255,947,252




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CNA FINANCIAL
CORPORATIONINDEX  
 Item
    
    
    
    PageNumber
    
    
    
    NumberPART I. Financial Information1.
    
    Condensed Consolidated Financial Statements (Unaudited):Condensed Consolidated Balance Sheets at June 30, 2004 and at December 31,
2003
    
    3Condensed Consolidated Statements of Operations for the Three and Six Months Ended
June 30, 2004 and 2003
    
    4Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30,
2004 and 2003
    
    5Notes to Condensed Consolidated Financial Statements
    
    62.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    473.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    1084.
    
    Disclosure Controls and Procedures
    
    114PART II. Other Information1.
    
    Legal Proceedings
    
    1152.
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
    
    1154.
    
    Matters Subject to a Vote of Security Holders
    

    1156.
    
    Exhibits and Reports on Form 8-K
    
    116Signatures
    
    117CertificationCertificationCertificationCertification




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##### Table of Contents



CNA FINANCIAL CORPORATION 
 PART I. FINANCIAL INFORMATION
 
 ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 June 30,
    
    December 31,2004
    
    2003(In millions, except share data)AssetsInvestments:Fixed maturity securities at fair value (amortized cost of $30,012 and $27,564)
    
    $
    30,143
    
    
    $
    28,678Equity securities at fair value (cost of $218 and $293)
    
    
    300
    
    
    
    527Mortgage loans and real estate (less accumulated depreciation of $11 and $10)
    
    
    24
    
    
    
    25Limited partnership investments
    
    
    1,686
    
    
    
    1,117Other invested assets
    
    
    5
    
    
    
    215Short-term investments, at cost which approximates fair value
    
    
    3,853
    
    
    
    7,538Total investments
    
    
    36,011
    
    
    
    38,100Cash
    
    
    103
    
    
    
    139Reinsurance receivables (less allowance for uncollectible receivables of $503 and $573)
    
    
    15,651
    
    
    
    15,681Insurance receivables (less allowance for doubtful accounts of $386 and $375)
    
    
    2,521
    
    
    
    2,707Accrued investment income
    
    
    318
    
    
    
    323Receivables for securities sold
    
    
    1,119
    
    
    
    836Deferred acquisition costs
    
    
    1,343
    
    
    
    2,533Prepaid reinsurance premiums
    
    
    1,027
    
    
    
    1,252Federal income taxes recoverable (includes $68 and $594 due from Loews Corporation)
    
    
    86
    
    
    
    607Deferred income taxes
    
    
    1,031
    
    
    
    600Property and equipment at cost (less accumulated depreciation of $673 and $727)
    
    
    271
    
    
    
    314Goodwill and other intangible assets
    
    
    162
    
    
    
    162Assets related to businesses held for sale
    
    
    200
    
    
    
    Other assets
    
    
    766
    
    
    
    1,571Separate account business
    
    
    576
    
    
    
    3,678Total assets
    
    $
    61,185
    
    
    $
    68,503Liabilities and Stockholders EquityLiabilities:Insurance reserves:Claim and claim adjustment expense
    
    $
    31,563
    
    
    $
    31,730Unearned premiums
    
    
    4,610
    
    
    
    4,891Future policy benefits
    
    
    5,634
    
    
    
    8,161Policyholders funds
    
    
    1,787
    
    
    
    601Collateral on loaned securities and derivatives
    
    
    223
    
    
    
    442Payables for securities purchased
    
    
    1,098
    
    
    
    1,902Participating policyholders funds
    
    
    66
    
    
    
    118Short term debt
    
    
    506
    
    
    
    263Long term debt ($46 and $0 of surplus notes due to Loews Corporation)
    
    
    1,208
    
    
    
    1,641Reinsurance balances payable
    
    
    3,156
    
    
    
    3,432Liabilities related to businesses held for sale
    
    
    170
    
    
    
    Other liabilities
    
    
    1,995
    
    
    
    2,436Separate account business
    
    
    576
    
    
    
    3,678Total liabilities
    
    
    52,592
    
    
    
    59,295Commitments and contingencies (Notes F, G, I and K)Minority interest
    
    
    263
    
    
    
    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 shares issued; and
255,947,252 and 223,617,337 shares outstanding)
    
    
    645
    
    
    
    565Additional paid-in capital
    
    
    1,701
    
    
    
    1,031Retained earnings
    
    
    5,324
    
    
    
    5,160Accumulated other comprehensive income
    
    
    52
    
    
    
    841Treasury stock (2,230,033 and 2,232,933 shares), at cost
    
    
    (69
    )
    
    
    (69
    )8,403
    
    
    
    9,028Notes receivable for the issuance of common stock
    
    
    (73
    )
    
    
    (76
    )Total stockholders equity
    
    
    8,330
    
    
    
    8,952Total liabilities and stockholders equity
    
    $
    61,185
    
    
    $
    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
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions, except per share data)RevenuesNet earned premiums
    
    $
    2,106
    
    
    $
    2,197
    
    
    $
    4,274
    
    
    $
    4,578Net investment income
    
    
    380
    
    
    
    427
    
    
    
    853
    
    
    
    859Realized investment gains (losses), net of
participating policyholders and minority
interests
    
    
    105
    
    
    
    378
    
    
    
    (353
    )
    
    
    302Other revenues
    
    
    72
    
    
    
    97
    
    
    
    154
    
    
    
    205Total revenues
    
    
    2,663
    
    
    
    3,099
    
    
    
    4,928
    
    
    
    5,944Claims, Benefits and ExpensesInsurance claims and policyholders benefits
    
    
    1,625
    
    
    
    2,108
    
    
    
    3,263
    
    
    
    3,978Amortization of deferred acquisition costs
    
    
    307
    
    
    
    481
    
    
    
    740
    
    
    
    939Other operating expenses
    
    
    375
    
    
    
    400
    
    
    
    707
    
    
    
    779Interest
    
    
    31
    
    
    
    33
    
    
    
    66
    
    
    
    67Total claims, benefits and expenses
    
    
    2,338
    
    
    
    3,022
    
    
    
    4,776
    
    
    
    5,763Income before income tax and minority interest
    
    
    325
    
    
    
    77
    
    
    
    152
    
    
    
    181Income tax (expense) benefit
    
    
    (29
    )
    
    
    (5
    )
    
    
    25
    
    
    
    (23
    )Minority interest
    
    
    (7
    )
    
    
    (2
    )
    
    
    (13
    )
    
    
    (5
    )Net income
    
    $
    289
    
    
    $
    70
    
    
    $
    164
    
    
    $
    153Basic and Diluted Earnings Per ShareBasic and diluted earnings per share
available to common stockholders
    
    $
    1.07
    
    
    $
    0.25
    
    
    $
    0.52
    
    
    $
    0.55Weighted average outstanding common stock and
common stock equivalents
    
    
    255.9
    
    
    
    223.6
    
    
    
    255.9
    
    
    
    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)
 Six months ended June 30
    
    2004
    
    2003(In millions)Cash Flows from Operating ActivitiesNet income
    
    $
    164
    
    
    $
    153Adjustments to reconcile net income to net cash flows provided by operating activities:Change in bad debt provision for insurance and reinsurance receivables
    
    
    (57
    )
    
    
    91Minority interest
    
    
    13
    
    
    
    5Loss on disposal of property and equipment
    
    
    
    
    
    
    18Deferred income tax provision
    
    
    (17
    )
    
    
    131Realized investment gains (losses), net of participating policyholders and minority interests
    
    
    353
    
    
    
    (302
    )Equity method income
    
    
    (107
    )
    
    
    (97
    )Amortization of bond discount
    
    
    1
    
    
    
    (33
    )Depreciation
    
    
    36
    
    
    
    44Changes in:Receivables
    
    
    (951
    )
    
    
    (896
    )Deferred acquisition costs
    
    
    118
    
    
    
    (97
    )Accrued investment income
    
    
    (32
    )
    
    
    (63
    )Federal income taxes payable/recoverable
    
    
    511
    
    
    
    (208
    )Prepaid reinsurance premiums
    
    
    225
    
    
    
    (116
    )Reinsurance balances payable
    
    
    (242
    )
    
    
    77Insurance reserves
    
    
    805
    
    
    
    1,276Other, net
    
    
    (133
    )
    
    
    132Net purchases of trading securities
    
    
    (4
    )
    
    
    Total adjustments
    
    
    519
    
    
    
    (38
    )Net cash flows provided by operating activities
    
    
    683
    
    
    
    115Cash Flows from Investing ActivitiesPurchases of fixed maturity securities
    
    
    (31,300
    )
    
    
    (34,111
    )Proceeds from fixed maturity securities:Sales
    
    
    23,439
    
    
    
    28,924Maturities, calls and redemptions
    
    
    2,751
    
    
    
    3,062Purchases of equity securities
    
    
    (112
    )
    
    
    (151
    )Proceeds from sales of equity securities
    
    
    309
    
    
    
    265Change in short-term investments
    
    
    3,941
    
    
    
    1,722Change in collateral on loaned securities and derivatives
    
    
    (219
    )
    
    
    433Change in other investments
    
    
    63
    
    
    
    (3
    )Purchases of property and equipment
    
    
    (24
    )
    
    
    (54
    )Dispositions
    
    
    631
    
    
    
    (44
    )Other, net
    
    
    (21
    )
    
    
    5Net cash flows provided (used) by investing activities
    
    
    (542
    )
    
    
    48Net Cash Flows from Financing ActivitiesPrincipal payments on debt
    
    
    (536
    )
    
    
    (135
    )Proceeds from issuance of surplus notes
    
    
    346
    
    
    
    Returns and deposits of policyholder account balances on investment contracts
    
    
    10
    
    
    
    (13
    )Other
    
    
    3
    
    
    
    (1
    )Net cash flows used by financing activities
    
    
    (177
    )
    
    
    (149
    )Net change in cash
    
    
    (36
    )
    
    
    14Cash, beginning of period
    
    
    139
    
    
    
    126Cash, end of period
    
    $
    103
    
    
    $
    140Supplemental Disclosures of Cash Flow Information:Cash paid (received):Interest
    
    $
    57
    
    
    $
    69Federal income taxes
    
    
    (540
    )
    
    
    81Non-cash transactions:Notes receivable for the issuance of common stock
    
    
    
    
    
    
    1
 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 June 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 three
and six months ended June 30, 2004 and 2003. See Note N for further
information. CNA Group Life Assurance Company (CNAGLA) was sold to Hartford Financial
Services Group, Inc. 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 six months ended June 30, 2003. See Note N for
further information. The accompanying Condensed Consolidated Financial Statements have been prepared
in conformity with accounting principles generally accepted in the United
States of America (GAAP). Certain financial information that is normally
included in annual financial statements, including certain financial statement
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 June 30, 2004 and for the three and six months
ended June 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. 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 6




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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 Company has determined that 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 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 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. 7




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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. 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. June 30,
    
    January 1,2004
    
    2004 (a)(In millions)AssetsInvestments:Fixed maturity securities, available-for-sale
    
    $
    882
    
    
    $
    1,220Fixed maturity securities, trading
    
    
    405
    
    
    
    304Equity securities
    
    
    4
    
    
    
    4Limited partnerships
    
    
    468
    
    
    
    419Short term investments, available-for-sale
    
    
    10
    
    
    
    55Short term investments, trading
    
    
    315
    
    
    
    414Total investments
    
    
    2,084
    
    
    
    2,416Accrued investment income
    
    
    11
    
    
    
    13Receivables for securities sold
    
    
    83
    
    
    
    97Other assets
    
    
    
    
    
    
    1Total assets
    
    $
    2,178
    
    
    $
    2,527LiabilitiesLiabilities:Insurance reserves:Claim and claim adjustment expense
    
    
    1
    
    
    
    1Future policy benefits
    
    
    530
    
    
    
    617Policyholders funds
    
    
    1,223
    
    
    
    1,324Collateral on loaned securities and derivatives
    
    
    
    
    
    
    17Payables for securities purchased
    
    
    87
    
    
    
    43Other liabilities
    
    
    65
    
    
    
    47Total liabilities
    
    $
    1,906
    
    
    $
    2,049
 (a) Includes assets and liabilities of the individual life business sold
on April 30, 2004. See Note N for further information. 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 2003and 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
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 is effective for the
first interim or annual period beginning after June 15, 2004, and is not
expected to 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 8




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) Certain Investments(EITF 03-1) as applicable to debt and equity securities
that are within the scope of SFAS 115 Accounting for Certain Investments in
Debt and Equity Securitiesand equity securities that are accounted for using
the cost method specified in Accounting Policy Board Opinion No. 18 The Equity
Method of Accounting for Investments in Common Stock. 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. EITF
03-1 outlines that 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 is effective for reporting periods beginning after June
15, 2004. The Company is currently evaluating the impact of this new accounting standard
on its process for determining other-than-temporary impairment of equity and
fixed maturity securities. Adoption of this standard 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 will likely also impact the recognition of investment income on
impaired securities. 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. Note C. Earnings Per Share Earnings 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 diluted earnings per share was 255.9 million for the
three and six months ended June 30, 2004 and 223.6 million for the three and
six months ended June 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 June 30, 2004, the Company has $95 million of undeclared but
accumulated dividends. The Series H Issue dividend amounts for the three and
six months ended June 30, 2004 and 2003 have been subtracted from Net Income to
determine income available to common stockholders. Diluted earnings 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 six months ended June 30, 2004 and 2003,
approximately one million shares attributable to the exercise of outstanding
options were excluded from the calculation of diluted earnings per share
because the exercise price of these options was greater than the average market
price of CNA common stock. 9




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) The computation of earnings per share was as follows. Earnings Per Share Three Months
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions, except per share amounts)Net income
    
    $
    289
    
    
    $
    70
    
    
    $
    164
    
    
    $
    153Less: undeclared preferred stock dividend
    
    
    (16
    )
    
    
    (15
    )
    
    
    (32
    )
    
    
    (30
    )Net income available to common stockholders
    
    $
    273
    
    
    $
    55
    
    
    $
    132
    
    
    $
    123Weighted average outstanding common stock and common
stock equivalents
    
    
    255.9
    
    
    
    223.6
    
    
    
    255.9
    
    
    
    223.6Effect of dilutive securities, employee stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Adjusted weighted average outstanding common stock
and common stock equivalents assuming conversions
    
    
    255.9
    
    
    
    223.6
    
    
    
    255.9
    
    
    
    223.6Basic and diluted earnings per share available to
common stockholders
    
    $
    1.07
    
    
    $
    0.25
    
    
    $
    0.52
    
    
    $
    0.55
 The Company applies the intrinsic value method by following 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. The following table illustrates the pro forma effect on net income 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 and Earnings Per Share Three Months
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions, except per share amounts)Net income, as reported
    
    $
    289
    
    
    $
    70
    
    
    $
    164
    
    
    $
    153Less: Total stock-based compensation cost determined
under the fair value method, net of tax
    
    
    
    
    
    
    (1
    )
    
    
    (1
    )
    
    
    (1
    )Pro forma net income
    
    
    289
    
    
    
    69
    
    
    
    163
    
    
    
    152Less: undeclared preferred stock dividend
    
    
    (16
    )
    
    
    (15
    )
    
    
    (32
    )
    
    
    (30
    )Pro forma net income available to common stockholders
    
    $
    273
    
    
    $
    54
    
    
    $
    131
    
    
    $
    122Basic and diluted earnings per share, as reported
    
    $
    1.07
    
    
    $
    0.25
    
    
    $
    0.52
    
    
    $
    0.55Basic and diluted earnings per share, pro forma
    
    $
    1.07
    
    
    $
    0.25
    
    
    $
    0.52
    
    
    $
    0.55
 10




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) Note D. Investments The significant components of net investment income are presented in the
following table. Net Investment Income Three Months
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Fixed maturity securities
    
    $
    386
    
    
    $
    422
    
    
    $
    793
    
    
    $
    842Short term investments
    
    
    9
    
    
    
    12
    
    
    
    25
    
    
    
    32Limited partnerships
    
    
    30
    
    
    
    75
    
    
    
    105
    
    
    
    98Equity securities
    
    
    4
    
    
    
    4
    
    
    
    8
    
    
    
    9Income from trading portfolio (a)
    
    
    14
    
    
    
    
    
    
    
    34
    
    
    
    Interest on funds withheld and other deposits
    
    
    (56
    )
    
    
    (93
    )
    
    
    (106
    )
    
    
    (140
    )Other
    
    
    1
    
    
    
    18
    
    
    
    11
    
    
    
    43Gross investment income
    
    
    388
    
    
    
    438
    
    
    
    870
    
    
    
    884Investment expense
    
    
    (8
    )
    
    
    (11
    )
    
    
    (17
    )
    
    
    (25
    )Net investment income
    
    $
    380
    
    
    $
    427
    
    
    $
    853
    
    
    $
    859
 (a) The change in net unrealized gains (losses) on trading securities
still held, included in net investment income, was $(2) million and $2 million
for the three and six months ended June 30, 2004. The components of realized investment results from available-for-sale
securities are presented in the following table. Realized Investment Gains (Losses) Three Months
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Realized investment gains (losses):Fixed maturity securities:U.S. Government bonds
    
    $
    (1
    )
    
    $
    37
    
    
    $
    9
    
    
    $
    75Corporate and other taxable bonds
    
    
    27
    
    
    
    244
    
    
    
    33
    
    
    
    126Tax-exempt bonds
    
    
    (92
    )
    
    
    76
    
    
    
    (19
    )
    
    
    95Asset-backed bonds
    
    
    (4
    )
    
    
    23
    
    
    
    35
    
    
    
    41Redeemable preferred stock
    
    
    3
    
    
    
    (5
    )
    
    
    5
    
    
    
    (10
    )Total fixed maturity securities
    
    
    (67
    )
    
    
    375
    
    
    
    63
    
    
    
    327Equity securities
    
    
    166
    
    
    
    58
    
    
    
    177
    
    
    
    58Derivative securities
    
    
    49
    
    
    
    (55
    )
    
    
    17
    
    
    
    (77
    )Short term investments
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    10Other, including disposition of businesses net of
participating policyholders interest
    
    
    (39
    )
    
    
    (4
    )
    
    
    (604
    )
    
    
    (17
    )Realized investment gains (losses) before allocation to
participating policyholders and minority interests
    
    
    109
    
    
    
    380
    
    
    
    (347
    )
    
    
    301Allocated to participating policyholders and minority interest
    
    
    (4
    )
    
    
    (2
    )
    
    
    (6
    )
    
    
    1Realized investment gains (losses), net of participating
policyholders and minority interests
    
    $
    105
    
    
    $
    378
    
    
    $
    (353
    )
    
    $
    302
 Realized investment gains were $105 million and $378 million for the three
months ended June 30, 2004 and 2003. The decline in pretax realized gains was
primarily driven by unfavorable results in fixed maturity securities, partially
offset by a $162 million pretax gain on the disposition of the
Companys equity holdings 11




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) of Canary Wharf Group PLC (Canary Wharf), a London-based real estate
investment, and increased realized gains related to derivative securities. Realized investment losses were $353 million for the six months ended June 30,
2004 as compared to realized investment gains of $302 million for the six
months ended June 30, 2003. The decrease in the pretax realized investment
results was due primarily to a $622 million pretax loss on the sale of the
individual life insurance business (See Note N for further information), and
decreased realized gains related to fixed maturity securities. These decreases
were partially offset by a $162 million pretax gain on Canary Wharf, and
increased realized gains related to derivative securities. Realized investment gains for the three and six months ended June 30, 2003
included $31 million and $286 million of pretax impairment losses for
other-than-temporary declines in fair values for fixed maturity and equity
securities. These impairment losses were primarily for securities in certain
market sectors, including the airline, healthcare and energy industries. There
were no impairment losses for other-than-temporary declines in fair value for
fixed maturity and equity securities for the three and six months ended June
30, 2004. Investments in the general account had a total net unrealized gain of $213
million at June 30, 2004 compared with $1,348 million at December 31, 2003.
The net unrealized position at June 30, 2004 was composed of a net unrealized
gain of $131 million for fixed maturities and a net unrealized gain of $82
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. The following tables summarize the unrealized gain (loss) position related to
fixed maturity and equity securities. Unrealized Gains (Losses) on Fixed Maturity and Equity Securities Cost or
    
    Gross
    
    Gross Unrealized Losses
    
    NetAmortized
    
    Unrealized
    
    Less than
    
    Greater than
    
    UnrealizedJune 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
    
    $
    962
    
    
    $
    84
    
    
    $
    12
    
    
    $
    6
    
    
    $
    66Asset-backed securities
    
    
    9,091
    
    
    
    81
    
    
    
    148
    
    
    
    3
    
    
    
    (70
    )States, municipalities and political
subdivisions  tax-exempt
    
    
    8,989
    
    
    
    67
    
    
    
    188
    
    
    
    11
    
    
    
    (132
    )Corporate securities
    
    
    7,036
    
    
    
    288
    
    
    
    138
    
    
    
    26
    
    
    
    124Other debt securities
    
    
    3,135
    
    
    
    216
    
    
    
    69
    
    
    
    6
    
    
    
    141Redeemable preferred stock
    
    
    154
    
    
    
    6
    
    
    
    2
    
    
    
    2
    
    
    
    2Options embedded in convertible debt
securities
    
    
    240
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total fixed maturity securities
available-for-sale
    
    
    29,607
    
    
    
    742
    
    
    
    557
    
    
    
    54
    
    
    
    131Total fixed maturity trading securities
    
    
    405
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Equity securities:Common stock
    
    
    150
    
    
    
    76
    
    
    
    6
    
    
    
    
    
    
    
    70Non-redeemable preferred stock
    
    
    68
    
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    12Total equity securities
    
    
    218
    
    
    
    88
    
    
    
    6
    
    
    
    
    
    
    
    82Total fixed maturity and equity securities
    
    $
    30,230
    
    
    $
    830
    
    
    $
    563
    
    
    $
    54
    
    
    $
    213
 12




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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
 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
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)General accountSwaps
    
    $
    22
    
    
    $
    (12
    )
    
    $
    23
    
    
    $
    (12
    )Futures purchased
    
    
    15
    
    
    
    
    
    
    
    28
    
    
    
    Futures sold, not yet purchased
    
    
    24
    
    
    
    (39
    )
    
    
    (6
    )
    
    
    (39
    )Forwards
    
    
    (1
    )
    
    
    1
    
    
    
    1
    
    
    
    1Forwards sold, not yet purchased
    
    
    3
    
    
    
    
    
    
    
    5
    
    
    
    Commitments to purchase government and municipal securities
    
    
    
    
    
    
    (7
    )
    
    
    (12
    )
    
    
    (18
    )Equity warrants
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    Collateralized debt obligation liabilities
    
    
    2
    
    
    
    2
    
    
    
    4
    
    
    
    (9
    )Options written
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    Options embedded in convertible debt securities
    
    
    43
    
    
    
    43
    
    
    
    15
    
    
    
    9Total
    
    $
    108
    
    
    $
    (12
    )
    
    $
    61
    
    
    $
    (68
    )Separate accountsFutures purchased
    
    $
    
    
    
    $
    112
    
    
    $
    
    
    
    $
    75Futures sold, not yet purchased
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )Options purchased
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )Options written
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1Total
    
    $
    
    
    
    $
    110
    
    
    $
    
    
    
    $
    74
 13




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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 ValueJune 30, 2004
    
    Amount
    
    Asset
    
    (Liability)(In
millions)General accountSwaps
    
    $
    578
    
    
    $
    1
    
    
    $
    Futures purchased
    
    
    1,072
    
    
    
    4
    
    
    
    Futures sold, not yet purchased
    
    
    2,921
    
    
    
    
    
    
    
    (10
    )Forwards purchased
    
    
    82
    
    
    
    1
    
    
    
    Forwards sold, not yet purchased
    
    
    247
    
    
    
    
    
    
    
    (3
    )Equity warrants
    
    
    11
    
    
    
    1
    
    
    
    Options purchased
    
    
    74
    
    
    
    1
    
    
    
    Options written
    
    
    72
    
    
    
    
    
    
    
    Collateralized debt obligation liabilities
    
    
    76
    
    
    
    
    
    
    
    (2
    )Options embedded in convertible debt securities
    
    
    780
    
    
    
    240
    
    
    
    Total
    
    $
    5,913
    
    
    $
    248
    
    
    $
    (15
    )Separate accountsOptions written
    
    $
    22
    
    
    $
    
    
    
    $
    Total
    
    $
    22
    
    
    $
    
    
    
    $
    
 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. 14




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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 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 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. 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 15




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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 adversely 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 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 16




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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. 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 to avoid the
application of tort reform statute effective dates; enactment of national
federal legislation to address asbestos claims; a further increase in
asbestos and environmental pollution claims which cannot now be anticipated;
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. 17




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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 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. 18




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) The following table provides data related to CNAs APMT claim and claim
adjustment expense reserves. APMT Reserves June 30, 2004
    
    December 31, 2003Environmental
    
    
    
    
    
    EnvironmentalPollution and
    
    
    
    
    
    Pollution andAsbestos
    
    Mass Tort
    
    Asbestos
    
    Mass Tort(In millions)Gross reserves
    
    $
    3,282
    
    
    $
    812
    
    
    $
    3,347
    
    
    $
    839Ceded reserves
    
    
    (1,541
    )
    
    
    (288
    )
    
    
    (1,580
    )
    
    
    (262
    )Net reserves
    
    $
    1,741
    
    
    $
    524
    
    
    $
    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. As of June 30, 2004 and December 31, 2003, CNA carried approximately $1,741
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 $40 million of unfavorable asbestos-related net
claim and claim adjustment expense reserve development for the six months ended
June 30, 2004 and no 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 The Trenwick
Group Ltd. (Trenwick). See Note H for further details. The Company paid
asbestos-related claims, net of reinsurance recoveries, of $66 million and $70
million for the six months ended June 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. 19




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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 76,800 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 20




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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 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 21




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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 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
half 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 June 30, 2004 and December 31, 2003, CNA carried approximately $524
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 six months ended
June 30, 2004 and 2003. The Company paid environmental pollution-related
claims and mass tort-related claims, net of reinsurance recoveries, of $59
million and $36 million for the six months ended June 30, 2004 and 2003.
Additionally, the Company recorded $6 million of current accident year losses
related to mass tort in the second quarter of 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, 22




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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. The most significant silica exposures identified to
date include a relatively small number of accounts with significant numbers of
new claims reported in 2003 and substantial insurance limits issued by the Company.
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. Net Prior Year Development Unfavorable net prior year development of $146 million, including $255 million
of unfavorable claim and allocated claim adjustment expense reserve development
and $109 million of favorable premium development, was recorded for the six
months ended June 30, 2004. Unfavorable net prior year development of $534
million, including $370 million of unfavorable claim and allocated claim
adjustment expense reserve development and $164 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 $31,563 million and $31,730
million at June 30, 2004 and December 31, 2003. The net carried claim and
claim adjustment expense reserves for CNAF were $17,428 million and $17,514
million at June 30, 2004 and December 31, 2003. Standard Lines Unfavorable net prior year development of $7 million, including $113 million of
unfavorable claim and allocated claim adjustment expense reserve development
and $106 million of favorable premium development, was recorded for the six
months ended June 30, 2004 for Standard Lines. Unfavorable net prior year
development of $314 million, including $134 million of unfavorable claim and
allocated claim adjustment expense reserve development and $180 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 $14,275
million and $9,083 million at June 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 23




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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. The following discusses net prior year development for Standard Lines recorded
for the six months ended June 30, 2003. 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, 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. The review did not cover the
large account business where the claims are handled by a third-party
administrator. 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 analysis showed that the actual number of claims and the
average claim size were larger than expected. The development was recorded in
accident years prior to 2002. Approximately $21 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. The
development was due to an increase in the size of known claims and increases in
policyholder defense costs. The reserve development was recorded in accident
years prior to 2001. 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.
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 development was recorded
in accident year 2000. Unfavorable net prior year claim and allocated claim adjustment expense reserve
development of approximately $36 million was recorded for 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. Offsetting these unfavorable developments was a $75 million underwriting
benefit from cessions to corporate aggregate reinsurance treaties. The benefit
is comprised of $180 million of ceded losses and $105 million of ceded premiums
for accident years 2000 and 2001. See Note H for further discussion. Favorable prior year claim and allocated claim adjustment expense reserve
development was also recorded in property lines during 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 Unfavorable net prior year development of $60 million, including $74 million of
unfavorable net claim and allocated claim adjustment expense reserve
development and $14 million of favorable premium development, was recorded for
the six months ended June 30, 2004 for Specialty Lines. Unfavorable net 24




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) prior year development of $92 million, including $99 million of unfavorable net
claim and allocated claim adjustment expense reserve development and $7 million
of favorable premium development, was recorded for the same period in 2003.
The gross and net carried claim and claim adjustment expense reserves were
$4,576 million and $3,130 million at June 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. 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. The remaining unfavorable net prior year claim and
allocated claim adjustment expense reserve development was principally the
result of 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 six months ended June 30, 2003. Approximately $50 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development was recorded 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 primarily in accident
years 2001 and 2002. Approximately $37 million of losses were recorded as the result of a
commutation of three ceded reinsurance treaties covering CNA HealthPro,
relating to accident years 1999 through 2001. 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
developments on one large claim. Corporate and Other Non-Core Unfavorable net prior year development of $64 million, including $53 million of
net unfavorable claim and allocated claim adjustment expense reserve
development and $11 million of unfavorable premium development was recorded for
the six months ended June 30, 2004 for Corporate and Other. Unfavorable net
prior year development of $115 million, including $124 million of net
unfavorable claim and allocated claim adjustment expense reserve development
and $9 million of favorable premium development was recorded for the same
period in 2003. The gross and net carried claim and claim adjustment expense
reserves were $8,979 million and $3,391 million at June 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. In the second quarter of 2004, the Company finalized commutation agreements
with several members of the Trenwick Group. These commutations resulted in
unfavorable net prior year development 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 six months ended June 30, 2003. 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 25




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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 is
comprised of $24 million of ceded losses and $14 million of ceded premiums for
accident years 2000 and 2001. See Note H for further discussion. 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 $56 million and
$93 million for the three months ended June 30, 2004 and 2003, and $106 million
and $140 million for the six months ended June 30, 2004 and 2003. The amount
subject to interest crediting rates on such contracts was $2,696 million and
$2,789 million at June 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. 26




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) The following table summarizes the amounts receivable from reinsurers at June
30, 2004 and December 31, 2003. Components of reinsurance receivables
    
    June 30, 2004
    
    December 31, 2003(In millions)Reinsurance receivables related to insurance reserves:Ceded claim and claim adjustment expense
    
    $
    14,134
    
    
    $
    14,216Ceded future policy benefits
    
    
    1,229
    
    
    
    1,218Ceded policyholders funds
    
    
    68
    
    
    
    7Billed reinsurance receivables
    
    
    723
    
    
    
    813Reinsurance receivables
    
    
    16,154
    
    
    
    16,254Allowance for uncollectible reinsurance
    
    
    (503
    )
    
    
    (573
    )Reinsurance receivables, net of allowance
for uncollectible reinsurance
    
    $
    15,651
    
    
    $
    15,681
 The Company has established an allowance for uncollectible reinsurance. The
allowance for uncollectible reinsurance was $503 million and $573 million at
June 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. The effects of reinsurance on earned premiums are shown in the following table. Components of Earned Premiums For the six months ended June 30
    
    Direct
    
    Assumed
    
    Ceded
    
    Net(In millions)2004Property and casualty
    
    $
    5,393
    
    
    $
    127
    
    
    $
    1,758
    
    
    $
    3,762Accident and health
    
    
    659
    
    
    
    26
    
    
    
    291
    
    
    
    394Life
    
    
    323
    
    
    
    
    
    
    
    205
    
    
    
    118Total earned premiums
    
    $
    6,375
    
    
    $
    153
    
    
    $
    2,254
    
    
    $
    4,2742003Property and casualty
    
    $
    5,281
    
    
    $
    376
    
    
    $
    2,222
    
    
    $
    3,435Accident and health
    
    
    790
    
    
    
    55
    
    
    
    29
    
    
    
    816Life
    
    
    529
    
    
    
    9
    
    
    
    211
    
    
    
    327Total earned premiums
    
    $
    6,600
    
    
    $
    440
    
    
    $
    2,462
    
    
    $
    4,578
 Life premiums are primarily from long duration contracts; property and casualty
premiums and accident and health premiums are primarily from short duration
contracts. 27




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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. 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. During the second quarter of 2004, the Company recorded $3
million of ceded premiums under this provision. 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
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Ceded earned premiums
    
    $
    (3
    )
    
    $
    (28
    )
    
    $
    (3
    )
    
    $
    (28
    )Ceded claim and claim adjustment expense
    
    
    
    
    
    
    78
    
    
    
    
    
    
    
    78Interest charges
    
    
    (22
    )
    
    
    (22
    )
    
    
    (42
    )
    
    
    (35
    )Pretax benefit (expense)
    
    $
    (25
    )
    
    $
    28
    
    
    $
    (45
    )
    
    $
    15
 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. 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 fully utilized. 28




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) The pretax impact of the CCC Cover was as follows: Pretax Impact of CCC Cover Three Months
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Ceded earned premiums
    
    $
    
    
    
    $
    (91
    )
    
    $
    
    
    
    $
    (91
    )Ceded claim and claim adjustment expense
    
    
    
    
    
    
    126
    
    
    
    
    
    
    
    126Interest charges
    
    
    (11
    )
    
    
    (27
    )
    
    
    (22
    )
    
    
    (35
    )Pretax benefit (expense)
    
    $
    (11
    )
    
    $
    8
    
    
    $
    (22
    )
    
    $
    
 Note I. Debt Debt is composed of the following obligations. Debt June 30,
    
    December 31,2004
    
    2003(In millions)Variable rate debt:Credit facility  CNA Surety, due September 30, 2005
    
    $
    20
    
    
    $
    30Term loan  CNA Surety, due through September 30, 2005
    
    
    15
    
    
    
    20Credit 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
    
    
    
    241Debenture, CNA Surety, face amount of $31, due April 29, 2034
    
    
    30
    
    
    
    Capital leases, 10.400%-11.500%, due through December 31, 2011
    
    
    32
    
    
    
    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
    
    $
    1,714
    
    
    $
    1,904Short term debt
    
    $
    506
    
    
    $
    263Long term debt
    
    
    1,208
    
    
    
    1,641Total debt
    
    $
    1,714
    
    
    $
    1,904
 The $250 million CNAF credit facility was repaid on April 20, 2004. The CCC Group surplus note has a 20-year term and bears interest at LIBOR plus
350 basis points, reset annually. The note is mandatorily prepayable upon the
occurrence of certain events. 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 the $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 29




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) securities bear interest at a rate of LIBOR plus a 3.4% margin 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 3.4% and matures in April of 2034. As of June 30, 2004, the
interest rate on the junior subordinated debenture was 5.0%. 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 credit facility
balance by $10 million. 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 June 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
2.9%. Effective January 30, 2003, CNA Surety entered into a swap agreement on
the term loan portion of the agreement which uses 3-month LIBOR to determine
the swap increment. As a result, the effective interest rate on the $15
million in outstanding borrowings on the term loan was 2.8% at June 30, 2004.
Related to the $20 million revolving credit agreement, the effective interest
rate at June 30, 2004 was 2.9%. The combined aggregate maturities for debt at June 30, 2004 are presented in
the following table. Maturity of Debt (In millions)2004
    
    $
    72005
    
    
    5262006
    
    
    2542007
    
    
    122008
    
    
    354Thereafter
    
    
    569Less original issue discount
    
    
    (8
    )Total
    
    $
    1,714
 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 30




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Pension BenefitsService cost
    
    $
    13
    
    
    $
    7
    
    
    $
    22
    
    
    $
    15Interest cost on projected benefit obligation
    
    
    76
    
    
    
    36
    
    
    
    119
    
    
    
    72Expected return on plan assets
    
    
    (81
    )
    
    
    (35
    )
    
    
    (126
    )
    
    
    (72
    )Prior service cost amortization
    
    
    1
    
    
    
    
    
    
    
    2
    
    
    
    1Actuarial loss
    
    
    3
    
    
    
    1
    
    
    
    10
    
    
    
    3Net periodic pension cost
    
    $
    12
    
    
    $
    9
    
    
    $
    27
    
    
    $
    19Postretirement benefitsService cost
    
    $
    2
    
    
    $
    1
    
    
    $
    4
    
    
    $
    3Interest cost on projected benefit obligation
    
    
    12
    
    
    
    6
    
    
    
    18
    
    
    
    11Prior service cost amortization
    
    
    (12
    )
    
    
    (4
    )
    
    
    (17
    )
    
    
    (8
    )Actuarial loss
    
    
    1
    
    
    
    1
    
    
    
    3
    
    
    
    2Net periodic postretirement cost
    
    $
    3
    
    
    $
    4
    
    
    $
    8
    
    
    $
    8
 At December 31, 2003, CNA expected to contribute $12 million to its pension
plan and $22 million to its postretirement healthcare and life insurance
benefit plans in 2004. As of June 30, 2004, $13 million of contributions have
been made to its pension plan and $11 million to its postretirement healthcare
and life insurance benefit plans. CNA plans to contribute an additional $4
million to its pension plan and $11 million to its postretirement healthcare
and life insurance benefit plans during the remainder of 2004. 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 June 30, 2004 and December 31, 2003, there were approximately
$50 million and $58 million of outstanding letters of credit. The Company is obligated to make future payments totaling $299 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: $36
million in 2004; $60 million in 2005; $51 million in 2006; $41 million in 2007;
$33 million in 2008; and $78 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: $10 million in 2004 and $5 million in 2005. 31




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) As of June 30, 2004 and December 31, 2003, the Company had committed
approximately $141 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 June 30,
2004, the Company had commitments to purchase $64 million and sell $3 million
of various bank loan participations. In the normal course of investing activities, CCC had committed approximately
$51 million as of June 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 June 30, 2004, the Company had $95 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 loans 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
June 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 potential amount of future payments that the Company could be
required to pay under these guarantees are approximately $8 million at June 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. 32




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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 June 30, 2004
that the Company could be required to pay under this guarantee are
approximately $315 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 June 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
June 30, 2004, the aggregate amount of quantifiable indemnification agreements
in effect for sales of business entities, assets and third party loans was $959
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 June 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 June 30, 2004 and December 31, 2003. 33




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) 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
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Net income
    
    $
    289
    
    
    $
    70
    
    
    $
    164
    
    
    $
    153Other comprehensive income (loss):Change in unrealized gains/losses on general account investments:Holding gains (losses) arising during the period
    
    
    (1,072
    )
    
    
    755
    
    
    
    (611
    )
    
    
    963Net unrealized gains/losses at beginning of period included in
realized gains (losses) during the period
    
    
    (241
    )
    
    
    53
    
    
    
    (525
    )
    
    
    169Net change in unrealized gains/losses on general account
investments
    
    
    (1,313
    )
    
    
    808
    
    
    
    (1,136
    )
    
    
    1,132Net change in unrealized gains/losses on separate accounts and
other
    
    
    (11
    )
    
    
    25
    
    
    
    (74
    )
    
    
    41Foreign currency translation adjustment
    
    
    (29
    )
    
    
    10
    
    
    
    (13
    )
    
    
    21Allocation to participating policyholders and minority interests
    
    
    15
    
    
    
    (15
    )
    
    
    17
    
    
    
    (15
    )Other comprehensive income (loss), before tax
    
    
    (1,338
    )
    
    
    828
    
    
    
    (1,206
    )
    
    
    1,179Deferred income tax expense (benefit) related to other comprehensive
income
    
    
    466
    
    
    
    (285
    )
    
    
    417
    
    
    
    (413
    )Other comprehensive income (loss), net of tax
    
    
    (872
    )
    
    
    543
    
    
    
    (789
    )
    
    
    766Total comprehensive income (loss)
    
    $
    (583
    )
    
    $
    613
    
    
    $
    (625
    )
    
    $
    919
 34




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##### Table of Contents



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. 35




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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). 36




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) CorporateFor the three months ended
    
    Standard
    
    Specialty
    
    Life and Group
    
    and OtherJune 30, 2004
    
    Lines
    
    Lines
    
    Non-Core
    
    Non-Core
    
    Eliminations
    
    Total(In millions)Net earned premiums
    
    $
    1,315
    
    
    $
    567
    
    
    $
    202
    
    
    $
    26
    
    
    $
    (4
    )
    
    $
    2,106Net investment income
    
    
    119
    
    
    
    59
    
    
    
    142
    
    
    
    60
    
    
    
    
    
    
    
    380Other revenues
    
    
    30
    
    
    
    32
    
    
    
    26
    
    
    
    9
    
    
    
    (25
    )
    
    
    72Total operating revenues
    
    
    1,464
    
    
    
    658
    
    
    
    370
    
    
    
    95
    
    
    
    (29
    )
    
    
    2,558Claims, benefits and expenses
    
    
    1,339
    
    
    
    538
    
    
    
    414
    
    
    
    76
    
    
    
    (29
    )
    
    
    2,338Operating income (loss)
before income tax and
minority interest
    
    
    125
    
    
    
    120
    
    
    
    (44
    )
    
    
    19
    
    
    
    
    
    
    
    220Income tax (expense) benefit
on operating income (loss)
    
    
    (25
    )
    
    
    (34
    )
    
    
    18
    
    
    
    (1
    )
    
    
    
    
    
    
    (42
    )Minority interest
    
    
    (2
    )
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7
    )Net operating income (loss)
    
    
    98
    
    
    
    81
    
    
    
    (26
    )
    
    
    18
    
    
    
    
    
    
    
    171Realized investment gains
(losses), net of
participating policyholders
and minority interests
    
    
    77
    
    
    
    30
    
    
    
    (56
    )
    
    
    54
    
    
    
    
    
    
    
    105Income tax (expense) benefit
on realized investment gains
(losses)
    
    
    (27
    )
    
    
    (12
    )
    
    
    70
    
    
    
    (18
    )
    
    
    
    
    
    
    13Net income (loss)
    
    $
    148
    
    
    $
    99
    
    
    $
    (12
    )
    
    $
    54
    
    
    $
    
    
    
    $
    289
 37




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) CorporateFor the three months ended
    
    Standard
    
    Specialty
    
    Life and Group
    
    and OtherJune 30, 2003
    
    Lines
    
    Lines
    
    Non-Core
    
    Non-Core
    
    Eliminations
    
    Total(In millions)Net earned premiums
    
    $
    1,018
    
    
    $
    459
    
    
    $
    603
    
    
    $
    144
    
    
    $
    (27
    )
    
    $
    2,197Net investment income
    
    
    105
    
    
    
    53
    
    
    
    211
    
    
    
    58
    
    
    
    
    
    
    
    427Other revenues
    
    
    61
    
    
    
    30
    
    
    
    35
    
    
    
    3
    
    
    
    (32
    )
    
    
    97Total operating revenues
    
    
    1,184
    
    
    
    542
    
    
    
    849
    
    
    
    205
    
    
    
    (59
    )
    
    
    2,721Claims, benefits and expenses
    
    
    1,405
    
    
    
    555
    
    
    
    796
    
    
    
    325
    
    
    
    (59
    )
    
    
    3,022Operating income (loss) before income tax and
minority interest
    
    
    (221
    )
    
    
    (13
    )
    
    
    53
    
    
    
    (120
    )
    
    
    
    
    
    
    (301
    )Income tax (expense) benefit on operating
income (loss)
    
    
    85
    
    
    
    9
    
    
    
    (15
    )
    
    
    45
    
    
    
    
    
    
    
    124Minority interest
    
    
    2
    
    
    
    (3
    )
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    (2
    )Net operating income (loss)
    
    
    (134
    )
    
    
    (7
    )
    
    
    38
    
    
    
    (76
    )
    
    
    
    
    
    
    (179
    )Realized investment gains, net of
participating policyholders and minority
interests
    
    
    184
    
    
    
    59
    
    
    
    53
    
    
    
    82
    
    
    
    
    
    
    
    378Income tax expense on realized investment gains
    
    
    (62
    )
    
    
    (21
    )
    
    
    (18
    )
    
    
    (28
    )
    
    
    
    
    
    
    (129
    )Net income (loss)
    
    $
    (12
    )
    
    $
    31
    
    
    $
    73
    
    
    $
    (22
    )
    
    $
    
    
    
    $
    70
 38




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) CorporateFor the six months ended
    
    Standard
    
    Specialty
    
    Life and Group
    
    and OtherJune 30, 2004
    
    Lines
    
    Lines
    
    Non-Core
    
    Non-Core
    
    Eliminations
    
    Total(In millions)Net earned premiums
    
    $
    2,573
    
    
    $
    1,096
    
    
    $
    528
    
    
    $
    102
    
    
    $
    (25
    )
    
    $
    4,274Net investment income
    
    
    257
    
    
    
    121
    
    
    
    348
    
    
    
    127
    
    
    
    
    
    
    
    853Other revenues
    
    
    70
    
    
    
    57
    
    
    
    60
    
    
    
    16
    
    
    
    (49
    )
    
    
    154Total operating revenues
    
    
    2,900
    
    
    
    1,274
    
    
    
    936
    
    
    
    245
    
    
    
    (74
    )
    
    
    5,281Claims, benefits and expenses
    
    
    2,625
    
    
    
    1,041
    
    
    
    956
    
    
    
    228
    
    
    
    (74
    )
    
    
    4,776Operating income (loss) before
income tax and minority interest
    
    
    275
    
    
    
    233
    
    
    
    (20
    )
    
    
    17
    
    
    
    
    
    
    
    505Income tax (expense) benefit on
operating income (loss)
    
    
    (59
    )
    
    
    (68
    )
    
    
    13
    
    
    
    1
    
    
    
    
    
    
    
    (113
    )Minority interest
    
    
    (4
    )
    
    
    (9
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (13
    )Net operating income (loss)
    
    
    212
    
    
    
    156
    
    
    
    (7
    )
    
    
    18
    
    
    
    
    
    
    
    379Realized investment gains (losses),
net of participating policyholders
and minority interests
    
    
    134
    
    
    
    50
    
    
    
    (618
    )
    
    
    81
    
    
    
    
    
    
    
    (353
    )Income tax (expense) benefit on
realized investment gains (losses)
    
    
    (46
    )
    
    
    (19
    )
    
    
    231
    
    
    
    (28
    )
    
    
    
    
    
    
    138Net income (loss)
    
    $
    300
    
    
    $
    187
    
    
    $
    (394
    )
    
    $
    71
    
    
    $
    
    
    
    $
    164As of June 30, 2004(In millions)Reinsurance receivables
    
    $
    5,382
    
    
    $
    1,548
    
    
    $
    3,302
    
    
    $
    5,922
    
    
    $
    
    
    
    $
    16,154Insurance receivables
    
    
    2,306
    
    
    
    358
    
    
    
    115
    
    
    
    128
    
    
    
    
    
    
    
    2,907Insurance reserves:Claim and claim adjustment expense
    
    $
    14,275
    
    
    $
    4,576
    
    
    $
    3,733
    
    
    $
    8,979
    
    
    $
    
    
    
    $
    31,563Unearned premiums
    
    
    2,207
    
    
    
    1,527
    
    
    
    176
    
    
    
    709
    
    
    
    (9
    )
    
    
    4,610Future policy benefits
    
    
    
    
    
    
    
    
    
    
    5,634
    
    
    
    
    
    
    
    
    
    
    
    5,634Policyholders funds
    
    
    52
    
    
    
    
    
    
    
    1,735
    
    
    
    
    
    
    
    
    
    
    
    1,787Deferred acquisition costs
    
    $
    506
    
    
    $
    277
    
    
    $
    553
    
    
    $
    7
    
    
    $
    
    
    
    $
    1,343
 39




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED) CorporateFor the six months ended
    
    Standard
    
    
    
    
    
    Specialty
    
    Life and Group
    
    and OtherJune 30, 2003
    
    Lines
    
    
    
    
    
    Lines
    
    Non-Core
    
    Non-Core
    
    
    
    
    
    Eliminations
    
    Total(In millions)Net earned premiums
    
    $
    2,237
    
    
    
    
    
    
    $
    887
    
    
    $
    1,189
    
    
    $
    319
    
    
    
    
    
    
    $
    (54
    )
    
    $
    4,578Net investment income
    
    
    234
    
    
    
    
    
    
    
    102
    
    
    
    414
    
    
    
    109
    
    
    
    
    
    
    
    
    
    
    
    859Other revenues
    
    
    132
    
    
    
    
    
    
    
    47
    
    
    
    76
    
    
    
    15
    
    
    
    
    
    
    
    (65
    )
    
    
    205Total operating revenues
    
    
    2,603
    
    
    
    
    
    
    
    1,036
    
    
    
    1,679
    
    
    
    443
    
    
    
    
    
    
    
    (119
    )
    
    
    5,642Claims, benefits and expenses
    
    
    2,774
    
    
    
    
    
    
    
    975
    
    
    
    1,583
    
    
    
    550
    
    
    
    
    
    
    
    (119
    )
    
    
    5,763Operating income (loss) before
income tax and minority interest
    
    
    (171
    )
    
    
    
    
    
    
    61
    
    
    
    96
    
    
    
    (107
    )
    
    
    
    
    
    
    
    
    
    
    (121
    )Income tax (expense) benefit on
operating income (loss)
    
    
    80
    
    
    
    
    
    
    
    (15
    )
    
    
    (29
    )
    
    
    43
    
    
    
    
    
    
    
    
    
    
    
    79Minority interest
    
    
    1
    
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    (5
    )Net operating income (loss)
    
    
    (90
    )
    
    
    
    
    
    
    41
    
    
    
    67
    
    
    
    (65
    )
    
    
    
    
    
    
    
    
    
    
    (47
    )Realized investment gains (losses),
net of participating policyholders
and minority interests
    
    
    191
    
    
    
    
    
    
    
    62
    
    
    
    (51
    )
    
    
    100
    
    
    
    
    
    
    
    
    
    
    
    302Income tax (expense) benefit on
realized investment gains (losses)
    
    
    (66
    )
    
    
    
    
    
    
    (22
    )
    
    
    18
    
    
    
    (32
    )
    
    
    
    
    
    
    
    
    
    
    (102
    )Net income
    
    $
    35
    
    
    
    
    
    
    $
    81
    
    
    $
    34
    
    
    $
    3
    
    
    
    
    
    
    $
    
    
    
    $
    153As 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
 40




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##### Table of Contents



CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The following table provides revenue by line of business for each reportable
segment. Revenue by Line of Business Three Months
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Standard LinesProperty
    
    $
    168
    
    
    $
    166
    
    
    $
    333
    
    
    $
    324Casualty
    
    
    1,135
    
    
    
    969
    
    
    
    2,235
    
    
    
    2,044CNA Global
    
    
    238
    
    
    
    233
    
    
    
    466
    
    
    
    426Standard Lines revenue
    
    
    1,541
    
    
    
    1,368
    
    
    
    3,034
    
    
    
    2,794Specialty LinesProfessional Liability Insurance (CNA Pro)
    
    
    521
    
    
    
    424
    
    
    
    997
    
    
    
    778Surety
    
    
    88
    
    
    
    92
    
    
    
    175
    
    
    
    172Warranty
    
    
    79
    
    
    
    85
    
    
    
    152
    
    
    
    148Specialty Lines revenue
    
    
    688
    
    
    
    601
    
    
    
    1,324
    
    
    
    1,098Life and Group Non-CoreLife & Annuity
    
    
    33
    
    
    
    284
    
    
    
    (258
    )
    
    
    456Health
    
    
    257
    
    
    
    575
    
    
    
    521
    
    
    
    1,088Other
    
    
    24
    
    
    
    43
    
    
    
    55
    
    
    
    84Life and Group Non-Core revenue
    
    
    314
    
    
    
    902
    
    
    
    318
    
    
    
    1,628Corporate and Other Non-CoreCNA Re
    
    
    57
    
    
    
    189
    
    
    
    160
    
    
    
    376Other
    
    
    92
    
    
    
    98
    
    
    
    166
    
    
    
    167Corporate and Other Non-Core revenue
    
    
    149
    
    
    
    287
    
    
    
    326
    
    
    
    543Eliminations
    
    
    (29
    )
    
    
    (59
    )
    
    
    (74
    )
    
    
    (119
    )Total revenue
    
    $
    2,663
    
    
    $
    3,099
    
    
    $
    4,928
    
    
    $
    5,944
 Note N. Significant Transactions Individual Life Sale On April 30, 2004, the Company completed the sale of its individual life
insurance business to Swiss Re for approximately $700 million. 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 recorded a realized
investment loss of $53 million pretax ($17 million gain after-tax) and $622
million pretax ($389 million after-tax) for the three and six months ended June
30, 2004. An estimated impairment loss was recorded in the first quarter of
2004 in anticipation of the pending sale. The disproportionate income tax
provision on the loss related to the life sale for the three months ended June
30, 2004, arose from a change in estimate related to the estimated tax benefit
recorded at March 31, 2004. The change in estimate is due to the completion of
a formal study of the final tax basis of VFL. 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 $(9) million and $173
million for 41




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) the three months ended June 30, 2004 and 2003, and $151 million and $306
million for the six months ended June 30, 2004 and 2003. The net results for
this business through the sale date were a loss of $14 million and net income
of $21 million for the three months ended June 30, 2004 and 2003 and a loss of
$6 million and net income of $4 million for the six months ended June 30, 2004
and 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 Financial
Services Group, Inc. (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 $316 million and $596 million for the three and six
months ended June 30, 2003. Net income was $18 million and $15 million for the
three and six months ended June 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 three and six months ended June 30, 2004. 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 six months
ended June 30, 2004 and 2003, CNA received $553 million from Loews and paid $73
million to 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
June 30, 2004 exceeds the related common stock collateral by $28 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 42




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 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%. Payment of the
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
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. Of these letters of credit, a replacement due to
expire in August of 2004 remains in the amount of $3 million. 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 June 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, including accrued
interest. 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 an affiliate contributed
$5 million in the aggregate to the contractors capital by forgiving certain of
the contractors indebtedness. The contractor has initiated 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. 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. CNA Surety is presently in
discussions with regulatory authorities concerning the level of bonds written
for the national contractor. 43




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 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 and underlying all of 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 could
be up to $200 million. 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 this contract. There were no reinsurance
balances payable under this stop loss contract as of June 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 44




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 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 impact of
this permitted practice was to increase statutory surplus by approximately $348
million at June 30, 2004. 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. 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 June 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 the CNAFs 2004 debt service and principal repayment requirements. As of
June 30, 2004, there is approximately $55 million of 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 Surplus
    
    Statutory Net Income (Loss)
    
    Statutory Net Income (Loss)Three months ended June 30
    
    Six months ended June 30June 30, 2004
    
    December 31, 2003
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Property and casualty companies
    
    $
    6,563
    
    
    $
    6,170
    
    
    
    139
    
    
    
    (59
    )
    
    
    377
    
    
    
    0Life and group insurance
companies (a)
    
    
    1,238
    
    
    
    707
    
    
    
    376
    
    
    
    30
    
    
    
    679
    
    
    
    (62
    )
 (a) The December 31, 2003 Statutory Capital and Surplus includes the individual
life insurance business which was sold on April 30, 2004. The Statutory Net
Income (loss) for the three and six months ended June 30, 2004 and 2003
includes the individual life insurance business. The Statutory Net Income
(loss) for the three and six months ended June 30, 2003 includes the group
benefits business sold on December 31, 2003. Note Q. Assets and Liabilities Related to Businesses Held for Sale In connection with CNAs decision to focus on its property and casualty
business, CNA has entered into a definitive agreement to sell the business of
CNA Trust, its limited operations bank located in Costa Mesa, California, which
provides full trustee and pension third-party administrative services to the
under 500 employer market. Accordingly, the assets and liabilities of CNA
Trust have been classified as Assets Related to Businesses Held for Sale and
Liabilities Related to Businesses Held for Sale on the Condensed Consolidated
Balance Sheet at June 30, 2004. The estimated fair value of the business less
costs to sell exceeds the carrying value of CNA Trust, and therefore the gain
will be recorded at the closing date. The transaction closed on
August 1, 2004. 45




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CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The following table provides the components of the assets and liabilities held
for sale. June 30, 2004
    
    CNA Trust(In millions)InvestmentsFixed maturity securities, available-for-sale
    
    $
    8Short term investments, available-for-sale
    
    
    177Total investments
    
    
    185Cash
    
    
    7Accrued investment income
    
    
    3Other assets
    
    
    3Property and Equipment, at cost
    
    
    2Total assets related to businesses held for sale
    
    $
    200Deferred income taxes
    
    $
    1Other liabilities
    
    
    169Total liabilities related to businesses held for sale
    
    $
    170
 The assets and liabilities of CNA Trust were $216 million and $184 million at
December 31, 2003. The revenues of CNA Trust were $4 million and $7 million
for the three months ended June 30, 2004 and 2003 and $10 million and $14
million for the six months ended June 30, 2004 and 2003. Net results for this
business were a net loss of $1.8 million and net income of $0.7 million for the
three months ended June 30, 2004 and 2003, and a net loss of $2.1 million and
net income of $0.4 million for the six months ended June 30, 2004 and 2003. 46




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CNA FINANCIAL CORPORATION
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 property and casualty 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 June 30, 2004.
The following discussion should be read in conjunction with the Condensed
Consolidated Financial Statements in Item 1 of Part 1. CONSOLIDATED OPERATIONS 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. Sale of CNA Trust In May of 2004, CNA entered into a definitive agreement to sell the business of
CNA Trust to Union Bank of California. As a result of the pending sale, CNA classified
the assets and liabilities of CNA Trust as Assets Related to Businesses Held
for Sale and Liabilities Related to Businesses Held for Sale in the Condensed
Consolidated Balance Sheets. See Note Q to the Condensed Consolidated
Financial Statements in Item 1 for further discussion. The
transaction closed on August 1, 2004. 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 are excluded from the sale.
Additionally, the Nashville, Tennessee insurance servicing and administration
building was transferred as part of the sale. Consideration from the sale was
approximately $700 million. CNA recorded a realized investment loss
of $53 million pretax ($17 million gain after-tax) and $622 million pretax
($389 million after-tax) for the three and six months ended June 30, 2004. An
estimated impairment loss was recorded in the first quarter of 2004 in
anticipation of the pending sale. The disproportionate income tax provision on
the loss related to the life sale for the three months ended June 30, 2004,
arose from a change in estimate related to the estimated tax benefit recorded
at March 31, 2004. The change in estimate is due to the completion of a formal
study of the final tax basis of VFL. 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 ($163 million pretax),
including an after-tax realized investment gain of $8 million ($13 million
pretax) recorded in the second quarter of 2004. 47




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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
will manage 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 discussed
below 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 has achieved the
targeted workforce reduction. Actions related to reducing commissions and
other acquisition expenses began in 2003 and will continue through 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
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 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. 48




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued Revised Business Segment Reporting As a result of the strategic review and other actions described above, CNA
changed how it manages its core operations and makes business decisions.
Accordingly, in the first quarter of 2004, the Company revised its reportable
business segment structure to reflect these changes. 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 the 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 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 Asbestos,
Environment Pollution and Mass Tort (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. 49




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued Throughout this Managements Discussion and Analysis (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 (including the realized gains (losses) on the sale of these
businesses) for the three and six months ended June 30, 2004 and 2003. CorporateStandard
    
    Specialty
    
    Life and Group
    
    and OtherConsolidated Net Income (Loss)
    
    Lines
    
    Lines
    
    Non-Core
    
    Non-Core (b)
    
    TotalThree months ended June 30, 2004Net results of businesses retained
    
    $
    148
    
    
    $
    99
    
    
    $
    (12
    )
    
    $
    54
    
    
    $
    289Net results of businesses sold (a)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total consolidated net income
(loss) for the three months ended
June 30, 2004
    
    $
    148
    
    
    $
    99
    
    
    $
    (12
    )
    
    $
    54
    
    
    $
    289Three months ended June 30, 2003Net results of businesses retained
    
    $
    (12
    )
    
    $
    31
    
    
    $
    33
    
    
    $
    (22
    )
    
    $
    30Net results of businesses sold (a)
    
    
    
    
    
    
    
    
    
    
    40
    
    
    
    
    
    
    
    40Total consolidated net income
(loss) for the three months ended
June 30, 2003
    
    $
    (12
    )
    
    $
    31
    
    
    $
    73
    
    
    $
    (22
    )
    
    $
    70
  (a)
    
    Included the group benefits business sold on December 31, 2003 and
the individual life business sold on April 30, 2004. The sale of the
individual life business resulted in an after-tax realized investment
gain on sale of $17 million for the three months ended June 30, 2004.
An after-tax realized investment gain of $8 million was recorded for
the three months ended June 30, 2004 related to the sale of the group
benefits business.(b)
    
    Included $16 million and $35 million of Net Income for the three
months ended June 30, 2004 and 2003, from CNA Re, which is in run-off. CorporateStandard
    
    Specialty
    
    Life and Group
    
    and OtherConsolidated Net Income (Loss)
    
    Lines
    
    Lines
    
    Non-Core
    
    Non-Core (b)
    
    TotalSix months ended June 30, 2004Net results of businesses retained
    
    $
    300
    
    
    $
    187
    
    
    $
    8
    
    
    $
    71
    
    
    $
    566Net results of businesses sold (a)
    
    
    
    
    
    
    
    
    
    
    (402
    )
    
    
    
    
    
    
    (402
    )Total consolidated net income
(loss) for the six months ended
June 30, 2004
    
    $
    300
    
    
    $
    187
    
    
    $
    (394
    )
    
    $
    71
    
    
    $
    164Six months ended June 30, 2003Net results of businesses retained
    
    $
    35
    
    
    $
    81
    
    
    $
    14
    
    
    $
    3
    
    
    $
    133Net results of businesses sold (a)
    
    
    
    
    
    
    
    
    
    
    20
    
    
    
    
    
    
    
    20Total consolidated net income
(loss) for the six months ended
June 30, 2003
    
    $
    35
    
    
    $
    81
    
    
    $
    34
    
    
    $
    3
    
    
    $
    153
 50




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued  (a)
    
    Included the group benefits business sold on December 31, 2003 and
the individual life business sold on April 30, 2004. The sale of the
individual life business resulted in an after-tax realized investment
loss on sale of $389 million for the six months ended June 30, 2004.
An after-tax realized investment gain of $8 million was recorded for
the six months ended June 30, 2004 related to the sale of the group
benefits business.(b)
    
    Included $37 million and $69 million of Net Income for the six
months ended June 30, 2004 and 2003 from CNA Re, which is in run-off. CorporateStandard
    
    Specialty
    
    Life and Group
    
    and OtherNet Earned Premiums
    
    Lines
    
    Lines
    
    Non-Core
    
    Non-Core (b)
    
    TotalThree months ended
June 30, 2004Net earned premiums
of businesses
retained
    
    $
    1,315
    
    
    $
    567
    
    
    $
    192
    
    
    $
    22
    
    
    $
    2,096Net earned premiums
of businesses sold
(a)
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    10Total net earned
premiums for the
three months ended
June 30, 2004
    
    $
    1,315
    
    
    $
    567
    
    
    $
    202
    
    
    $
    22
    
    
    $
    2,106Three months ended
June 30, 2003Net earned premiums
of businesses
retained
    
    $
    1,018
    
    
    $
    459
    
    
    $
    235
    
    
    $
    117
    
    
    $
    1,829Net earned premiums
of businesses sold
(a)
    
    
    
    
    
    
    
    
    
    
    368
    
    
    
    
    
    
    
    368Total net earned
premiums for the
three months ended
June 30, 2003
    
    $
    1,018
    
    
    $
    459
    
    
    $
    603
    
    
    $
    117
    
    
    $
    2,197
 CorporateStandard
    
    Specialty
    
    Life and Group
    
    and OtherNet Earned Premiums
    
    Lines
    
    Lines
    
    Non-Core
    
    Non-Core (b)
    
    TotalSix months ended
June 30, 2004Net earned premiums
of businesses
retained
    
    $
    2,573
    
    
    $
    1,096
    
    
    $
    413
    
    
    $
    77
    
    
    $
    4,159Net earned premiums
of businesses sold
(a)
    
    
    
    
    
    
    
    
    
    
    115
    
    
    
    
    
    
    
    115Total net earned
premiums for the
six months ended
June 30, 2004
    
    $
    2,573
    
    
    $
    1,096
    
    
    $
    528
    
    
    $
    77
    
    
    $
    4,274Six months ended
June 30, 2003Net earned premiums
of businesses
retained
    
    $
    2,237
    
    
    $
    887
    
    
    $
    458
    
    
    $
    265
    
    
    $
    3,847Net earned premiums
of businesses sold
(a)
    
    
    
    
    
    
    
    
    
    
    731
    
    
    
    
    
    
    
    731Total net earned
premiums for the
six months ended
June 30, 2003
    
    $
    2,237
    
    
    $
    887
    
    
    $
    1,189
    
    
    $
    265
    
    
    $
    4,578
 51




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##### Table of Contents



CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS 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 $27 million and $134 million of Net Earned Premiums for
the three months ended June 30, 2004 and 2003 and $100 million and $287
million of Net Earned Premiums for the six months ended June 30, 2004
and 2003 from CNA Re, which is in run-off. 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 will generally have an unfavorable impact on
the loss and loss adjustment expense ratios and a favorable impact on the
expense ratios. The following table includes the consolidated results of operations. For more
detailed components of CNAs business operations, see the segment discussions
within this MD&A. Three Months
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions, except per share data)RevenuesNet earned premiums
    
    $
    2,106
    
    
    $
    2,197
    
    
    $
    4,274
    
    
    $
    4,578Net investment income
    
    
    380
    
    
    
    427
    
    
    
    853
    
    
    
    859Realized investment gains (losses), net of
participating policyholders and minority
interests
    
    
    105
    
    
    
    378
    
    
    
    (353
    )
    
    
    302Other revenues
    
    
    72
    
    
    
    97
    
    
    
    154
    
    
    
    205Total revenues
    
    
    2,663
    
    
    
    3,099
    
    
    
    4,928
    
    
    
    5,944Claims, Benefits and ExpensesInsurance claims and policyholders benefits
    
    
    1,625
    
    
    
    2,108
    
    
    
    3,263
    
    
    
    3,978Amortization of deferred acquisition costs
    
    
    307
    
    
    
    481
    
    
    
    740
    
    
    
    939Other operating expenses
    
    
    375
    
    
    
    400
    
    
    
    707
    
    
    
    779Interest
    
    
    31
    
    
    
    33
    
    
    
    66
    
    
    
    67Total claims, benefits and expenses
    
    
    2,338
    
    
    
    3,022
    
    
    
    4,776
    
    
    
    5,763Income before income tax and minority interest
    
    
    325
    
    
    
    77
    
    
    
    152
    
    
    
    181Income tax (expense) benefit
    
    
    (29
    )
    
    
    (5
    )
    
    
    25
    
    
    
    (23
    )Minority interest
    
    
    (7
    )
    
    
    (2
    )
    
    
    (13
    )
    
    
    (5
    )Net income
    
    $
    289
    
    
    $
    70
    
    
    $
    164
    
    
    $
    153Basic and Diluted Earnings Per ShareBasic and diluted earnings per share
available to common stockholders
    
    $
    1.07
    
    
    $
    0.25
    
    
    $
    0.52
    
    
    $
    0.55Weighted average outstanding common stock and
common stock equivalents
    
    
    255.9
    
    
    
    223.6
    
    
    
    255.9
    
    
    
    223.6
 Three Month Comparison Net income increased $219 million for the three months ended June 30, 2004 as
compared with the same period in 2003. This improvement was driven primarily
by lower unfavorable net prior year development and decreased expenses, as
discussed below. These improvements were partially offset by decreased net
realized investment gains. 52




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##### Table of Contents



CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued Realized investment gains were $105 million and $378 million for the three
months ended June 30, 2004 and 2003. The decline in pretax realized gains was
primarily driven by unfavorable results in fixed maturity securities, 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
investment, and increased realized gains related to derivative securities. Net earned premiums decreased $91 million for the three months ended June 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 items
were decreased premiums ceded to corporate aggregate reinsurance treaties and
other treaties in the second quarter of 2004 as compared to the second quarter
of 2003, principally due to the unfavorable net prior year development recorded
in the second quarter of 2003. Six Month Comparison Net income increased $11 million for the six months ended June 30, 2004 as
compared with the same period in 2003. This improvement was driven primarily
by improved underwriting results in the property and casualty segments
including decreased unfavorable net prior year development, as discussed below.
These increases were partially offset by reduced net realized investment
results in 2004 as compared to gains in 2003. Realized investment losses were $353 million for the six months ended June 30,
2004 as compared to realized investment gains of $302 million for the six
months ended June 30, 2003. The decrease in the pretax investment results was
due primarily to a $622 million pretax loss on the sale of individual life
insurance business, and decreased realized gains for fixed maturity securities.
These decreases were partially offset by a $162 million pretax gain on Canary
Wharf, and increased realized gains for derivative securities. Net earned premiums decreased $304 million for the six months ended June 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 items were decreased premiums ceded to corporate aggregate and
other reinsurance treaties in 2004 as compared to 2003 principally due to the
unfavorable net prior year development recorded in the second quarter of 2003. Net Prior Year Development A significant component of the results of operations for the period ended June
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. 53




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued The following tables summarize the pretax net prior year development by segment
for the three and six months ended June 30, 2004 and 2003. Net Prior Year
Development For the three months ended
    
    Standard
    
    Specialty
    
    Corporate and OtherJune 30, 2004
    
    Lines
    
    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)
    
    $
    115
    
    
    $
    73
    
    
    $
    2
    
    
    $
    190APMT
    
    
    
    
    
    
    
    
    
    
    31
    
    
    
    31Total
    
    
    115
    
    
    
    73
    
    
    
    33
    
    
    
    221Pretax unfavorable net prior year development before impact of
premium development
    
    
    115
    
    
    
    73
    
    
    
    33
    
    
    
    221Unfavorable (favorable) premium development, excluding
impact of corporate aggregate reinsurance treaties
    
    
    (92
    )
    
    
    (13
    )
    
    
    11
    
    
    
    (94
    )Ceded premiums related to corporate aggregate reinsurance
treaties
    
    
    2
    
    
    
    
    
    
    
    1
    
    
    
    3Total premium development
    
    
    (90
    )
    
    
    (13
    )
    
    
    12
    
    
    
    (91
    )Total unfavorable net prior year development (pretax)
    
    $
    25
    
    
    $
    60
    
    
    $
    45
    
    
    $
    130Total unfavorable net prior year development (after-tax)
    
    $
    16
    
    
    $
    39
    
    
    $
    30
    
    
    $
    85
 Net Prior Year Development For the three months ended
    
    Standard
    
    Specialty
    
    CorporateJune 30, 2003
    
    Lines
    
    Lines
    
    and Other 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)
    
    $
    246
    
    
    $
    101
    
    
    $
    118
    
    
    $
    465Ceded losses related to corporate aggregate reinsurance treaties
    
    
    (180
    )
    
    
    
    
    
    
    (24
    )
    
    
    (204
    )Pretax unfavorable net prior year development before impact of
premium development
    
    
    66
    
    
    
    101
    
    
    
    94
    
    
    
    261Unfavorable (favorable) premium development, excluding
impact of corporate aggregate reinsurance treaties
    
    
    116
    
    
    
    3
    
    
    
    (8
    )
    
    
    111Ceded premiums related to corporate aggregate reinsurance
treaties
    
    
    105
    
    
    
    
    
    
    
    14
    
    
    
    119Total premium development
    
    
    221
    
    
    
    3
    
    
    
    6
    
    
    
    230Total unfavorable net prior year development (pretax)
    
    $
    287
    
    
    $
    104
    
    
    $
    100
    
    
    $
    491Total unfavorable net prior year development (after-tax)
    
    $
    187
    
    
    $
    68
    
    
    $
    65
    
    
    $
    320
 54




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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 six months ended
    
    Standard
    
    Specialty
    
    Corporate andJune 30, 2004
    
    Lines
    
    Lines
    
    Other 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)
    
    $
    113
    
    
    $
    74
    
    
    $
    13
    
    
    $
    200APMT
    
    
    
    
    
    
    
    
    
    
    40
    
    
    
    40Total
    
    
    113
    
    
    
    74
    
    
    
    53
    
    
    
    240Pretax unfavorable net prior year development before impact of
premium development
    
    
    113
    
    
    
    74
    
    
    
    53
    
    
    
    240Unfavorable (favorable) premium development, excluding
impact of corporate aggregate reinsurance treaties
    
    
    (108
    )
    
    
    (14
    )
    
    
    10
    
    
    
    (112
    )Ceded premiums related to corporate aggregate reinsurance
treaties
    
    
    2
    
    
    
    
    
    
    
    1
    
    
    
    3Total premium development
    
    
    (106
    )
    
    
    (14
    )
    
    
    11
    
    
    
    (109
    )Total unfavorable net prior year development (pretax)
    
    $
    7
    
    
    $
    60
    
    
    $
    64
    
    
    $
    131Total unfavorable net prior year development (after-tax)
    
    $
    4
    
    
    $
    39
    
    
    $
    42
    
    
    $
    85
 Net Prior Year Development For the six months ended
    
    Standard
    
    Specialty
    
    Corporate andJune 30, 2003
    
    Lines
    
    Lines
    
    Other 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)
    
    $
    314
    
    
    $
    99
    
    
    $
    148
    
    
    $
    561Ceded losses related to corporate aggregate reinsurance treaties
    
    
    (180
    )
    
    
    
    
    
    
    (24
    )
    
    
    (204
    )Pretax unfavorable net prior year development before impact of
premium development
    
    
    134
    
    
    
    99
    
    
    
    124
    
    
    
    357Unfavorable (favorable) premium development, excluding
impact of corporate aggregate reinsurance treaties
    
    
    75
    
    
    
    (7
    )
    
    
    (23
    )
    
    
    45Ceded premiums related to corporate aggregate reinsurance
treaties
    
    
    105
    
    
    
    
    
    
    
    14
    
    
    
    119Total premium development
    
    
    180
    
    
    
    (7
    )
    
    
    (9
    )
    
    
    164Total unfavorable net prior year development (pretax)
    
    $
    314
    
    
    $
    92
    
    
    $
    115
    
    
    $
    521Total unfavorable net prior year development (after-tax)
    
    $
    204
    
    
    $
    59
    
    
    $
    75
    
    
    $
    338
 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 55




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 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 56




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##### Table of Contents



CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 115 Accounting for Certain Investments in Debt and Equity
Securities and equity securities that are accounted for using the cost method
specified in Accounting Policy Board Opinion No. 18 The Equity Method of
Accounting for Investments in Common Stock. 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. EITF 03-1 outlines
that 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 is
effective for reporting periods beginning after June 15, 2004. The Company is currently evaluating the impact of this new accounting
standard on its process for determining other-than-temporary impairment of
equity and fixed maturity securities. Adoption of this standard 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 will likely also impact the recognition of investment
income on impaired securities. Such an impact will 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. 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 adversely 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. 57




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 June 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 has initiated restructuring efforts to reduce costs and improve cash
flow and is attempting to develop additional sources of funds. Based on the
contractors restructuring efforts to date, the Company estimates that amounts
due under the credit facility are collectible. 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: 58




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued  
    
    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;
    
    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. 59




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 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. 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 $56 million and
$93 million for the three months ended June 30, 2004 and 2003, and $106 60




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued million and $140 million for the six months ended June 30, 2004 and 2003. The
amount subject to interest crediting rates on such contracts was $2,696 million
and $2,789 million at June 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 June
30, 2004 and December 31, 2003. Components of reinsurance receivables
    
    June 30, 2004
    
    December 31, 2003(In millions)Reinsurance receivables related to insurance reserves:Ceded claim and claim adjustment expense
    
    $
    14,134
    
    
    $
    14,216Ceded future policy benefits
    
    
    1,229
    
    
    
    1,218Ceded policyholders funds
    
    
    68
    
    
    
    7Billed reinsurance receivables
    
    
    723
    
    
    
    813Reinsurance receivables
    
    
    16,154
    
    
    
    16,254Allowance for uncollectible reinsurance
    
    
    (503
    )
    
    
    (573
    )Reinsurance receivables, net of allowance for
uncollectible reinsurance
    
    $
    15,651
    
    
    $
    15,681
 The Company has established an allowance for uncollectible reinsurance
receivables. The allowance for uncollectible reinsurance receivables was $503
million and $573 million at June 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. 61




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued The effects of reinsurance on earned premiums are shown in the following table. Components of Earned Premiums For the six months ended June 30
    
    Direct
    
    Assumed
    
    Ceded
    
    Net(In millions)2004Property and casualty
    
    $
    5,393
    
    
    $
    127
    
    
    $
    1,758
    
    
    $
    3,762Accident and health
    
    
    659
    
    
    
    26
    
    
    
    291
    
    
    
    394Life
    
    
    323
    
    
    
    
    
    
    
    205
    
    
    
    118Total earned premiums
    
    $
    6,375
    
    
    $
    153
    
    
    $
    2,254
    
    
    $
    4,2742003Property and casualty
    
    $
    5,281
    
    
    $
    376
    
    
    $
    2,222
    
    
    $
    3,435Accident and health
    
    
    790
    
    
    
    55
    
    
    
    29
    
    
    
    816Life
    
    
    529
    
    
    
    9
    
    
    
    211
    
    
    
    327Total earned premiums
    
    $
    6,600
    
    
    $
    440
    
    
    $
    2,462
    
    
    $
    4,578
 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 for
the three-year period 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
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Ceded earned premiums
    
    $
    (3
    )
    
    $
    (28
    )
    
    $
    (3
    )
    
    $
    (28
    )Ceded claim and claim adjustment expense
    
    
    
    
    
    
    78
    
    
    
    
    
    
    
    78Interest charges
    
    
    (22
    )
    
    
    (22
    )
    
    
    (42
    )
    
    
    (35
    )Pretax benefit (expense)
    
    $
    (25
    )
    
    $
    28
    
    
    $
    (45
    )
    
    $
    15
 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. 62




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##### Table of Contents



CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 fully utilized. If the aggregate loss ratio would exceed these
certain thresholds, then additional interest charges on funds withheld would be
approximately $32 million in 2004. The pretax impact of the CCC Cover was as follows: Pretax Impact of CCC Cover Three Months
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Ceded earned premiums
    
    $
    
    
    
    $
    (91
    )
    
    $
    
    
    
    $
    (91
    )Ceded claim and claim adjustment expense
    
    
    
    
    
    
    126
    
    
    
    
    
    
    
    126Interest charges
    
    
    (11
    )
    
    
    (27
    )
    
    
    (22
    )
    
    
    (35
    )Pretax benefit (expense)
    
    $
    (11
    )
    
    $
    8
    
    
    $
    (22
    )
    
    $
    
 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
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Standard Lines
    
    $
    (23
    )
    
    $
    35
    
    
    $
    (43
    )
    
    $
    21Specialty Lines
    
    
    (4
    )
    
    
    (1
    )
    
    
    (6
    )
    
    
    (2
    )Corporate and Other
    
    
    (9
    )
    
    
    2
    
    
    
    (18
    )
    
    
    (4
    )Pretax benefit (expense)
    
    $
    (36
    )
    
    $
    36
    
    
    $
    (67
    )
    
    $
    15
 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. 63




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS 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, individual life and
group life and health 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. It is expected that attempts
will be made to secure extension of the Act in Congress. However, passage of a
law extending the Act is by no means assured. Among other steps, CNA will, if
the Act is not extended, 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 that 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 six months ended June 30, 2004 and 2003. During 2004, $1
million in payments were charged against the liability. As of June 30, 2004,
the accrued liability relating to employee termination and related benefit
costs was $3 million. The remaining accrual is expected to be paid in 2004. No restructuring and other related charges related to the 2001 Plan were
incurred for the three or six months ended June 30, 2004 and 2003. During
2004, $4 million in payments for lease termination costs were charged against
the liability. As of June 30, 2004, the accrued liability, relating primarily
to lease termination costs, was $16 million. Of the remaining accrual,
approximately $3 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 64




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##### Table of Contents



CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 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). 65




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued Reconciliation of Underwriting Income to Net Income Three months ended
    
    Standard
    
    SpecialtyJune 30, 2004
    
    Lines
    
    Lines(In millions)Underwriting income
    
    $
    4
    
    
    $
    57Net investment income
    
    
    119
    
    
    
    59Other revenues
    
    
    30
    
    
    
    32Other expenses
    
    
    (28
    )
    
    
    (28
    )Income before income tax expense, minority interest and net realized investment
gains
    
    
    125
    
    
    
    120Income tax expense
    
    
    (25
    )
    
    
    (34
    )Minority interest
    
    
    (2
    )
    
    
    (5
    )Income before net realized investment gains
    
    
    98
    
    
    
    81Realized investment gains, net of participating policyholders and minority interest
    
    
    77
    
    
    
    30Income tax (expense) on realized investment gains
    
    
    (27
    )
    
    
    (12
    )Net income
    
    $
    148
    
    
    $
    99
 Reconciliation of Underwriting Loss to Net Income (Loss) Three months ended
    
    Standard
    
    SpecialtyJune 30, 2003
    
    Lines
    
    Lines(In millions)Underwriting loss
    
    $
    (327
    )
    
    $
    (71
    )Net investment income
    
    
    105
    
    
    
    53Other revenues
    
    
    61
    
    
    
    30Other expenses
    
    
    (60
    )
    
    
    (25
    )Loss before income tax benefit, minority interest and net realized investment gains
    
    
    (221
    )
    
    
    (13
    )Income tax benefit
    
    
    85
    
    
    
    9Minority interest
    
    
    2
    
    
    
    (3
    )Loss before net realized investment gains
    
    
    (134
    )
    
    
    (7
    )Realized investment gains, net of participating policyholders and minority interest
    
    
    184
    
    
    
    59Income tax expense on realized investment gains
    
    
    (62
    )
    
    
    (21
    )Net income (loss)
    
    $
    (12
    )
    
    $
    31
 66




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued Reconciliation of Underwriting Income to Net Income Six months ended
    
    Standard
    
    SpecialtyJune 30, 2004
    
    Lines
    
    Lines(In millions)Underwriting income
    
    $
    7
    
    
    $
    110Net investment income
    
    
    257
    
    
    
    121Other revenues
    
    
    70
    
    
    
    57Other expenses
    
    
    (59
    )
    
    
    (55
    )Income before income tax benefit, minority interest and net realized investment gains
    
    
    275
    
    
    
    233Income tax (expense)
    
    
    (59
    )
    
    
    (68
    )Minority interest
    
    
    (4
    )
    
    
    (9
    )Income before net realized investment gains
    
    
    212
    
    
    
    156Realized investment gains, net of participating policyholders and minority interest
    
    
    134
    
    
    
    50Income tax (expense) on realized investment gains
    
    
    (46
    )
    
    
    (19
    )Net income
    
    $
    300
    
    
    $
    187
 Reconciliation of Underwriting Loss to Net Income Six months ended
    
    Standard
    
    SpecialtyJune 30, 2003
    
    Lines
    
    Lines(In millions)Underwriting loss
    
    $
    (414
    )
    
    $
    (50
    )Net investment income
    
    
    234
    
    
    
    102Other revenues
    
    
    132
    
    
    
    47Other expenses
    
    
    (123
    )
    
    
    (38
    )Income (loss) before income tax (benefit) expense, minority interest and net
realized investment gains
    
    
    (171
    )
    
    
    61Income tax (expense) benefit
    
    
    80
    
    
    
    (15
    )Minority interest
    
    
    1
    
    
    
    (5
    )Income (loss) before net realized investment gains
    
    
    (90
    )
    
    
    41Realized investment gains, net of participating policyholders and minority interest
    
    
    191
    
    
    
    62Income tax (expense) on realized investment gains
    
    
    (66
    )
    
    
    (22
    )Net income
    
    $
    35
    
    
    $
    81
 67




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##### Table of Contents



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 5 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 68




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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
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Net written premiums
    
    $
    1,209
    
    
    $
    1,087
    
    
    $
    2,474
    
    
    $
    2,360Net earned premiums
    
    
    1,315
    
    
    
    1,018
    
    
    
    2,573
    
    
    
    2,237Underwriting income (loss)
    
    
    4
    
    
    
    (327
    )
    
    
    7
    
    
    
    (414
    )Income (loss) before net realized investment gains
    
    
    98
    
    
    
    (134
    )
    
    
    212
    
    
    
    (90
    )Net realized investment gains
    
    
    50
    
    
    
    122
    
    
    
    88
    
    
    
    125Net income (loss)
    
    
    148
    
    
    
    (12
    )
    
    
    300
    
    
    
    35RatiosLoss and loss adjustment expense
    
    
    70.5
    %
    
    
    88.0
    %
    
    
    68.0
    %
    
    
    80.0
    %Expense
    
    
    30.3
    
    
    
    43.0
    
    
    
    31.9
    
    
    
    37.3Dividend
    
    
    (1.1
    )
    
    
    1.1
    
    
    
    (0.2
    )
    
    
    1.2Combined
    
    
    99.7
    %
    
    
    132.1
    %
    
    
    99.7
    %
    
    
    118.5
    %
 Three Month Comparison Net income increased $160 million for the three months ended June 30, 2004 as
compared with the same period in 2003. This improvement was driven primarily
by decreased unfavorable net prior year development, as discussed below, and
increased net investment income. These increases in net income were partially
offset by decreased net realized investment gains. 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 $122 million for the three
months ended June 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,
principally due to the unfavorable net prior year development recorded in the
second quarter of 2003. The increase in net written premiums was partially
offset by decreased retention and new business across most property and
casualty lines. 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 5% and 17% for the three months ended
June 30, 2004 and 2003 for the contracts that renewed during the period.
Retention rates of 67% and 75% were achieved for those contracts that were up
for renewal. Net earned premiums increased $297 million for the three months ended June 30,
2004 as compared with the same period in 2003. These increases were primarily
driven by increased favorable net prior year premium development and decreased
ceded premiums related to corporate aggregate and other reinsurance treaties as
described above. 69




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued Underwriting results improved by $331 million and the combined ratio decreased
32.4 points for the three months ended June 30, 2004 as compared with the same
period in 2003. The loss ratio decreased 17.5 points primarily due to
decreased net unfavorable prior year development and lower catastrophe losses.
Catastrophe losses of $4 million and $48 million were recorded for the three
months ended June 30, 2004 and 2003. Catastrophe losses recorded in the second
quarter of 2003 were primarily related to Texas tornados and Midwest rain
storms. The expense ratio decreased 12.7 points for the three months ended June 30,
2004 as compared with the same period in 2003. This decrease was primarily due
to reduced expenses as a result of the expense initiatives described above.
Also contributing to this decrease was an increased net earned premium base and
a decrease in the change in provision for insurance receivables in 2004 as
compared with the same period in 2003. The dividend ratio decreased 2.2 points for the three months ended June 30,
2004 as compared with the same period in 2003 due to net prior year favorable
dividend development, primarily related to workers compensation products. A
review was completed in the second quarter of 2004 which indicated dividend
development that was lower than prior expectations based on decreased usage of
dividend programs. Unfavorable net prior year development of $25 million was recorded for the
three months ended June 30, 2004, including $115 million of unfavorable claim
and allocated claim adjustment expense reserve development and $90 million of
favorable premium development. Unfavorable net prior year development of $287
million, including $66 million of unfavorable claim and allocated claim
adjustment expense reserve development and $221 million of unfavorable premium
development, was recorded for the same period in 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. 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. The following discusses net prior year development for Standard Lines recorded
for the three months ended June 30, 2003. 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, 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. The review did not cover the
large account business where claims are handled by a third-party administrator
(TPA). 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 70




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 analysis showed
that the actual number of claims and the average claim size were larger than
expected. The development was recorded in accident years prior to 2002. Approximately $11 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
development was due to an increase in the size of known claims and increases in
policyholder defense costs. The reserve development was recorded in accident
years prior to 2001. 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.
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 this contract. The development was recorded
in accident year 2000. Unfavorable net prior year claim and allocated claim adjustment expense reserve
development of approximately $11 million was recorded for 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. Offsetting these unfavorable developments for the three months ended June 30,
2003, was a $75 million underwriting benefit from cessions to corporate
aggregate reinsurance treaties. The 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 the MD&A for further discussion of the
Companys aggregate reinsurance treaties. Six Month Comparison Net income increased $265 million for the six months ended June 30, 2004 as
compared with the same period in 2003. This increase in net income was
attributable to the same reasons as discussed above in the three month
comparison. Net written premiums for Standard Lines increased $114 million and net earned
premiums increased $336 million for the six months ended June 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 18% for the six months ended
June 30, 2004 and 2003 for the contracts that renewed during the period.
Retention rates of 70% and 73% were achieved for those contracts that were up
for renewal. Competitive market pressures are expected to continue to
contribute to the moderation in rate increases as property and casualty market
pricing continues to soften. Underwriting results improved by $421 million and the combined ratio decreased
18.8 points for the six months ended June 30, 2004 as compared with the same
period in 2003. The loss ratio decreased 12.0 points primarily due to
decreased net unfavorable prior year development and lower catastrophe losses.
Catastrophe losses of $10 million and $62 million were recorded for the six
months ended June 30, 2004 71




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued and 2003. Catastrophe losses recorded in the first half of 2003 were
primarily related to Texas tornados and Midwest rain storms. The expense ratio decreased 5.4 points for the six months ended June 30, 2004
as compared with the same period in 2003. This decrease was primarily due to
reduced expenses driven by the Companys expense initiatives. Also
contributing to the decrease was an increased net earned premium base and a
decrease in the bad debt provision recorded for insurance receivables as
discussed above in the three months comparison. The dividend ratio decreased 1.4 points for the six months ended June 30, 2004
as compared with the same period in 2003 due to net prior year favorable
development as discussed in the three months comparison. Unfavorable net prior year development of $7 million was recorded for the six
months ended June 30, 2004, including $113 million of unfavorable claim and
allocated claim adjustment expense reserve development and $106 million of
favorable premium development. Unfavorable net prior year development of $314
million, including $134 million of unfavorable claim and allocated claim
adjustment expense reserve development and $180 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 $14,275 million
and $14,282 million at June 30, 2004 and December 31, 2003. The net carried
claim and claim adjustment expense reserves were $9,083 million and $8,967
million at June 30, 2004 and December 31, 2003. For the six months ended June 30, 2004, the Company recorded pretax income of
$9 million related to a net reduction of the allowance for uncollectible
reinsurance receivables, due to the reasons discussed above. See the three months comparison above for discussion of net prior year
development for the six months ended June 30, 2004. The following discusses net prior year development for Standard Lines recorded
for the six months ended June 30, 2003. 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, 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. The review did not cover the
large account business where claims are handled by a third-party administrator
(TPA). 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 analysis showed that the actual number of claims and the
average claim size were larger than expected. The development was recorded in
accident years prior to 2002. Approximately $21 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. The
development was due to an increase in the size of known claims and increases in
policyholder defense costs. The reserve development was recorded in accident
years prior to 2001. 72




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS 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.
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 this contract. The development was recorded
in accident year 2000. Unfavorable net prior year claim and allocated claim adjustment expense reserve
development of approximately $36 million was recorded for 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. Offsetting these unfavorable developments for the three months ended June 30,
2003, was a $75 million underwriting benefit from cessions to corporate
aggregate reinsurance treaties. The 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 the MD&A for further discussion of the
Companys aggregate reinsurance treaties. Favorable prior year claim and allocated claim adjustment expense reserve
development was also recorded in property lines during 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 73




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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. 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
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Net written premiums
    
    $
    592
    
    
    $
    487
    
    
    $
    1,173
    
    
    $
    963Net earned premiums
    
    
    567
    
    
    
    459
    
    
    
    1,096
    
    
    
    887Underwriting income (loss)
    
    
    57
    
    
    
    (71
    )
    
    
    110
    
    
    
    (50
    )Income (loss) before net realized investment gains
    
    
    81
    
    
    
    (7
    )
    
    
    156
    
    
    
    41Net realized investment gains
    
    
    18
    
    
    
    38
    
    
    
    31
    
    
    
    40Net income
    
    
    99
    
    
    
    31
    
    
    
    187
    
    
    
    81RatiosLoss and loss adjustment expense
    
    
    64.2
    %
    
    
    87.5
    %
    
    
    63.6
    %
    
    
    77.3
    %Expense
    
    
    25.6
    
    
    
    27.9
    
    
    
    26.1
    
    
    
    28.2Dividend
    
    
    0.2
    
    
    
    0.1
    
    
    
    0.3
    
    
    
    0.1Combined
    
    
    90.0
    %
    
    
    115.5
    %
    
    
    90.0
    %
    
    
    105.6
    %
 Three Month Comparison Net income increased $68 million for the three months ended June 30, 2004 as
compared with the same period in 2003. This improvement was driven primarily
by improved underwriting results and increased net investment income. The
increases in net income were partially offset by decreased net realized
investment gains. 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 $105 million and net earned
premiums increased $108 million for the three months ended June 30, 2004 as
compared with the same period in 2003. These increases were primarily driven
by increases in rate and new business, principally in Professional Liability
Insurance (CNA Pro). Specialty Lines averaged rate increases of 10% and 29% for the three months
ended June 30, 2004 and 2003 for the contracts that renewed during the period.
Retention rates of 79% and 81% were achieved for those contracts that were up
for renewal. Underwriting results improved by $128 million and the combined ratio decreased
25.5 points for the three months ended June 30, 2004 as compared with the same
period in 2003. The loss ratio decreased 23.3 points due principally to
decreased unfavorable net prior year development, an improvement in the current
net accident year loss ratio and a decrease in bad debt reserves for
uncollectible reinsurance. 74




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued The expense ratio decreased 2.3 points primarily due to decreased underwriting
expenses due to the Companys expense initiatives and the increased earned
premium base. Unfavorable net prior year development was $60 million, including $73 million
of unfavorable claim and allocated claim adjustment expense and $13 million of
favorable premium development, for the three months ended June 30, 2004.
Unfavorable net prior year development of $104 million, including $101 million
of unfavorable claim and allocated claim adjustment expense development and $3
million of unfavorable premium development, was recorded for the same period in
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. The remaining unfavorable net prior year claim and
allocated claim adjustment expense reserve development was principally the
result of the increased emergence of several large D&O claims primarily in
recent accident years. For the three months ended June 30, 2004, the Company recorded pretax income of
$59 million related to a net reduction of the allowance for uncollectible
reinsurance receivables, primarily due to a release of a previously established
allowance related to Trenwick. The release resulted from the finalization of
commutation agreements in the second quarter of 2004. The commutation resulted
in unfavorable net prior year development which is reflected within the
development noted above. The following discusses net prior year development for Specialty Lines recorded
for the three months ended June 30, 2003. Unfavorable net prior year claim and allocated claim adjustment expense of
approximately $50 million was recorded for directors and officers exposures, as
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
primarily in accident years 2001 and 2002. Approximately $37 million of losses were recorded as the result of a
commutation of three ceded reinsurance treaties covering CNA HealthPro, related
to accident years 1999 through 2001. 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 developments on one large claim. Six Month Comparison Net income increased $106 million for the six months ended June 30, 2004 as
compared with the same period in 2003. This increase in net income was
primarily attributable to the same reasons as discussed above in the three
month comparison. Net written premiums for Specialty Lines increased $210 million and net earned
premiums increased $209 million for the six months ended June 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. 75




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued Specialty Lines averaged rate increases of 12% and 33% for the six months ended
June 30, 2004 and 2003 for the contracts that renewed during the period.
Retention rates of 81% and 80% were achieved for those contracts that were up
for renewal. Underwriting results improved by $160 million and the combined ratio decreased
15.6 points for the six months ended June 30, 2004 as compared with the same
period in 2003. The loss ratio decreased 13.7 points due principally to
decreased net prior year development and an improvement in the current net
accident year loss ratio. The expense ratio decreased 2.1 points due primarily to decreased underwriting
expenses as discussed above in the three month comparison. Unfavorable net prior year development was $60 million, including $74 million
of unfavorable claim and allocated claim adjustment expense and $14 million of
favorable premium development for the six months ended June 30, 2004.
Unfavorable net prior year development of $92 million, including $99 million of
unfavorable claim and allocated claim adjustment expense development and $7
million of favorable premium development, was recorded for the same period in
2003. The gross carried claim and claim adjustment expense reserves for
Specialty Lines were $4,576 million and $4,200 million at June 30, 2004 and
December 31, 2003. The net carried claim and claim adjustment expense reserves
were $3,130 million and $2,919 million at June 30, 2004 and December 31, 2003. Net prior year development recorded in both 2004 and 2003 for Specialty Lines
was described above in the three month comparison. For the six months ended June 30, 2004, the Company recorded pretax income of
$59 million related to a net reduction of the allowance for uncollectible
reinsurance receivables, due to the reasons noted above. LIFE AND GROUP NON-CORE Business Overview Group Operations and Life Operations (formerly separate reportable segments)
have now 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 results include results of the individual
life business that was sold on April 30, 2004, for periods prior to the sale. 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. 76




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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. The following table summarizes the results of operations for Life and Group
Non-Core. Results of Operations Three Months
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Net earned premiums
    
    $
    202
    
    
    $
    603
    
    
    $
    528
    
    
    $
    1,189Income (loss) before net realized investment gains (losses)
    
    
    (26
    )
    
    
    38
    
    
    
    (7
    )
    
    
    67Net realized investment gains (losses)
    
    
    14
    
    
    
    35
    
    
    
    (387
    )
    
    
    (33
    )Net income (loss)
    
    
    (12
    )
    
    
    73
    
    
    
    (394
    )
    
    
    34
 Three Month Comparison Net earned premiums for Life and Group Non-Core decreased $401 million in the
second 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. Net earned premiums for the sold life and group businesses
were $10 million and $368 million for the three months ended June 30, 2004 and
2003. Net earned premiums also decreased in the remaining lines of business,
which are in runoff and are expected to continue to decrease. Net results decreased $85 million in the second 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. Net income for the sold life and group businesses was $0.2 million
and $40 million of net income for the three months ended June 30, 2004 and
2003. Also, net results decreased in the second quarter of 2004 as compared
with the same period in 2003 as a result of a $22 million
after-tax ($34
million pretax) increase in insurance reserves and the allowance for
uncollectible reinsurance 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. Six Month Comparison Net earned premiums for Life and Group Non-Core decreased $661 million for the
six months ended June 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 $731
million for the six months ended June 30, 2004 and 2003. Net earned premiums
also decreased in the remaining lines of business, which are in runoff and are
expected to continue to decrease. Net results decreased $428 million for the six months ended June 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 $622 million pretax ($389 million after-tax) for the sale of the
individual life business. Net results also decreased due to the absence of
favorable results from the group benefits and individual life businesses and
the strengthening of IGI insurance reserves and the allowance for uncollectible
reinsurance reserves as discussed above. Net results for the sold life and group
businesses were $402 million of net loss (including the loss on sale) and $20
million of net income for the six months ended June 30, 2004 and 2003. 77




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Revenues
    
    $
    120
    
    
    $
    228
    
    
    $
    252
    
    
    $
    424Net income (loss)
    
    
    54
    
    
    
    (22
    )
    
    
    71
    
    
    
    3
 Three Month Comparison Revenues decreased $108 million for the three months ended June 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 net realized investment gains.
See the Investments section of this MD&A for additional information on net
realized investment gains (losses). Net income increased $76 million for the three months ended June 30, 2004 as
compared with the same period in 2003. The increase in net income was due
primarily to lower unfavorable net prior year development, a $12 million
after-tax reduction of unallocated loss adjustment expenses (ULAE) reserves in
connection with a favorable extra contractual-obligation claim settlement and a
decrease in the provision for uncollectible reinsurance receivables. The
company recorded a $14 million after-tax ($22 million pretax) net reduction in
the allowance for uncollectible reinsurance receivables for the three months
ended June 30, 2004, primarily related to the Trenwick Group commutation noted
below, as compared with a $26 million after-tax ($40 million pretax) increase
which was recorded in the same period in 2003. Unfavorable net prior year development of $45 million was recorded for the
three months ended June 30, 2004, including $33 million of unfavorable net
prior year claim and allocated claim adjustment expense reserve development and
$12 million of unfavorable premium development. Unfavorable net prior year
development of $100 million was recorded for the three months ended June 30,
2003, including $94 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development and $6 million of unfavorable
premium development. The net prior year development recorded for the three months ended June 30,
2004 relates to commutation agreements with several members of the Trenwick
Group which resulted in unfavorable net 78




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 three months ended June 30, 2003 Unfavorable net prior year claim and allocated claim adjustment expense reserve
development of approximately $75 million was recorded in the second quarter of
2003 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 the Reinsurance section of this MD&A for
further discussion. Six Month Comparison Revenues decreased $172 million for the six months ended June 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. 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. Net income increased $68 million for the six months ended June 30, 2004 as
compared with the same period in 2003. The increase in net income was due
primarily to the reasons discussed above. Unfavorable net prior year development of $64 million was recorded for the six
months ended June 30, 2004, including $53 million of unfavorable net prior year
claim and allocated claim adjustment expense reserve development and $11
million of unfavorable premium development. Unfavorable net prior year
development of $115 million was recorded for the six months ended June 30,
2003, including $124 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development and $9 million of favorable
premium development. The gross carried claim and claim adjustment expense
reserves for Corporate and Other Non-Core were $8,979 million and $9,672
million at June 30, 2004 and December 31, 2003. The net carried claim and
claim adjustment expense reserves were $3,391 million and $3,737 million at
June 30, 2004 and December 31, 2003. Net prior year development recorded in both 2004 and 2003 for Corporate and
Other Non-Core was described above in the three month comparison. 79




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 to avoid the
application of tort reform statute effective dates; enactment of national
federal legislation to address asbestos claims; a further increase in
asbestos and environmental pollution claims which cannot now be anticipated;
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. 80




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 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 June 30, 2004
    
    December 31, 2003Environmental
    
    
    
    
    
    EnvironmentalPollution and
    
    
    
    
    
    Pollution andAsbestos
    
    Mass Tort
    
    Asbestos
    
    Mass Tort(In millions)Gross reserves
    
    $
    3,282
    
    
    $
    812
    
    
    $
    3,347
    
    
    $
    839Ceded reserves
    
    
    (1,541
    )
    
    
    (288
    )
    
    
    (1,580
    )
    
    
    (262
    )Net reserves
    
    $
    1,741
    
    
    $
    524
    
    
    $
    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 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. 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 81




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 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 half of 2004. As of June 30, 2004 and December 31, 2003, CNA carried approximately $1,741
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 $40 million of unfavorable asbestos-related net
claim and claim adjustment expense reserve development for the six months ended
June 30, 2004 and no asbestos-related net claim and claim adjustment expense
development for the same periods 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 $66
million and $70 million for the six months ended June 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 June 30,
2004, CNA had eleven structured settlement agreements with a reserve net of
reinsurance of $180 million. As to the eleven structured settlement agreements
existing at June 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 June 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 82




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 June 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 $90
million, net of reinsurance as of June 30, 2004. As of December 31, 2003, 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 June 30, 2004, the Company had 174 large
accounts and had established reserves of $393 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 June 30, 2004, the Company had 1,117 small accounts,
approximately 83% of its total active asbestos accounts, with reserves of $162
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 June 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 June 30, 2004, the unassigned IBNR reserve was $687 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.  83




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued The tables below depict CNAs overall pending asbestos accounts and associated
reserves at June 30, 2004 and December 31, 2003 Pending Asbestos Accounts and Associated Reserves Net paid losses
    
    Net Asbestos
    
    Percent ofNumber of
    
    in 2004
    
    reserves
    
    AsbestosJune 30, 2004
    
    policyholders
    
    (In millions)
    
    (In millions)
    
    Net ReservesPolicyholders with settlement agreementsStructured Settlements
    
    
    11
    
    
    $
    28
    
    
    $
    180
    
    
    
    11
    %Wellington
    
    
    4
    
    
    
    4
    
    
    
    19
    
    
    
    1Coverage in place
    
    
    31
    
    
    
    2
    
    
    
    90
    
    
    
    5Fibreboard
    
    
    1
    
    
    
    
    
    
    
    54
    
    
    
    3Total with settlement agreements
    
    
    47
    
    
    
    34
    
    
    
    343
    
    
    
    20Other policyholders with active accountsLarge asbestos accounts
    
    
    174
    
    
    
    19
    
    
    
    393
    
    
    
    23Small asbestos accounts
    
    
    1,117
    
    
    
    12
    
    
    
    162
    
    
    
    9Total other policyholders
    
    
    1,291
    
    
    
    31
    
    
    
    555
    
    
    
    32Assumed reinsurance and pools
    
    
    
    
    
    
    1
    
    
    
    156
    
    
    
    9Unassigned IBNR
    
    
    
    
    
    
    
    
    
    
    687
    
    
    
    39Total
    
    
    1,338
    
    
    $
    66
    
    
    $
    1,741
    
    
    
    100
    %
 Pending Asbestos Accounts and Associated Reserves Net paid losses
    
    Net Asbestos
    
    Percent ofNumber of
    
    In 2003
    
    reserves
    
    AsbestosAt December 31, 2003
    
    policyholders
    
    (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 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- 84




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 76,800 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
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 85




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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
    
    missing policies and proof of coverage 86




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued  
    
    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 the
possible creation of a national privately financed trust, which if established
through federal legislation, 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, what will be the terms
and conditions of its establishment or 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. 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 87




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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
half 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 June 30, 2004 and December 31, 2003, CNA carried approximately $524
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 six months ended
June 30, 2004 and 2003. The Company paid environmental pollution-related
claims and mass tort-related claims, net of reinsurance recoveries, of $59
million and $36 million for the six months ended June 30, 2004 and 2003.
Additionally, the Company recorded $6 million of current accident year losses
related to mass tort in the second quarter of 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. 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 June 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 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 June 30, 2004, CNA had negotiated
thirteen coverage in place agreements and had established a reserve of $11 88




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 June 30, 2004, the Company had 129
large accounts with a collective reserve of $87 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 June 30, 2004, CNA
had 439 small accounts with a collective reserve of $54 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 June 30, 2004 and
December 31, 2003. At June 30, 2004, the Companys unassigned IBNR reserve was $162 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. The charts below depict CNAs overall pending environmental pollution accounts
and associated reserves at June 30, 2004 and December 31, 2003. At June 30, 2004 Net
    
    Percent ofNet Paid Losses
    
    Environmental
    
    EnvironmentalNumber of
    
    in 2004
    
    Pollution Reserve
    
    Pollution NetPolicyholders
    
    (In millions)
    
    (In millions)
    
    ReservesPolicyholders with Settlement AgreementsStructured Settlements
    
    
    2
    
    
    $
    12
    
    
    $
    7
    
    
    
    2
    %Coverage In Place
    
    
    13
    
    
    
    2
    
    
    
    11
    
    
    
    3
    %Total with Settlement Agreements
    
    
    15
    
    
    
    14
    
    
    
    18
    
    
    
    5
    %Other Policyholders with Active AccountsLarge Pollution Accounts
    
    
    129
    
    
    
    15
    
    
    
    87
    
    
    
    25
    %Small Pollution Accounts
    
    
    439
    
    
    
    7
    
    
    
    54
    
    
    
    15
    %Total Other Policyholders
    
    
    568
    
    
    
    22
    
    
    
    141
    
    
    
    40
    %Assumed Reinsurance & Pools
    
    
    
    
    
    
    
    
    
    
    37
    
    
    
    10
    %Unassigned IBNR
    
    
    
    
    
    
    
    
    
    
    162
    
    
    
    45
    %Total
    
    
    583
    
    
    $
    36
    
    
    $
    358
    
    
    
    100
    %
 89




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##### Table of Contents



CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued Percent ofNet Paid Losses
    
    Net Environmental
    
    EnvironmentalNumber of
    
    in 2003
    
    Pollution Reserves
    
    Pollution NetAt December 31, 2003
    
    Policyholders
    
    (In millions)
    
    (In millions)
    
    ReservePolicyholders with Settlement AgreementsStructured Settlements
    
    
    1
    
    
    $
    17
    
    
    $
    12
    
    
    
    3
    %Coverage In Place
    
    
    6
    
    
    
    3
    
    
    
    8
    
    
    
    2
    %Total with Settlement Agreements
    
    
    7
    
    
    
    20
    
    
    
    20
    
    
    
    5
    %Other Policyholders with Active AccountsLarge Pollution Accounts
    
    
    144
    
    
    
    21
    
    
    
    86
    
    
    
    22
    %Small Pollution Accounts
    
    
    432
    
    
    
    14
    
    
    
    53
    
    
    
    13
    %Total Other Policyholders
    
    
    576
    
    
    
    35
    
    
    
    139
    
    
    
    35
    %Assumed Reinsurance & Pools
    
    
    
    
    
    
    2
    
    
    
    38
    
    
    
    10
    %Unassigned IBNR
    
    
    
    
    
    
    
    
    
    
    197
    
    
    
    50
    %Total
    
    
    583
    
    
    $
    57
    
    
    $
    394
    
    
    
    100
    %
 90




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##### Table of Contents



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 was 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 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. Net Investment Income The significant components of net investment income are presented in the
following table. Net Investment Income Three Months
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Fixed maturity securities
    
    $
    386
    
    
    $
    422
    
    
    $
    793
    
    
    $
    842Short term investments
    
    
    9
    
    
    
    12
    
    
    
    25
    
    
    
    32Limited partnerships
    
    
    30
    
    
    
    75
    
    
    
    105
    
    
    
    98Equity securities
    
    
    4
    
    
    
    4
    
    
    
    8
    
    
    
    9Income from trading portfolio (a)
    
    
    14
    
    
    
    
    
    
    
    34
    
    
    
    Interest on funds withheld and other deposits
    
    
    (56
    )
    
    
    (93
    )
    
    
    (106
    )
    
    
    (140
    )Other
    
    
    1
    
    
    
    18
    
    
    
    11
    
    
    
    43Gross investment income
    
    
    388
    
    
    
    438
    
    
    
    870
    
    
    
    884Investment expense
    
    
    (8
    )
    
    
    (11
    )
    
    
    (17
    )
    
    
    (25
    )Net investment income
    
    $
    380
    
    
    $
    427
    
    
    $
    853
    
    
    $
    859
 (a) The change in net unrealized gains (losses) on trading securities still
held, included in net investment income, was $(2) million and $2 million for
the three and six months ended June 30, 2004 The Company experienced lower net investment income for the three and six
months ended June 30, 2004 as compared with the same periods in 2003. This
decrease was due primarily to the decline in assets associated with the sale of
the Companys life and group business and lower investment yields on fixed
maturity securities. These decreases were partially offset by additional income
from the indexed group annuity contracts as a result of the adoption of SOP
03-01 and reduced interest expense on funds withheld and other deposits. The
higher interest expense on funds withheld and other deposits in second quarter
of 2003 was due to additional premiums ceded to the corporate aggregate and
other finite reinsurance treaties. The bond segment of the investment portfolio yielded 4.8% and 5.4% for the six
months ended June 30, 2004 and 2003. 91




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS 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
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Realized investment gains (losses):Fixed maturity securities:U.S. Government bonds
    
    $
    (1
    )
    
    $
    37
    
    
    $
    9
    
    
    $
    75Corporate and other taxable bonds
    
    
    27
    
    
    
    244
    
    
    
    33
    
    
    
    126Tax-exempt bonds
    
    
    (92
    )
    
    
    76
    
    
    
    (19
    )
    
    
    95Asset-backed bonds
    
    
    (4
    )
    
    
    23
    
    
    
    35
    
    
    
    41Redeemable preferred stock
    
    
    3
    
    
    
    (5
    )
    
    
    5
    
    
    
    (10
    )Total fixed maturity securities
    
    
    (67
    )
    
    
    375
    
    
    
    63
    
    
    
    327Equity securities
    
    
    166
    
    
    
    58
    
    
    
    177
    
    
    
    58Derivative securities
    
    
    49
    
    
    
    (55
    )
    
    
    17
    
    
    
    (77
    )Short term investments
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    10Other, including disposition of individual life insurance
business net of participating policyholders interest
    
    
    (39
    )
    
    
    (4
    )
    
    
    (604
    )
    
    
    (17
    )Realized investment gains (losses) before allocation to
participating policyholders and minority interests
    
    
    109
    
    
    
    380
    
    
    
    (347
    )
    
    
    301Allocated to participating policyholders and minority interest
    
    
    (4
    )
    
    
    (2
    )
    
    
    (6
    )
    
    
    1Realized investment gains (losses), net of participating
policyholders and minority interests
    
    $
    105
    
    
    $
    378
    
    
    $
    (353
    )
    
    $
    302
 Realized investment gains were $105 million and $378 million for the three
months ended June 30, 2004 and 2003. The decline in pretax realized gains was
primarily driven by unfavorable results in the fixed maturity securities,
partially offset by a $162 million pretax gain on the disposition of its equity
holdings of Canary Wharf and increased realized gains related to derivative
securities. Realized investment losses were $353 million for the six months ended June 30,
2004 as compared to realized investment gains of $302 million for the six
months ended June 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, and decreased realized gains on the sale of fixed maturity
securities. These decreases were partially offset by a $162 million pretax
gain on Canary Wharf, and increased realized gains for derivative securities. 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. 92




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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
    
    Six MonthsPeriod ended June 30
    
    2004
    
    2003
    
    2004
    
    2003(In millions)Net realized gains (losses) on fixed maturity securities
and equity securities:Fixed maturity securities:Gross realized gains
    
    $
    88
    
    
    $
    410
    
    
    $
    313
    
    
    $
    695Gross realized losses
    
    
    (155
    )
    
    
    (35
    )
    
    
    (250
    )
    
    
    (368
    )Net realized gains (losses) on fixed maturity securities
    
    
    (67
    )
    
    
    375
    
    
    
    63
    
    
    
    327Equity securities:Gross realized gains
    
    
    169
    
    
    
    58
    
    
    
    182
    
    
    
    70Gross realized losses
    
    
    (3
    )
    
    
    
    
    
    
    (5
    )
    
    
    (12
    )Net realized gains on equity securities
    
    
    166
    
    
    
    58
    
    
    
    177
    
    
    
    58Net realized gains on fixed maturity and equity securities
    
    $
    99
    
    
    $
    433
    
    
    $
    240
    
    
    $
    385


93



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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 six months ended June 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 noted 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 Six Months Ending June 30, 2004Fair
    
    
    
    
    
    Months inValue at
    
    
    
    
    
    UnrealizedDate of
    
    Loss
    
    Loss PriorIssuer Description and Discussion
    
    Sale
    
    On Sale
    
    To Sale(In millions)Municipal issuer of revenue bonds that authorizes the
financing of water facilities. Loss was incurred as a
result of unfavorable interest rate change.
    
    $
    258
    
    
    $
    12
    
    
    
    0-6Issues and sells mortgage backed securities. Issuer
was chartered by United States Congress to facilitate
housing ownership for low to middle income Americans.
    
    
    1,562
    
    
    
    8
    
    
    
    0-12Various securities issued by the United States
Treasury. Volatility of interest rates prompted
movement to other asset classes.
    
    
    2,509
    
    
    
    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 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.
    
    
    159
    
    
    
    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
    
    
    
    0-6Municipal issuer of revenue bonds that supports
transportation services. Loss was incurred as a
result of unfavorable interest rate change.
    
    
    209
    
    
    
    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
    
    
    
    0-12Company acquires, sells, and operates power
generation facility. The loss reflects intense
competition and price pressure in the sector.
    
    
    53
    
    
    
    6
    
    
    
    0-12Total
    
    $
    5,142
    
    
    $
    73
 94




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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 June 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
    
    $
    1,028
    
    
    
    3
    %
    
    $
    1,900
    
    
    
    5
    %Asset-backed securities
    
    
    9,021
    
    
    
    25
    
    
    
    8,757
    
    
    
    23States, municipalities and political subdivisions  tax-exempt
    
    
    8,857
    
    
    
    24
    
    
    
    7,970
    
    
    
    21Corporate securities
    
    
    7,160
    
    
    
    20
    
    
    
    6,482
    
    
    
    17Other debt securities
    
    
    3,276
    
    
    
    9
    
    
    
    3,264
    
    
    
    9Redeemable preferred stock
    
    
    156
    
    
    
    
    
    
    
    104
    
    
    
    Options embedded in convertible debt securities
    
    
    240
    
    
    
    1
    
    
    
    201
    
    
    
    Total fixed maturity securities available-for-sale
    
    
    29,738
    
    
    
    82
    
    
    
    28,678
    
    
    
    75Fixed maturity trading securities:U.S. Treasury securities and obligations of government agencies
    
    
    72
    
    
    
    
    
    
    
    
    
    
    
    Asset-backed securities
    
    
    112
    
    
    
    
    
    
    
    
    
    
    
    Corporate securities
    
    
    171
    
    
    
    1
    
    
    
    
    
    
    
    Other debt securities
    
    
    45
    
    
    
    
    
    
    
    
    
    
    
    Redeemable preferred stock
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    Total fixed maturity trading securities
    
    
    405
    
    
    
    1
    
    
    
    
    
    
    
    Equity securities:Common stock
    
    
    220
    
    
    
    1
    
    
    
    383
    
    
    
    1Non-redeemable preferred stock
    
    
    80
    
    
    
    
    
    
    
    144
    
    
    
    Total equity securities
    
    
    300
    
    
    
    1
    
    
    
    527
    
    
    
    1Short term investments available-for-sale
    
    
    3,538
    
    
    
    10
    
    
    
    7,538
    
    
    
    20Short term trading securities
    
    
    315
    
    
    
    1
    
    
    
    
    
    
    
    Limited partnerships
    
    
    1,686
    
    
    
    5
    
    
    
    1,117
    
    
    
    3Other investments
    
    
    29
    
    
    
    
    
    
    
    240
    
    
    
    1Total general account investments
    
    $
    36,011
    
    
    
    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 $213
million at June 30, 2004 compared with $1,348 million at December 31, 2003.
The net unrealized position at June 30, 2004 was composed of a net unrealized
gain of $131 million for fixed maturities and a net unrealized gain of $82
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. 95




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued Unrealized Gains (Losses) on Fixed Maturity and Equity Securities Cost or
    
    Gross
    
    Gross Unrealized Losses
    
    NetAmortized
    
    Unrealized
    
    Less than
    
    Greater than
    
    UnrealizedJune 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
    
    $
    962
    
    
    $
    84
    
    
    $
    12
    
    
    $
    6
    
    
    $
    66Asset-backed securities
    
    
    9,091
    
    
    
    81
    
    
    
    148
    
    
    
    3
    
    
    
    (70
    )States, municipalities and political
subdivisions  tax-exempt
    
    
    8,989
    
    
    
    67
    
    
    
    188
    
    
    
    11
    
    
    
    (132
    )Corporate securities
    
    
    7,036
    
    
    
    288
    
    
    
    138
    
    
    
    26
    
    
    
    124Other debt securities
    
    
    3,135
    
    
    
    216
    
    
    
    69
    
    
    
    6
    
    
    
    141Redeemable preferred stock
    
    
    154
    
    
    
    6
    
    
    
    2
    
    
    
    2
    
    
    
    2Options embedded in convertible debt
securities
    
    
    240
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total fixed maturity securities
available-for-sale
    
    
    29,607
    
    
    
    742
    
    
    
    557
    
    
    
    54
    
    
    
    131Total fixed maturity trading securities
    
    
    405
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Equity securities:Common stock
    
    
    150
    
    
    
    76
    
    
    
    6
    
    
    
    
    
    
    
    70Non-redeemable preferred stock
    
    
    68
    
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    12Total equity securities
    
    
    218
    
    
    
    88
    
    
    
    6
    
    
    
    
    
    
    
    82Total fixed maturity and equity securities
    
    $
    30,230
    
    
    $
    830
    
    
    $
    563
    
    
    $
    54
    
    
    $
    213
 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
  96




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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 June 30, 2004, the carrying value of the general account fixed maturities
available-for-sale was $29,738 million, representing 82% of the total
investment portfolio. The net unrealized gain related to this fixed maturity
portfolio was $131 million, comprised of $742 million in gross unrealized gains
and $611 million in gross unrealized losses. Municipal securities represented
33%, corporate bonds represented 27%, asset-backed securities represented 25%,
and all other fixed maturity securities represented 15% of the gross unrealized
losses. Within corporate bonds, the largest industry sectors were financial,
consumer cyclical and consumer non-cyclical, which represented 41%, 18%, and
13% of the gross unrealized losses. Gross unrealized losses in any single
issuer was 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 June 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
    %
    
    
    2
    %Due after one year through five years
    
    
    5
    
    
    
    5Due after five years through ten years
    
    
    14
    
    
    
    19Due after ten years
    
    
    42
    
    
    
    49Asset-backed securities
    
    
    38
    
    
    
    25Total
    
    
    100
    %
    
    
    100
    %
 The following table summarizes, for fixed maturity and equity securities
available-for-sale in an unrealized loss position at June 30, 2004 and December
31, 2003, the aggregate fair value and gross unrealized loss by length of time,
those securities that have been continuously in an unrealized loss position. 97




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued Gross Unrealized Loss Aging June 30, 2004
    
    December 31, 2003Gross
    
    
    
    
    
    GrossEstimated
    
    Unrealized
    
    Estimated
    
    UnrealizedFair Value
    
    Loss
    
    Fair Value
    
    Loss(In millions)Fixed maturity securities:Investment grade:0-6 months
    
    $
    14,919
    
    
    $
    479
    
    
    $
    4,138
    
    
    $
    507-12 months
    
    
    293
    
    
    
    26
    
    
    
    834
    
    
    
    3613-24 months
    
    
    362
    
    
    
    41
    
    
    
    76
    
    
    
    11Greater than 24 months
    
    
    1
    
    
    
    
    
    
    
    51
    
    
    
    3Total investment grade
    
    
    15,575
    
    
    
    546
    
    
    
    5,099
    
    
    
    100Non-investment grade:0-6 months
    
    
    853
    
    
    
    46
    
    
    
    134
    
    
    
    57-12 months
    
    
    54
    
    
    
    6
    
    
    
    60
    
    
    
    713-24 months
    
    
    33
    
    
    
    4
    
    
    
    16
    
    
    
    1Greater than 24 months
    
    
    60
    
    
    
    9
    
    
    
    105
    
    
    
    10Total non-investment grade
    
    
    1,000
    
    
    
    65
    
    
    
    315
    
    
    
    23Total fixed maturity securities
    
    
    16,575
    
    
    
    611
    
    
    
    5,414
    
    
    
    123Equity securities:0-6 months
    
    
    23
    
    
    
    3
    
    
    
    23
    
    
    
    27-12 months
    
    
    6
    
    
    
    3
    
    
    
    10
    
    
    
    213-24 months
    
    
    1
    
    
    
    
    
    
    
    3
    
    
    
    Greater than 24 months
    
    
    6
    
    
    
    
    
    
    
    6
    
    
    
    Total equity securities
    
    
    36
    
    
    
    6
    
    
    
    42
    
    
    
    4Total fixed maturity and equity securities
    
    $
    16,611
    
    
    $
    617
    
    
    $
    5,456
    
    
    $
    127
 The Companys non-investment grade fixed maturity securities available-for-sale
as of June 30, 2004 that were in a gross unrealized loss position had a fair
value of $1,000 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 June 30, 2004 and December 31, 2003. 98




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued Unrealized Loss Aging for Non-investment Grade Securities Fair Value as a Percentage of Book ValueEstimated
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    GrossUnrealizedJune 30, 2004
    
    Fair Value
    
    90-99%
    
    80-89%
    
    70-79%
    
    <70%
    
    Loss(In millions)Fixed maturity securities:Non-investment grade:0-6 months
    
    $
    853
    
    
    $
    29
    
    
    $
    14
    
    
    $
    
    
    
    $
    3
    
    
    $
    467-12 months
    
    
    54
    
    
    
    1
    
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    613-24 months
    
    
    33
    
    
    
    1
    
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    4Greater than 24 months
    
    
    60
    
    
    
    1
    
    
    
    3
    
    
    
    5
    
    
    
    
    
    
    
    9Total non-investment grade
    
    $
    1,000
    
    
    $
    32
    
    
    $
    25
    
    
    $
    5
    
    
    $
    3
    
    
    $
    65
 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. 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 99




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 June 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 June 30, 2004 that
were in a gross unrealized loss position had a fair value of $36 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, 90% and 93% of which were rated as investment grade at June 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 June 30,
    
    
    
    
    
    December 31,2004
    
    %
    
    2003
    
    %(In millions)U.S. Government and affiliated agency securities
    
    $
    1,722
    
    
    
    6
    %
    
    $
    2,818
    
    
    
    10
    %Other AAA rated
    
    
    14,356
    
    
    
    48
    
    
    
    12,779
    
    
    
    45AA and A rated
    
    
    6,314
    
    
    
    21
    
    
    
    6,329
    
    
    
    22BBB rated
    
    
    4,676
    
    
    
    15
    
    
    
    4,631
    
    
    
    16Below investment-grade
    
    
    2,914
    
    
    
    10
    
    
    
    2,017
    
    
    
    7Total
    
    $
    29,982
    
    
    
    100
    %
    
    $
    28,574
    
    
    
    100
    %
 At June 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) or Moodys Investors Service (Moodys).
The remaining bonds were rated by other rating agencies or Company management. 100




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 June 30, 2004 was $328 million
which represents 0.9% of the Companys total investment portfolio. These
securities were in a net unrealized gain position of $107 million at June 30,
2004. Of the non-traded securities, 53% are priced by unrelated third party
sources. Included in CNAs general account fixed maturity securities at June 30, 2004
are $9,133 million of asset-backed securities, at fair value, consisting of
approximately 44% in collateralized mortgage obligations (CMOs), 7% in
corporate asset-backed obligations, 8% in U.S. Government agency issued
pass-through certificates and 41% 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 June 30,
    
    December 31,2004
    
    2003(In millions)Short-term investments available-for-sale:Commercial paper
    
    $
    2,461
    
    
    $
    4,458U.S. Treasury securities
    
    
    275
    
    
    
    1,068Money market funds
    
    
    315
    
    
    
    1,230Other
    
    
    487
    
    
    
    782Total short-term investments available-for-sale
    
    
    3,538
    
    
    
    7,538Short-term trading securities:Commercial paper
    
    
    35
    
    
    
    U.S. Treasury securities
    
    
    60
    
    
    
    Money market funds
    
    
    211
    
    
    
    Other
    
    
    9
    
    
    
    Total short-term trading securities
    
    
    315
    
    
    
    Total short-term investments
    
    $
    3,853
    
    
    $
    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. 101




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS 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 six months ended June 30, 2004, net cash provided by operating
activities was $683 million as compared with $115 million for the same period
in 2003. The increase in cash provided by operating activities related
primarily to federal tax refunds received in 2004 as compared to taxes paid in
2003. 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 six months ended June 30, 2004, net cash used by investing activities
was $542 million as compared with net cash provided by investing activities of
$48 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 six months ended June 30, 2004, net cash used by financing activities
was $177 million as compared with $149 million net cash used 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. 102




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued A summary of the Companys commitments as of June 30, 2004 is presented in the
following table. Commitments 2009 andJune 30, 2004
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Beyond
    
    Total(In millions)Debt (a)
    
    $
    6
    
    
    $
    523
    
    
    $
    251
    
    
    $
    8
    
    
    $
    350
    
    
    $
    552
    
    
    $
    1,690Capital leases
    
    
    1
    
    
    
    3
    
    
    
    3
    
    
    
    4
    
    
    
    4
    
    
    
    17
    
    
    
    32Lease obligations
    
    
    36
    
    
    
    60
    
    
    
    51
    
    
    
    41
    
    
    
    33
    
    
    
    78
    
    
    
    299Guaranteed payment contracts
    
    
    10
    
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15Total
    
    $
    53
    
    
    $
    591
    
    
    $
    305
    
    
    $
    53
    
    
    $
    387
    
    
    $
    647
    
    
    $
    2,036
 (a) Does not include original issue discount of $8 million. 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. 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. 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 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 June 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 103




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued 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 June 30,
2004, there is approximately $55 million of this extraordinary dividend
capacity available for payment to CNAF. 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. 104




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued The table below reflects the various group ratings issued by A.M. Best, S&P,
Moodys and Fitch as of June 29, 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; 105




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS 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;  
    
    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;  
    
    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; 106




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CNA FINANCIAL CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, Continued  
    
    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. 107




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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 June 30,
2004 and December 31, 2003 due to instantaneous parallel increases in the
period end yield curve of 100 and 150 basis points. 108




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CNA FINANCIAL CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 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 June 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 June 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 June
30, 2004, a 10% and 25% decrease in the Index would result in a $199 million
and $498 million decrease compared to $245 million and $612 million decrease at
December 31, 2003, in the fair value of the Companys equity investments. 109




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CNA FINANCIAL CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Continued Of these amounts, under the 10% and 25% scenarios, $8 million and $21 million
at June 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 June 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
    
    EquityJune 30, 2004
    
    Value
    
    Rate Risk
    
    Risk
    
    Risk(In millions)General account:Fixed maturity securities available-for-sale
    
    $
    29,738
    
    
    $
    (2,067
    )
    
    $
    (42
    )
    
    $
    (30
    )Fixed maturity trading securities
    
    
    405
    
    
    
    (4
    )
    
    
    
    
    
    
    (4
    )Equity securities available-for-sale
    
    
    300
    
    
    
    
    
    
    
    (9
    )
    
    
    (30
    )Short term investments available-for-sale
    
    
    3,538
    
    
    
    (3
    )
    
    
    (2
    )
    
    
    Short term trading securities
    
    
    315
    
    
    
    
    
    
    
    
    
    
    
    Limited partnerships
    
    
    1,686
    
    
    
    7
    
    
    
    
    
    
    
    (20
    )Other invested assets
    
    
    28
    
    
    
    
    
    
    
    
    
    
    
    Interest rate swaps
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    Equity indexed futures for trading securities
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    (107
    )Other derivative securities
    
    
    
    
    
    
    (116
    )
    
    
    17
    
    
    
    Total general account
    
    
    36,011
    
    
    
    (2,182
    )
    
    
    (36
    )
    
    
    (191
    )Separate accounts:Fixed maturity securities
    
    
    471
    
    
    
    (24
    )
    
    
    
    
    
    
    Equity securities
    
    
    85
    
    
    
    
    
    
    
    
    
    
    
    (8
    )Short term investments
    
    
    13
    
    
    
    
    
    
    
    
    
    
    
    Other invested assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total separate accounts
    
    
    569
    
    
    
    (24
    )
    
    
    
    
    
    
    (8
    )Total securities
    
    $
    36,580
    
    
    $
    (2,206
    )
    
    $
    (36
    )
    
    $
    (199
    )Debt (carrying value)
    
    $
    1,714
    
    
    $
    (64
    )
    
    $
    
    
    
    $
    
 110




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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
    )
    
    $
    
    
    
    $
    
 111




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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 June 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
    
    EquityJune 30, 2004
    
    Value
    
    Rate Risk
    
    Risk
    
    Risk(In millions)General account:Fixed maturity securities available-for-sale
    
    $
    29,738
    
    
    $
    (3,055
    )
    
    $
    (83
    )
    
    $
    (76
    )Fixed maturity trading securities
    
    
    405
    
    
    
    (6
    )
    
    
    
    
    
    
    (9
    )Equity securities available-for-sale
    
    
    300
    
    
    
    
    
    
    
    (18
    )
    
    
    (74
    )Short term investments available-for-sale
    
    
    3,538
    
    
    
    (4
    )
    
    
    (4
    )
    
    
    Short term trading securities
    
    
    315
    
    
    
    
    
    
    
    
    
    
    
    Limited partnerships
    
    
    1,686
    
    
    
    10
    
    
    
    
    
    
    
    (50
    )Other invested assets
    
    
    28
    
    
    
    
    
    
    
    
    
    
    
    Interest rate swaps
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    Equity indexed futures for trading securities
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    (268
    )Other derivative securities
    
    
    
    
    
    
    (174
    )
    
    
    33
    
    
    
    Total general account
    
    
    36,011
    
    
    
    (3,227
    )
    
    
    (72
    )
    
    
    (477
    )Separate accounts:Fixed maturity securities
    
    
    471
    
    
    
    (36
    )
    
    
    
    
    
    
    Equity securities
    
    
    85
    
    
    
    
    
    
    
    
    
    
    
    (21
    )Short term investments
    
    
    13
    
    
    
    
    
    
    
    
    
    
    
    Other invested assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total separate accounts
    
    
    569
    
    
    
    (36
    )
    
    
    
    
    
    
    (21
    )Total securities
    
    $
    36,580
    
    
    $
    (3,263
    )
    
    $
    (72
    )
    
    $
    (498
    )Debt (carrying value)
    
    $
    1,714
    
    
    $
    (93
    )
    
    $
    
    
    
    $
    
 112




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##### Table of Contents



CNA FINANCIAL CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, 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
    )Equity securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    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
    )
    
    $
    
    
    
    $
    
 113




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##### Table of Contents



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 affected, or are
reasonably likely to materially affect, the Companys internal control over
financial reporting. 114




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##### Table of Contents



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 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities (b) The conversion of the Series I convertible preferred stock into CNAF common
stock on April 20, 2004 resulted in a total of 255,946,852 shares of CNAF
common stock outstanding. At conversion Loews owned 233,620,515 shares of
common stock, or approximately 91% of the outstanding shares. No cash proceeds
were received by CNA in connection with the conversion of the Series I
convertible preferred stock. 
 Item 4. Matters Subject to a Vote of Security Holders Set forth below is information relating to the 2004 Annual Meeting of
Shareholders of the Registrant. The annual meeting was called to order at 10:00 a.m., April 28, 2004.
Represented at the meeting, in person or by proxy, were 220,061,750 shares,
approximately 98.41% of the issued and outstanding shares entitled to vote. The following business was transacted: Election of Directors Over 97.55% of the votes cast for directors were voted for the election of the
following directors. The number of votes for and withheld with respect to each
director was as follows: Votes For
    
    Votes WithheldWalter L. Harris
    
    
    216,294,264
    
    
    
    3,767,486Stephen W. Lilienthal
    
    
    214,690,751
    
    
    
    5,370,999Paul J. Liska
    
    
    219,428,988
    
    
    
    632,762Don M. Randel
    
    
    219,367,479
    
    
    
    694,271Joseph Rosenberg
    
    
    216,254,295
    
    
    
    3,807,455James S. Tisch
    
    
    216,201,086
    
    
    
    3,860,664Preston R. Tisch
    
    
    216,194,359
    
    
    
    3,867,391Marvin Zonis
    
    
    219,263,506
    
    
    
    798,244
 Ratification of the appointment of Independent Certified Public Accountants Approved 219,828,659 votes, approximately 98.31% of the votes cast, voted to
ratify the appointment of Deloitte & Touche, LLP as independent certified
public accountants for the Company, 192,800 votes, approximately 0.09% of the
votes cast, voted against, and shares representing 40,291 votes, approximately
0.02% of the votes cast, abstained. Conversion of Series I Convertible Preferred Stock Pursuant to written notice sent to CNAF shareholders on March 29, 2004,
authorization of the conversion of the Series I convertible preferred stock
into CNAF common stock was given pursuant to written consent of Loews
Corporation. 115




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CNA FINANCIAL CORPORATION
PART II. OTHER INFORMATION Conversion of the Series I convertible preferred stock into CNAF common
stock occurred on April 20, 2004 pursuant to such consent. 
 Item 6. Exhibits and Reports on Form 8-K (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 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 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. (b) Reports on Form 8-K On April 29, 2004, CNA Financial Corporation issued a press release announcing
that Robert V. Deutsch, its Chief Financial Officer, would be leaving. On April 29, 2004, CNA Financial Corporation issued an earnings press release,
financial supplement and financial supplement appendix providing information on
its results of operations for the first quarter 2004 and prior periods. On April 30, 2004, CNA Financial Corporation issued a press release announcing
that it had completed the sale of its individual life insurance business to
Swiss Re Life & Health America Inc. for approximately $700 million. On May 17, 2004, CNA Financial Corporation issued a press release announcing
that it has entered into a definitive agreement to sell the assets of CNA Trust
to Union Bank of California. 116




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##### Table of Contents



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:  August 2, 2004
    By    /s/ Robert V. DeutschRobert V. DeutschExecutive Vice President and
Chief Financial Officer(Principal Accounting
Officer) 117