CNA conducts its operations through five operating segments: Standard Lines, Specialty Lines and CNA Re (which comprise the property and casualty segments), Group Operations and Life Operations. In addition to these five operating segments, certain other activities are reported in the Corporate and Other segment. These operating segments reflect the way CNA manages its operations and makes business decisions.
CNA Trust, a limited-operations bank specializing in 401(k) plan administration, and Institutional Markets, which provides guaranteed return investment products for qualified and non-qualified institutional buyers, was transferred from Life Operations to Group Operations. Group reinsurance, the business which assumes reinsurance from unaffiliated entities on group life, accident and health products and excess medical risk coverages for self-funded employers, was transferred from Group Operations to Corporate and Other to be included as part of run-off insurance operations. The Environmental Pollution and Mass Tort and Asbestos Reserves (APMT) related to assumed reinsurance, along with the assumed business underwritten through a managing general agent, IOA Global, which consists primarily of certain accident and health coverages, was transferred from CNA Re to Corporate and Other. The U.S. zone of Global business, which primarily offers international insurance to U.S. based corporations and U.S. insurance to foreign corporations, was transferred from Specialty Lines to Standard Lines.
Concurrent with the Company’s review of loss reserves, the Company completed comprehensive studies of estimated premium receivable accruals on retrospectively rated insurance policies and involuntary market facilities. These studies included ground-up reviews of retrospective premium accruals utilizing a more comprehensive database of retrospectively rated contracts. This review included application of the policy retrospective rating parameters to the revised estimate of ultimate loss ratio and consideration of actual interim cash settlement. This study resulted in a change in the estimated retrospective premiums receivable balances.
The 2001 Plan charges incurred and accrued by Standard Lines were $40 million in 2001, related entirely to employee termination and related benefit costs for planned reductions in the workforce of 1,063 positions gross and net, of which $27 million related to severance and outplacement costs and $13 million related to other salary costs. Through December 31, 2002, approximately 882 employees net were released due to the 2001 Plan. Approximately 39% of these employees were administrative, technology or financial support staff; approximately 52% of these employees were underwriters, claim adjusters and related insurance services staff; and approximately 9% of these employees were in various other positions. During December of 2002, $8 million of accrual was reduced primarily due to successful redeployment of employees to other positions within the organization. An accrual of $1 million remained at December 31, 2002 relating to employee termination costs which will be paid in 2003.
Insurance companies providing commercial property and casualty insurance are 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, but they are pre-empted in relation to prior approval requirements for rates and forms. The Act has policyholder notice requirements in order for insurers to be reimbursed for terrorism-related losses and, from the date of enactment until December 31, 2004, a mandatory offer requirement for terrorism coverage, although it may be rejected by insureds. The Secretary of the Department of the Treasury has discretion to extend this offer requirement until December 31, 2005.
The net operating loss was $451 million in 2001 as compared with net operating income of $205 million in 2000. Included in the 2001 results were $621 million related to the second quarter 2001 reserve strengthening, $50 million related to the WTC event and $30 million for restructuring and other related charges. Excluding these significant items, net operating results increased $45 million due to improved underwriting results across most lines, except workers compensation. Net operating income in 2000 benefited from a reduction of accruals for certain insurance-related assessments due to changes in the basis on which the assessments were calculated. The after-tax impact of this change was $60 million in 2000. This improvement was partially offset by decreased net investment income, principally as a result of a $69 million
Specialty Lines provides professional, financial and specialty domestic and international property and casualty products and services through a network of brokers, managing general agencies 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. Product offerings also include surety and fidelity bonds and vehicle and equipment warranty services.
The combined ratio increased by 12.8 points in 2001 as compared with 2000 and the underwriting results declined by $247 million. This change is due to increases in both the loss and expense ratios. The loss ratio increased 8.1 points primarily as a result of losses related to Enron, favorable loss reserve development recorded in 2000 for the architects and engineers business not present in 2001, and unfavorable underwriting results in global and marine lines related to the current accident year reserve strengthening discussed above. The increase in the expense ratio is due primarily to the write-off of unrecoverable deferred acquisition costs in the vehicle warranty line of business and increased expenses in the European operations.
The expense ratio decreased 7.8 points primarily as a result of a shift in business mix resulting in lower commission rates and a reduction in underwriting expenses relative to the earned premium base.
The combined ratio increased 30.5 points in 2001 as compared with 2000 and the underwriting results declined $184 million. The change in the combined ratio and underwriting results is due to increases in both the loss and expense ratios. The loss ratio increased 19.2 points due to prior underwriting year adverse loss reserve development and Enron-related losses discussed above. Partially offsetting this increase was a decrease in losses as a result of improvement in the current accident year loss ratios in the domestic and U.K. operations. While operating expenses have decreased for 2001 as compared with 2000, the expense ratio has increased due to the reduced net earned premium base.
Net written premiums for CNA Re decreased $427 million in 2001 as compared with 2000. Included in 2001 net written premiums were $59 million related to corporate aggregate reinsurance treaties and additional ceded premiums arising from both the reserve strengthening and WTC event. These reductions in net written premiums were more than offset by $89 million of reinstatement premiums related to the WTC event. Excluding these 2001 significant premium items, net written premiums decreased $457 million as a result of $161 million of ceded premiums related to corporate aggregate reinsurance treaties and the announced intention to sell the U.K. subsidiaries. Net earned premiums decreased $448 million in 2001 as compared with 2000 related primarily to the reasons noted above.
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 to 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 1,200 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.
The chart below depicts CNA’s overall pending asbestos accounts and associated reserves at December 31, 2002.
Due to the uncertainties created by volatility in claim numbers and settlement demands, the effect of bankruptcies, the extent to which non-impaired claimants can be precluded from making claims and the efforts by insureds to obtain coverage not subject to aggregate limits, the ultimate liability of CNA for asbestos-
Losses realized were attributable to reducing exposure to the credit and exchanging owned bonds for newly issued bonds with more desirable maturity structures. Losses represent 3% of the consideration for bonds sold.
Concurrent with the sale, several reinsurance agreements under which CCC had provided retrocessional protection to CNA Re U.K. were terminated. As part of the sale, CNA Re U.K.’s net exposure to all IGI Program liabilities was assumed by CCC. Further, CCC is providing a $100 million stop loss cover attaching at carried reserves on CNA Re U.K.’s 2001 underwriting year exposures for which CCC received premiums of $25 million.
For the year ended December 31, 2002, net cash provided by operating activities was $1,040 million as compared with net cash used in operating activities of $599 million in 2001. The improvement related primarily to federal tax refunds received in 2002 as compared to taxes paid in 2001 and decreased net payments for insurance claims.
For the year ended December 31, 2001, net cash used for investing activities was $205 million as compared with net cash inflows of $1,842 million in 2000. Cash flows for investing activities were related principally to increased net purchases of invested assets related to investing $1 billion of proceeds from the common stock rights offering completed in the third quarter of 2001.
development of claims and the impact on loss reserves, including changes in claim settlement practices;
As a result of a routine review of the Company’s periodic filings by the Division of Corporation Finance of the Securities and Exchange Commission (SEC), the Company has restated its financial statements. The restated financial statements reflect an adjustment to the Company’s historical accounting for its investment in life settlement contracts and the related revenue recognition. See Note T for further discussion.
Revenues on interest-sensitive contracts are composed of contract charges and fees, which are recognized over the coverage period. Premiums for other life insurance products and annuities are recognized as revenue when due after deductions for ceded insurance premiums.
and liabilities. Future tax benefits are recognized to the extent that realization of such benefits are more likely than not.
During 2002, the Company completed its initial goodwill impairment testing and recorded a $64 million pretax, or $57 million after-tax, impairment charge. In accordance with SFAS 142, the impairment charge, which primarily consists of a $51 million pretax, or $48 million after-tax, charge in Specialty Lines, a $12 million pretax, or $8 million after-tax, charge in Life Operations, and a $1 million pretax, or $1 million after-tax, charge in Corporate and Other, was recorded as a cumulative effect of a change in accounting principle as of January 1, 2002. Any impairment losses incurred after the initial application of this standard will be reported in operating results.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), to stock-based employee compensation under the Company’s stock-based compensation plans.
Realized investment losses included $890 million $129 million and $72 million of pretax impairment losses for the three years ended December 31, 2002, 2001 and 2000. The impairments recorded in 2002 were primarily the result of the continued credit deterioration on specific issuers in the bond and equity markets and the effects on such markets due to the overall slowing of the economy.
Other realized investment gains (losses) for the years ended December 31, 2002, 2001 and 2000 include gains and losses related to the sale and losses associated with the anticipated sale of certain operations or affiliates. See Note P for further details.
In the normal course of business, CNA invests in various financial assets, incurs various financial liabilities and enters into agreements involving derivative securities.
During 2001, the Company recorded estimated incurred losses of $468 million, pretax, net of reinsurance, related to the September 11, 2001 World Trade Center disaster and related events (WTC event). The loss estimate is based on a total industry loss of $50 billion and includes all lines of insurance. The estimate takes into account CNA’s substantial reinsurance agreements, including its catastrophe reinsurance program and corporate reinsurance programs. See Note H for further discussion of reinsurance. The Company has closely monitored reported losses as well as the collection of reinsurance on WTC event claims. As of December 31, 2002, the Company believes its recorded reserves, net of reinsurance, for the WTC event are adequate.
Approximately $50 million of favorable prior year reserve development during 2002 was recorded in commercial automobile liability. Most of the favorable development was from accident year 2000. The most recent actuarial review showed that underwriting actions have resulted in reducing the number of commercial automobile liability claims for recent accident years, especially the number of large losses.
A CNA E&S program, covering facilities that provide services to developmentally disabled individuals, accounts for approximately $50 million of the unfavorable reserve development. The development was due to an increase in the size of known claims and increases in policyholder defense costs. These increases became apparent as the result of an actuarial review completed during 2002, with most of the development recorded in accident years 1999 and 2000. The other program which contributed to the CNA E&S development covers tow truck and ambulance operators in the 2000 and 2001 accident years. This program was started in
During 2002, CNA Re revised its estimate of premiums and losses related to the WTC event. In estimating CNA Re’s WTC event losses, the Company performed a treaty-by-treaty analysis of exposure. The Company’s loss estimate was based on a number of assumptions including the loss to the industry, the loss to individual lines of business and the market share of CNA Re’s cedants. Information available in 2002 resulted in CNA Re increasing its estimate of WTC event related premiums and losses on its property facultative and property catastrophe business. The impact of increasing the estimate of gross WTC event losses by $144 million was fully offset on a net of reinsurance basis (before the impact of the CCC Cover) by higher reinstatement premiums and a reduction of return premiums.
Approximately $95 million of CNA Re’s net WTC loss estimate was attributable to its United Kingdom subsidiary, CNA Re U.K., which was sold in 2002. See Note P for further discussion of the sale.
Approximately $230 million of the adverse loss development was a result of several coverages provided to commercial entities. The gross and net carried claim and claim adjustment expense reserves for the Standard Lines business at the beginning of 2001 were $12,070 million and $9,129 million. Reserve analyses performed during 2001 showed unexpected increases in the size of claims for several lines, including commercial automobile liability, general liability and the liability portion of commercial multiple-peril coverages. In addition, the number of commercial automobile liability claims was higher than expected and several state-specific factors resulted in higher than anticipated losses, including developments associated with commercial automobile liability coverage in Ohio and general liability coverage provided to contractors in New York. The unfavorable development was driven principally by accident years 1997 through 2000. The remaining development affecting years prior to 1997 was driven principally by construction defect claims as described below.
CNA and its subsidiaries are also parties 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. See
CNA Trust, a limited-operations bank specializing in 401(k) plan administration, and Institutional Markets, which provides guaranteed return investment products for qualified and non-qualified institutional buyers, was transferred from Life Operations to Group Operations. Group reinsurance, the business which assumes reinsurance from unaffiliated entities on group life, accident and health products and excess medical risk coverages for self-funded employers, was transferred from Group Operations to Corporate and Other to be included as part of run-off insurance operations. The APMT reserves related to assumed reinsurance, along with the assumed business underwritten through a managing general agent, IOA Global, which consists primarily of certain accident and health coverages, was transferred from CNA Re to Corporate and Other. The U.S. zone of Global business, which primarily offers international insurance to U.S. based corporations and U.S. insurance to foreign corporations, was transferred from Specialty Lines to Standard Lines.
The overall goal of the IT Plan was to improve technology for the underwriting function and throughout the Company and to eliminate inefficiencies in the deployment of IT resources. The changes facilitated a strong focus on enterprise-wide system initiatives. The IT Plan had two main components, which included the reorganization of IT resources into the Technology and Operations Group with a structure based on centralized, functional roles and the implementation of an integrated technology roadmap that included common architecture and platform standards that directly support the Company’s strategies.
As summarized in the following table, during 2001, the Company incurred $62 million pretax, or $40 million after-tax, of restructuring and other related charges for the IT Plan. During 2002, $4 million pretax, or $3 million after-tax, of this accrual was reduced.
All lease termination costs and impaired asset charges, except lease termination costs incurred by operations in the United Kingdom and software write-offs incurred by Life Operations, were charged to the Corporate and Other segment because office closure and consolidation decisions were not within the control of the other segments affected. Lease termination costs incurred in the United Kingdom relate solely to the operations of CNA Re. All other charges were recorded in the segment benefiting from the services or existence of an employee or an asset.
The CNA Life Re business contributed net earned premiums of $229 million and net income of $18 million for the year ended December 31, 2000.
As discussed in Note T to the consolidated financial statements, the accompanying 2001 and 2000 consolidated financial statements have been restated.