Restated to reflect an adjustment to the Company’s historical accounting for CNA’s investment in life settlement contracts and the related revenue recognition. See Note T of the Consolidated Financial Statements included under Item 8 for further discussion.
Loews Corporation (Loews) owned approximately 90% of the outstanding common stock of CNAF as of December 31, 2002. The following discussion should be read in conjunction with Item 6. Selected Financial Data and Item 8. Financial Statements and Supplementary Data.
Subsequent to the issuance of the Company’s 2001 Consolidated Financial Statements and, 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 revised the historical accounting for its investment in life settlement contracts and the related revenue recognition. The Company has restated its previously reported financial statements as of December 31, 2001 and for the years ended December 31, 2001 and 2000 as well as its interim financial data for the first three quarters of 2002 and all interim periods of 2001.
Insurance reserves are established for both short and long-duration insurance contracts. Short-duration contracts are primarily related to property and casualty 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
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 operations.
Net operating income was $396 million in 2002 as compared with a net operating loss of $2,408 million in 2001. The net operating loss for 2001 included $2,079 million after-tax related to reserve strengthening recorded in the second quarter of 2001 resulting from a change in estimate of prior year net loss reserves and retrospective premium accruals. Additionally, 2001 results included estimated losses related to the September 11, 2001 World Trade Center Disaster and related events (WTC event) of $304 million after-tax and restructuring and other related charges of $165 million after-tax. Excluding these 2001 significant items, 2002 net operating results increased $256 million due primarily to improved underwriting results in the property and casualty segments and improved results in Group and Life Operations, partially offset by lower net investment income, net reserve strengthening for individual long term care in Life Operations and a reduced benefit from the use of reinsurance in 2002, including the reduced benefit from corporate aggregate reinsurance treaties. In 2002, the benefit from core corporate aggregate reinsurance treaties was $28 million as compared to a benefit of $61 million in 2001. The ceded premiums, ceded losses and interest charges related to corporate aggregate reinsurance treaties not related to the second quarter 2001 reserve strengthening and the WTC event are described as “Core.” Also contributing to the improvement was a $24 million after-tax reduction of the accrual for restructuring and other related charges in 2002. Net unfavorable reserve development, including premium and unallocated loss adjustment expense development, was $90 million after-tax in 2002 as compared to $236 million after-tax in 2001, excluding the second quarter 2001 reserve strengthening.
life reinsurance business, which was sold via an indemnity reinsurance agreement on December 31, 2000.
In the third quarter of 2001, the Company recorded the estimated impact of the WTC event, which resulted in $1,648 million of pretax gross losses, and $468 million pretax net of reinsurance and the related corporate aggregate reinsurance treaties benefit. The after-tax estimated impact was $304 million, net of reinsurance and the related corporate aggregate reinsurance treaties benefit. Further details of the WTC event are provided below as well as in the individual segment discussions of operations.
During 2001, the Company recorded ceded premiums, ceded losses and interest charges related to corporate aggregate reinsurance treaties in place for the 1999 through 2001 accident years. The discussion in the Reinsurance section below includes all premiums, losses and interest charges related to these treaties. However, in all other sections of the MD&A the applicable amounts ceded to these treaties as a result of the second quarter 2001 reserve strengthening and WTC event are included in the quantification of those significant items. The ceded premiums, ceded losses and interest charges related to corporate aggregate reinsurance treaties not related to these significant items are described as “Core.”
Based upon the significance of the second quarter 2001 reserve strengthening, the WTC event and restructuring and other related charges, the underwriting impact of these items is discussed in the aggregate in the following sections. When the Company discusses its 2001 underwriting results and ratios for its property and casualty segments, the discussion will compare 2001 underwriting results and ratios excluding the effect of these significant items. In the Company’s previous filings, the discussion of 2001 underwriting results excluded the benefit from corporate aggregate reinsurance treaties for Core operations. During 2002, the Company has also recorded benefits from corporate aggregate reinsurance treaties for Core operations; therefore, in order to provide a comparable presentation, the 2001 adjusted underwriting loss does not exclude the benefit from corporate aggregate reinsurance treaties from Core operations. The following table provides the details by segment of 2001 underwriting results as adjusted.
During the second quarter of 2001, the Company noted the continued emergence of adverse loss experience across several lines of business related to prior years, which are discussed in further detail below. The Company completed a number of reserve studies during the second quarter of 2001 for many of its lines of business, including those in which these adverse trends were noted.
The second quarter 2001 prior year reserve strengthening and related items comprising the amounts noted above are detailed by segment in the following table.
In the area of mass torts, several well-publicized verdicts arising out of bodily injury cases related to allegedly toxic mold led to a significant increase in mold-related claims in 2000 and
Throughout 2000, and into 2001, CNA experienced significant increases in new asbestos bodily injury claims. In light of this development, CNA formed the view that payments for asbestos claims could be higher in future years than previously estimated. Moreover, in late 2000 through mid-2001, industry sources such as rating agencies and actuarial firms released analyses and studies commenting on the increase in claim volumes and other asbestos liability developments. For example, A.M. Best Company (A.M. Best) released a study in May 2001 increasing its ultimate asbestos reserve estimate 63% from $40 billion to $65 billion, citing an unfunded insurance industry reserve shortfall of $33 billion. In June 2001, Tillinghast raised its asbestos ultimate exposure from $55 billion to $65 billion for the insurance industry and its estimate of the ultimate remaining asbestos liability for all industries was raised to $200 billion.
Approximately $600 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 Standard Lines at the beginning of 2001 was $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.
An analysis of assumed reinsurance business written by CNA Re showed that the paid and reported losses for recent accident years were higher than expectations, which resulted in management recording net unfavorable development on prior year loss reserves of approximately $560 million. The gross and net claim and claim adjustment expense reserves at the beginning of 2001 for CNA Re was $4,238 million and $2,735 million. Because of the long and variable reporting pattern associated with assumed reinsurance as well as uncertainty regarding possible changes in the reporting methods of the ceding companies, the carried reserves for assumed reinsurance was based mainly on the pricing assumptions until experience emerges to show that the pricing assumptions are no longer valid. The reviews completed during the second quarter of 2001, including analysis at the individual treaty level, showed that the pricing assumptions were no longer appropriate. The classes of business with the most significant changes included excess of loss liability, professional liability and proportional and retrocessional property. The unfavorable reserve development was driven principally by accident years 1996 through 2000.
term care facilities. Original assumptions were that these chains would exhibit loss ratios similar to the local facilities. The most recent review of these large chains indicated an overall loss ratio in excess of 500% versus approximately 100% for the remaining business. In addition, the average size of claims resulting from coverages provided to physicians and institutions providing healthcare related services increased more than expected. The review indicated that the average loss had increased to over $330 thousand. Prior to this review, the expectation for the average loss was approximately $250 thousand. Unfavorable reserve development of $240 million was recorded for accident years 1997 through 2000. The remaining unfavorable reserve development was attributable to accident years prior to 1997.
The Company’s overall reinsurance program includes certain property and casualty contracts, such as the corporate aggregate reinsurance treaties discussed in more detail later in this section, that are entered into and accounted for on a “funds withheld” basis. Under the funds withheld basis, the Company records the cash remitted to the reinsurer for the reinsurer’s margin, or cost of the reinsurance contract, as ceded premiums. The remainder of the premiums ceded under the reinsurance contract is recorded as funds withheld liabilities. The Company is required to increase the funds withheld balance at stated interest crediting rates applied to the funds withheld balance or as otherwise specified under the terms of the contract. The funds withheld liability is reduced by any cumulative claim payments made by the Company in excess of the Company’s retention under the reinsurance contract. If the funds withheld liability is exhausted, interest crediting will cease and additional claim payments are recoverable from the reinsurer. The funds withheld liability is recorded in reinsurance balances payable in the Consolidated Balance Sheets.
Amounts receivable from reinsurers were $12,696 million and $13,823 million at December 31, 2002 and 2001. Of these amounts, $957 million and $838 million were billed to reinsurers as of December 31, 2002 and 2001, as reinsurance contracts generally require payment of claims by the ceding company before the amount can be billed to the reinsurer. The remaining receivable relates to the estimated case and IBNR reserves and future policyholder benefits ceded under reinsurance contracts.
will no longer accept new business and are placing their books of business into run-off. The Company’s principal credit exposures from these recent events arise from reinsurance receivables from Gerling Global (Gerling), Trenwick and Commercial Risk insurance groups. At December 31, 2002, the Company had approximately $926 million of reinsurance receivables from these reinsurers, of which $384 million was not supported by collateral. The majority of the uncollateralized receivables were due from U.S.-domiciled insurers. Of the $384 million of reinsurance recoverables unsupported by collateral, $170 million relates to Gerling. Gerling has stated that the Company transfer approximately $204 million of funds withheld balances on three treaties relating to CNA HealthPro to a trust established by Gerling for the benefit of the company, or in the absence of such transfer, that these treaties be commuted. CNA has taken Gerling’s statement under advisement.
In certain circumstances, including significant deterioration of a reinsurer’s financial strength ratings, the Company may engage in commutation discussions with an individual reinsurer. 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, including any related to Gerling, could have an adverse material impact on the Company’s results of operations or equity.
The Company has established an allowance for doubtful accounts to provide for estimated uncollectible reinsurance receivables. The allowance for doubtful accounts was $196 million and $170 million at December 31, 2002 and 2001. While the Company believes the allowance for doubtful accounts is adequate based on current collateral and information currently available, failure of reinsurers to meet their obligations could have a material adverse impact on CNA's results of operations or equity.
In 1999, the Company entered into an aggregate reinsurance treaty related to the 1999 through 2001 accident years covering substantially all of the Company’s property and casualty lines of business (the Aggregate Cover). The Company has two sections of coverage under the terms of the Aggregate Cover. 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 contract, has annual limits of $500 million of ceded losses with an aggregate limit of $1 billion of ceded losses for the three year period. The ceded premiums 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 was only utilized for 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. If the aggregate loss ratio for the three-year period
In connection with the IT Plan, after the write-off of impaired assets, the Company accrued $30 million of restructuring and other related charges in 2001 (the IT Plan Initial Accrual).
The following table summarizes the IT Plan Initial Accrual and the activity in that accrual during 2001 and 2002.
The 2001 Plan charges incurred and accrued by CNA Re were $6 million. Costs related to employee termination and related benefit costs for planned reductions in the workforce of 33 positions gross and net, amounted to $2 million, all of which related to severance and outplacement costs. Payments of $1 million were made in 2002 for approximately 15 employees net released through December 31, 2002 due to the 2001 Plan. The remaining $4 million of charges incurred by CNA Re related to lease termination costs. Approximately $1 million was paid in 2002 related to lease termination costs. As a result of the sale of CNA Re U.K., the remaining accrual related to CNA Re of $4 million was reduced. See the Investments section of the MD&A for further details.
Approximately 28% of these employees were administrative, technology or financial support staff; and approximately 72% of these employees were underwriters, claim adjusters and related insurance services staff. Other costs of $35 million in Group Operations relate to a write-off of deferred acquisition costs on inforce variable life and annuity contracts, as the company believes that the decision to discontinue these products will negatively impact the persistency of the business.
The 2001 Plan charges incurred and accrued by the Corporate and Other segment were $82 million. Costs related to employee termination and related benefit costs for planned reductions in the workforce of 194 positions gross and net, amounted to $9 million, of which $6 million related to severance and outplacement costs and $3 million related to other salary costs. Through December 31, 2002, 157 employees net were released due to the 2001 Plan. Approximately 63% of these employees were administrative, technology or financial support staff; approximately 28% of these employees were underwriters, claim adjusters and related insurance services staff; and approximately 9% of these employees were in various other positions. In December of 2002, $1 million of the accrual was reduced for employee termination and related benefit costs. The Corporate and Other segment also incurred $73 million of lease termination and asset impairment charges related to office closure and consolidation decisions not within the control of the other segments affected. Additionally, $7 million was reversed and included in 2002 net income relating to lease obligations and $14 million relating to impaired asset charges. The Company’s original plan contained a timeline to consolidate and reduce the number of office locations. Due to unfavorable conditions in the commercial real estate market, certain office relocations and consolidations occurred later than planned. As a result of such delays, a portion of the planned leasehold write-offs and vacant office space were expensed as period costs, resulting in an excess initial accrual. Of the remaining $36 million accrual relating to lease termination costs and impaired asset charges, approximately $18 million is expected to be paid in 2003.
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 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. Some of the many uncertain future events about which the Company makes assumptions and estimates are claims severity, frequency of claims, mortality, morbidity, expected interest rates, economic inflation, the impact of underwriting policy and claims handling practices 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”).
The Company’s experience has been that the inherent uncertainties of estimating Insurance Reserves are generally greater for casualty coverages (particularly long-tail casualty risks such as APMT losses) than for property coverages. Estimates of the cost of future APMT claims are highly complex and include an assessment of, among other things, whether certain costs are covered under the policies and whether recovery limits apply, allocation of liability among numerous parties, some of whom are in bankruptcy proceedings, inconsistent court decisions and developing legal theories and tactics of plaintiffs’ lawyers. Reserves for property-related catastrophes, both natural disasters and man-made catastrophes such as terrorist acts, are also difficult to estimate. See the discussion of the Second Quarter 2001 Prior Year Reserve Strengthening, the WTC Event, and Environmental Pollution and Mass Tort and Asbestos Reserves in the MD&A for further information.
In addition to the uncertainties inherent in estimating APMT and catastrophe losses, the Company is subject to the uncertain effects of emerging or potential claims and coverage issues, which arise as industry practices and legal, judicial, social, and other environmental conditions change. These issues can 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. Either development could require material increases in claim and claim adjustment expense reserves. Examples of emerging or potential claims and coverage issues include: (i) increases in the number and size of water damage claims related to expenses for testing and remediation of mold conditions; (ii) increases in the number and size of claims relating to injuries from medical products, and exposure to lead and radiation related to cellular phone usage; (iii) expected increases in the number and size of claims relating to accounting and financial reporting, including director and officer and errors and omissions insurance claims, in an environment of major corporate bankruptcies; and (iv) a growing trend of plaintiffs targeting insurers in class action litigation relating to claims-handling and other practices. The future impact of these and other unforeseen emerging or potential claims and coverage issues is extremely hard 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.
condition. Any such increase in reserves would be recorded as a charge against the Company’s earnings for the period in which the change in estimate arises.
The estimated volatility noted above does not represent a range around the actuarial point estimate of the Company’s gross loss reserves, and it does not represent the range of all possible outcomes. The volatility represents an estimate of the inherent volatility associated with estimating loss reserves for the specific type of business written by each segment. The primary characteristics influencing the estimated level of volatility are the length of the claim settlement period, changes in medical and other claim costs, changes in the level of litigation or other dispute resolution processes, changes in the legal environment and the potential for different types of injuries emerging. Ceded reinsurance arrangements may reduce the volatility. Since ceded reinsurance arrangements vary by year, volatility in gross reserves may not result in comparable impacts to underwriting income or equity.
from date of enactment to December 31, 2002 (the Transition Period) to 7% during the first subsequent calendar year, 10% in year two and 15% in year three. 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.
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, exposure based pricing, relationships with selected distribution sources and understanding customers.
Also, Standard Lines, primarily through RSKCoSM, provides total risk management services relating to claim services, risk control, cost management and information services to the commercial insurance marketplace.
The 2001 adjusted underwriting loss and adjusted ratios exclude the impact of the second quarter 2001 reserve strengthening, the WTC event, both net of the related benefit of corporate aggregate reinsurance treaties, and restructuring and other related charges.
Partially offsetting these declines were both improved current gross accident year loss ratios and favorable net reserve development in 2002. Favorable net reserve development, including premium development, of $154 million was recorded in 2002 as compared with unfavorable net reserve development of $24 million recorded in 2001, excluding the second quarter 2001 reserve strengthening. The gross carried claim and claim adjustment expense reserve was $11,576 million and $12,854 million at December 31, 2002 and 2001. The net carried claim and claim adjustment expense reserve was $7,262 million and $7,788 million at December 31, 2002 and 2001.
Approximately $140 million of favorable prior year reserve development was attributable to participation in the Workers Compensation Reinsurance Bureau (WCRB), a reinsurance pool, and residual markets. The favorable prior year reserve development for WCRB was the result of information received from the WCRB that reported the results of a recent actuarial review. This information indicated that the Company’s net required reserves for accident years 1970 through 1996 were $60 million less than the carried reserves. In addition, during 2002, the Company commuted accident years 1965 through 1969 for a payment of approximately $5 million to cover carried reserves of approximately $13 million, resulting in further favorable reserve development of $8 million. The favorable residual market prior year reserve development was the result of lower than expected paid loss activity during recent
periods for accident years dating back to 1984. The paid losses during 2002 on prior accident years were approximately 60% of the previously expected amount.
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. An actuarial review completed during 2002 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.
Offsetting these favorable reserve developments were approximately $100 million of unfavorable reserve development in middle market workers compensation, approximately $70 million of unfavorable reserve development in programs written in CNA E&S, approximately $30 million of unfavorable reserve development on a contractors account package policy program and approximately $20 million of unfavorable development on middle market general liability coverages.
The unfavorable reserve development on workers compensation was principally due to additional reinsurance premiums for accident years 1999 through 2001.
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 is 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 from 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 1999. The Company expected that loss ratios for this business would be similar to its middle market commercial automobile liability business. Reviews completed during the year resulted in estimated loss ratios on the tow truck and ambulance business that are 25 points higher than the middle market commercial automobile liability loss ratios.
The expense ratio decreased 4.2 points as a result of decreased acquisition expenses, principally due to reduction in accruals for certain insurance-related assessments resulting from changes in the regulatory basis on which the assessments were calculated. Furthermore, the expense ratio decreased due to reduced head count as a result of the 2001 Plan and increased net earned premium base. The dividend ratio decreased 1.5 points primarily due to favorable current accident year dividends.
Net earned premiums decreased $1,518 million in 2001 as compared with 2000. Included in the 2001 net earned premiums were $1,195 million of ceded premiums related to corporate aggregate reinsurance treaties, additional ceded premiums and a change in estimate for retrospective premium accruals arising from the reserve strengthening, additional ceded premiums arising from the WTC event, and a change in estimate for involuntary market premium accruals. Excluding these 2001 significant premium items, net earned premiums decreased $323 million due primarily to the changes noted above in net written premiums.
Specialty Lines includes the following business groups: Professional Liability Insurance, CNA Guaranty and Credit, Surety, CNA Global and Warranty.
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, dental professionals and mid-size and large healthcare facilities and delivery systems. Additionally, CNA HealthPro offers risk management consulting services to assist customers in managing quality of care risks associated with the delivery of healthcare. Claim services are provided to manage and resolve claims. In addition, Caronia Corporation, an affiliate of CNA HealthPro, provides third-party claims administration for healthcare providers and facilities.
CNA Guaranty and Credit provides credit insurance on short term trade receivables for domestic and international clients as well as reinsurance to insurers who provide financial guarantees to issuers of asset-backed securities, money market funds and investment-grade corporate debt securities. The Guaranty business underwritten by CNA’s insurance affiliates excluding CNA’s ownership interest in R.V.I. Guaranty Co. Ltd. (RVI), an unconsolidated affiliate, is currently in run-off. The Credit business underwritten by CNA’s insurance affiliates was sold on December 31, 2002; however all inforce business and reserves at the date of sale were retained by CNA. The run-off of these businesses will occur over several years.
Surety consists primarily of CNA Surety Corporation (CNA Surety), and its insurance subsidiaries. CNA Surety is traded on the New York Stock Exchange (SUR) and is the largest publicly traded provider of surety bonds, with approximately 9.6% of that market, based upon 2001 A.M. Best written premium data. CNA Surety 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 approximately 34,000 independent agencies. CNA owns approximately 64% of CNA Surety.
strategic indigenous opportunities and currently has operations in Hawaii, Europe, Latin America and Canada.
Warranty provides warranty services that protect individuals and businesses from the financial burden associated with breakdown, under-performance or maintenance of a product. Products are distributed via a sales force employed or contracted through a program administrator. Warranty consists primarily of CNA National Warranty Corporation, which sells vehicle warranty services in the United States and Canada.
The combined ratio decreased 6.9 points in 2002 as compared with 2001, and the underwriting results improved $107 million as compared with the underwriting results for 2001. The change in the underwriting results and the combined ratio was driven by a decrease in the expense and dividend ratios, partially offset by an increase in the loss ratio. The loss ratio increased 1.8 points due principally to increased unfavorable net reserve development recorded in 2002. Partially offsetting these declines were improved current gross accident year loss ratios and rate increases across the entire book of business and the increased benefit related to additional cessions to the CCC Cover as a result of the prior year reserve development recorded in the third quarter of 2002. Net unfavorable reserve development, including premium development, of $137 million was recorded in 2002 as compared to unfavorable net reserve development of $46 million recorded in 2001, excluding the second quarter 2001 reserve strengthening. The gross carried reserve was $5,874 million and $5,668 million at December 31, 2002 and 2001. The net carried reserve was $3,373 million and $3,461 million at December 31, 2002 and 2001.
The expense ratio decreased 8.6 points as a result of the increase in earned premium base and the 2001 write-off of unrecoverable deferred acquisition costs in the vehicle warranty line of business and lower underwriting expenses due to decreased staff levels as a result of the 2001 Plan, and other expense reduction initiatives.
Net written premiums for Specialty Lines increased $432 million in 2002 as compared with 2001. Included in 2001 net written premiums were $68 million of ceded premium related to corporate aggregate reinsurance treaties, additional ceded premiums arising from both the reserve strengthening and WTC event, and a change in estimate for involuntary market premium accruals. Excluding these 2001 significant premium items, net written premiums increased $364 million primarily as a result of growth in most lines of business, including CNA Pro and Global, due to strong rate increases and increased new business.
The net operating loss was $329 million in 2001 as compared with net operating income of $196 million in 2000. Included in the 2001 results were $275 million related to the second quarter 2001 reserve strengthening, $12 million related to the WTC event and $6 million for restructuring and other related charges.
Excluding these significant items, net operating results decreased $232 million for 2001 as compared with 2000. This decrease was due primarily to unfavorable 2001 underwriting results for the London-based commercial and marine operations compared to 2000 and $30 million of after-tax losses related to Enron, as described above, in the fourth quarter of 2001. Additionally, net operating results declined as a result of the write-off of unrecoverable deferred acquisition costs and better alignment of premium earnings patterns with the emergence of claims in the vehicle warranty line of business, a decreased benefit from the use of finite reinsurance and decreased net investment income, principally resulting from a $29 million decline in limited partnership income.
Net written premiums for Specialty Lines increased $19 million in 2001 as compared with 2000. Included in 2001 net written premiums were $68 million related to corporate aggregate reinsurance treaties, additional ceded premiums arising from both the reserve strengthening and WTC event, and a change in estimate for involuntary market premium accruals. Excluding these 2001 significant premium items, net written premiums increased $87 million primarily as a result of strong production in coverage for law firms, long term care, and architects and engineers products as well as increased rate achievement in Europe, primarily in property lines and decreased ceded premiums related to finite reinsurance for the medical professional liability lines. Partially offsetting these increases was $77 million resulting from additional ceded premiums related to core corporate aggregate reinsurance treaties, as well as declines in the warranty and guaranty lines. Net written premiums also decreased $23 million due to a change in the timing of recording written premiums for policies with future effective dates. This change
was made in conjunction with statutorily required changes in recording written premiums and has no impact on net earned premiums or net income.
CNA Re offers treaty, facultative, and financial reinsurance, and operates primarily in the United States and select global markets as a reinsurer in the broker market for treaty products and in the direct market for facultative products.
Both treaty and facultative operations are headquartered in Chicago. CNA Re also operates Facultative branch offices in Atlanta, Chicago, Cleveland, Dallas, Hartford, New York, Philadelphia and Phoenix.
Additionally, net operating results in 2001 included a $160 million charge to strengthen prior underwriting year loss reserves for CNA Re U.K. There was no tax benefit related to this charge due to the inability to recover further tax benefits related to the underwriting losses of CNA Re U.K. Also included in 2001 were Enron-related losses of $22 million, primarily for reinsurance of surety obligations.
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 original 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
The combined ratio decreased 27.7 points in 2002 as compared with 2001, and underwriting results improved $194 million. The improvement in underwriting results and the combined ratio was driven by decreases in the loss and expense ratios. The loss ratio decrease of 19.9 points is principally due to lower net prior year reserve strengthening in 2002 as compared with 2001 and a net $32 million net underwriting benefit related to corporate aggregate reinsurance treaties recorded in 2002 and improved current accident year results. The 2001 net prior year reserve strengthening includes a $160 million after-tax charge to strengthen prior underwriting year reserves for CNA Re U.K. recorded in 2001. Net unfavorable reserve development, including premium development, of $43 million was recorded in 2002 as compared with $214 million of unfavorable development recorded in 2001, excluding the second quarter 2001 reserve strengthening. The gross carried reserve was $2,264 million and $4,644 million at December 31, 2002 and 2001. The net carried reserve was $1,362 million and $3,013 million at December 31, 2002 and 2001. At the sale date, the gross and net carried reserves related to CNA Re U.K. were $2,092 million and $1,316 million. At December 31, 2001, the gross and net carried reserves related to CNA Re U.K. were $2,367 million and $1,265 million.
Group Benefits is in the employee benefits marketplace and offers group term life and accident insurance, short term and long term disability, statutory disability, long term care and specialty medical products and related services. Target employers range from small private companies to large public corporations. Specific areas of opportunity include the small case market as well as under-served industries. Products are marketed through a nationwide operation of 31 sales offices, third-party administrators, managing general agents and insurance consultants.
Institutional Markets and Other is a provider of annuities and investment products to pension plan sponsors and other institutional customers. The products include traditional and synthetic guaranteed investment contracts (GICs), indexed contracts, group annuities and funding agreements. CNA offers an Index 500 product, which is a guaranteed investment contract that is indexed to the performance of the Standard & Poor’s 500® (S&P 500 ®) Index.
Also within Group Operations is CNA Trust, a limited operations bank located in Costa Mesa, California, which provides full trustee and pension third-party administrative services to the under 500-life employer markets. Products include qualified and non-qualified plans and IRAs. Products are marketed through life insurers and mutual fund companies.
Net earned premiums for Group Operations decreased $1,051 million for 2002 as compared with 2001. This decline was due primarily to the transfer of the Mail Handlers Plan partially offset by an increase in premiums in the disability and long term care products within Group Benefits. Net earned premiums for the Mail Handlers Plan was $1,151 million as compared with $2,218 million in 2001. Deposits for Group Operations decreased $41 million for 2002 as compared with 2001 primarily due to reduced sales of S&P 500 ® contracts in Institutional Markets.
Group Operations achieved rate increases that averaged approximately 5%, 6% and 3% in 2002, 2001 and 2000 for the disability, accident and life lines of business within Group Benefits. Premium persistency rates were approximately 81%, 81% and 84% in 2002, 2001 and 2000.
Net operating income decreased by $63 million in 2001 as compared with 2000. Included in the 2001 results were $35 million related to the WTC event and $27 million related to restructuring and other related charges. Included in the restructuring and other related charges was a $23 million write-off of deferred acquisition costs on inforce variable life and annuity contracts as the Company believed that its decision to discontinue these products would negatively impact the persistency of the business. Excluding these 2001 significant items, net operating results decreased $1 million primarily as a result of the sale of life reinsurance and a decrease in limited partnership income of $15 million. Life reinsurance contributed net operating income of $22 million in 2000. Partially offsetting these declines were improvements realized by exiting unprofitable lines of approximately $18 million and increased income in other product lines, primarily the single premium guaranteed annuity, GIC and disability and group long term care lines, of $18 million.
Net operating income increased by $31 million in 2002 as compared with 2001. Included in the 2001 results were $19 million related to restructuring and other related charges and $14 million related to the WTC event. Excluding these 2001 significant items, net operating results decreased $2 million due primarily to net reserve strengthening for individual long term care, unfavorable individual long term care morbidity and increased costs related to the life settlement business in 2002. These decreases were partially offset by higher net investment income, a decrease in reinsurance charges, favorable reserve development relating to the WTC event of $10 million after-tax recorded in 2002 as compared with 2001, and a $1 million after-tax reduction of the accrual for restructuring and other related charges recorded in 2002.
Sales volume for Life Operations decreased by $13 million in 2002 as compared with 2001. This decrease was attributable primarily to lower sales of structured settlement annuities, partially offset by increased sales in the individual long term care product. Net earned premiums increased $57 million in 2002 as compared with 2001 attributable primarily to growth in the individual long term care product partially offset by sales declines in structured settlement annuities.
Net operating income decreased by $56 million in 2001 as compared with 2000. Included in the 2001 results were $19 million related to restructuring and other related charges and $14 million related to the WTC event. Excluding these 2001 significant items, net operating results decreased $23 million due primarily to decreased net investment income from limited partnerships of $21 million.
Sales volume for Life Operations increased by $133 million in 2001 as compared with 2000. This increase was driven primarily by improved sales in structured settlements and increased
renewals and new sales in individual long term care products. Net earned premiums increased $100 million in 2001 as compared with 2000. This improvement is attributable primarily to improved sales of structured settlement annuities due to favorable pricing conditions and individual long term care products, partially offset by a decrease in new individual life business.
The following table details operating results for the Corporate and Other segment.
Net operating results increased by $999 million in 2002 as compared with 2001. The after-tax impact of the second quarter 2001 reserve strengthening on the Corporate and Other segment
Excluding these 2001 significant items, net operating results improved $68 million in 2002 as compared with 2001. Reduced expenses for e-Business initiatives and improved results for group reinsurance were offset by lower net investment income, principally resulting from a $6 million decline in limited partnership income, higher losses related to the runoff of CNA UniSource and severance and other costs related to changes in senior management in 2002. Also contributing to the improvement was a $17 million after-tax reduction in the accrual for restructuring and other related charges recorded in 2002.
During 2002, favorable net reserve development, including premium development, of $23 million was recorded in the Corporate and Other segment as compared with unfavorable net reserve development of $63 million recorded in 2001, excluding the second quarter 2001 reserve strengthening. The gross carried claim and claim adjustment expense reserve was $4,847 million and $5,043 million at December 31, 2002 and 2001. The net carried claim and claim adjustment expense reserve was $2,002 million and $2,110 million at December 31, 2002 and 2001.
The unfavorable reserve development on personal insurance was offset by favorable reserve development on other runoff business driven principally by financial and mortgage guarantee coverages from accident years 1997 and prior. The favorable reserve development on financial and mortgage guarantee coverages resulted from a review of the underlying exposures and the outstanding losses. This review showed that salvage and subrogation continues to be collected on these types of claims, thereby reducing estimated future losses net of anticipated reinsurance recoveries.
Total operating revenues decreased $31 million in 2002 as compared with 2001. This decrease was due primarily to reduced revenues for CNA UniSource, due to the exit of this business, and reduced net investment income partially offset by increased net earned premiums in group reinsurance.
was $837 million, including $778 million for APMT. See the Environmental Pollution and Mass Tort and Asbestos Reserves section following for a discussion of this charge. Net operating income for 2001 also decreased by $77 million for restructuring and other related charges and $17 million related to the WTC event for group reinsurance.
Excluding these 2001 significant items, net operating results increased $29 million primarily as a result of lower interest expense on corporate borrowings in 2001 as compared with 2000 and a non-recurring favorable adjustment of expense recoveries under a service contract related to personal insurance. These increases were partially offset by $45 million for non-recurring ceding commissions included in 2000 results related to the transfer of the personal insurance line of business to Allstate in 1999, $35 million related to increased eBusiness initiatives in 2001 and $12 million due to decreased limited partnership income.
Total operating revenues decreased $254 million in 2001 as compared with 2000. This decline was due to a decrease in net investment income and net earned premiums from run-off insurance operations, particularly the entertainment and agriculture insurance lines.
There was no asbestos or environmental pollution and mass tort-related net claim and claim adjustment expense reserve development for the year ended December 31, 2002. As a result of a change in estimate resulting from the Company’s semi-annual ground-up review of APMT accounts, gross and ceded APMT reserves were increased. The settlement scenarios that supported higher estimated gross and higher estimated ceded reserves were judged to be the most appropriate. However, net reserves remained unchanged. The estimation of reinsurance recoverables on accounts is highly dependent on the allocation of each account’s estimated ultimate losses to the available historical insurance coverage. This allocation becomes more refined as accounts and their insurers enter more serious settlement negotiations.
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
A number of proposals to reform Superfund have been made by various parties. In 2002, no reforms were enacted by Congress. 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 impact upon CNA’s results of operations or equity.
CNA’s property and casualty insurance subsidiaries also have exposure to asbestos-related claims. Estimation of asbestos-related claim and claim adjustment expense reserves involves many of the same limitations discussed above for environmental pollution claims, 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. Currently, the majority of asbestos bodily injury claims are filed by persons exhibiting few, if any, disease symptoms. It is estimated that approximately 90% of the current non-malignant asbestos claimants do not meet the American Medical Association’s definition of impairment. 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.
As of December 31, 2002 and 2001, CNA carried approximately $1,231 million and $1,252 million of claim and claim adjustment expense reserves, net of reinsurance recoverables, for reported and unreported asbestos-related claims.
There was no asbestos-related net claim and claim adjustment expense reserve development for the year ended December 31, 2002. Unfavorable asbestos-related net claim and claim adjustment expense reserve development for the years ended December 31, 2001 and 2000 amounted to $773 million and $65 million. The Company paid asbestos-related claims, net of reinsurance, of $20 million, $171 million and $126 million during the years ended December 31, 2002, 2001 and 2000, excluding payments made in connection with the 1993 settlement of litigation related to Fibreboard Corporation.
CNA, through its acquisition of The Continental Insurance Company (CIC) in 1995, acquired obligations under the Wellington Agreement. In 1985, 47 asbestos producers and their insurers, including CIC, executed the Wellington Agreement. The agreement intended to resolve all
CNA has also used coverage in place agreements to resolve large asbestos exposures. Coverage in place agreements are typically agreements between CNA and its policyholders identifying the policies and the terms for payment of asbestos related liabilities. Claims payments are contingent on presentation of adequate documentation showing exposure during the policy periods and other documentation supporting the demand for claims payment. Coverage in place agreements may have annual payment caps. At December 31, 2002, CNA had negotiated 23 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. The Company has evaluated these commitments and has established a $66 million reserve, net of reinsurance, to fund coverage in place agreements based on current projections of claims volumes and severities.
Some asbestos-related defendants have asserted that their claims for insurance 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 such exposures by aggressive settlement strategies. Nevertheless, there can be no assurance any of these settlement efforts will be successful, or that any such claims can be settled on terms acceptable to CNA. Adverse developments with respect to such matters discussed in this paragraph could have a material adverse impact on CNA’s results of operations or equity.
CNA reviews each active asbestos account every six months to determine whether changes in reserve estimates may be necessary. The Company considers input from its analyst 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 future exposures (including such factors as claims volume, disease mix, trial conditions, settlement demands and defense costs); 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.
related claims may vary substantially from the amount currently recorded. Other variables that will influence CNA’s ultimate exposure to asbestos-related claims will be medical inflation trends, jury attitudes, the strategies of plaintiff attorneys to broaden the scope of defendants, the mix of asbestos-related diseases presented, CNA’s abilities to recover reinsurance, future court decisions and the possibility of legislative reform. Adverse developments with respect to such matters discussed in this paragraph could have a material adverse impact on CNA’s results of operations or equity.
upon to indemnify policyholders and creating the potential that novel legal doctrines could be employed, which could accelerate the time when such indemnification payments could be due.
The results of operations or equity of CNA in future years may be adversely impacted by environmental pollution and mass tort and asbestos claim and claim adjustment expenses. Management will continue to review and monitor these liabilities and make further adjustments, including the potential for further reserve strengthening, as necessary.
Net realized investment results decreased $965 million after-tax in 2002 as compared with 2001. This decline was due primarily to the change in net realized gains (losses) on corporate and other taxable bonds and equity securities. The $359 million after-tax increase in realized loss of corporate and other taxable bonds relates primarily to impairment charges of $421 million after-tax recorded in various market sectors, the most significant being the telecommunication sector. The $814 million after-tax change in net realized gains (losses) of equity securities relates primarily to the Company’s 2001 gain of $647 million after-tax for the sale of Global Crossing Ltd. common stock (Global Crossing) and closing of the related hedge agreements. Also included was $157 million after-tax of 2002 impairments recorded in various market sectors.
Net realized investment gains increased $147 million in 2001 as compared with 2000. This increase was due primarily to after-tax gains from closing the hedge agreements, which were entered into during March 2000, related to the Company’s investment in Global Crossing of $647 million in 2001 as compared with $315 million in 2000 as well as gains of $58 million, resulting from the sale of a New York real estate property and gains from the sale of fixed maturity security investments. This improvement was partially offset by estimated losses recorded for the planned dispositions of certain operations, principally CNA Re U.K., described in more detail below as well as decreases in after-tax gains from the sale of Canary Wharf of $34 million in 2001 as compared with $289 million in 2000.
CNA classifies its fixed maturity securities (bonds and redeemable preferred stocks) and its equity securities as available-for-sale, 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 are reported as a component of other comprehensive income.
The following table provides further detail of gross realized gains and gross realized losses on fixed maturity securities and equity securities.
The largest realized losses from sales of securities aggregated by issuer for the twelve months ended December 31, 2002 totaled $254 million. The following table provides details of those largest realized losses aggregated by issuer 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 footnoted is a narrative providing the industry sector along with the facts and circumstances giving rise to the loss.
The pressure to the IPP sector began in April of 2002. At July 31, 2002, this issuer’s financial condition was in good standing. A decision was made to reduce the portfolios’ overall exposure to this sector including this issuer.
The issuer anticipated participating in proposed spectrum reallocation that was being reviewed by the Federal Communications Commission. This process was held up in the courts and took longer than expected. The trades that generated the losses took place in the fourth quarter of 2002. The sales were the result of a program to reduce exposures in this sector.
These losses were primarily attributable to the sale of fixed income and convertible preferred securities. The bonds were sold in a rapidly deteriorating market due to sector and issuer pressures.
These losses were generated by positions primarily held in convertible preferred stock holdings. The price decline reflects the pressures of the issuer, sector and general equity market conditions.
A portion of these securities were sold to reduce the overall position in the telecom sector. The issuer reported a deterioration of their financial condition and lost the financial support of their parent. The remaining securities held were impaired when new financial information was revealed in 2002.
The Impairment 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. 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 Consolidated Statements of Operations.
In the fourth quarter of 2001, the Company sold certain businesses as planned. The realized after-tax loss applicable to these businesses recognized in the second quarter of 2001 was $38 million. Revenues of these businesses included in the years ended December 31, 2001 and 2000 totaled approximately $30 million and $37 million. These businesses contributed approximately $11 million and $8 million of net losses in the years ended December 31, 2001 and 2000.
The following table details the carrying value of CNA’s general and separate account investment portfolios.
The Company’s general and separate account investment portfolio consists primarily of publicly traded government bonds, asset-backed securities, mortgage-backed securities, municipal bonds and corporate bonds.
Investments in the general account had a total net unrealized gain of $887 million at December 31, 2002 compared with $345 million at December 31, 2001. The unrealized position at December 31, 2002 was composed of a net unrealized gain of $742 million for fixed maturities, a net unrealized gain of $147 million for equity securities and a net unrealized loss of $2 million for short term securities. The unrealized position at December 31, 2001 was composed of a net unrealized gain of $194 million for fixed maturities, a net unrealized gain of $170 million for equity securities and a net unrealized loss of $19 million for short term securities.
At December 31, 2002 the carrying value of the general account fixed maturities was $26,275 million, representing 74% of the total investment portfolio. The net unrealized gain of this fixed maturity portfolio was $742 million, comprising gross unrealized gains of $1,377 million and gross unrealized losses of $635 million. The gross unrealized losses were primarily in corporate bonds with the largest industry sectors being utilities, communications and consumer-cyclical, which as a percentage of total gross unrealized losses were 23%, 17% and 16%. Gross unrealized losses in any single issuer did not exceed 0.2% of the carrying value of the total general account fixed maturity portfolio.
The following table provides the composition of fixed maturity securities with an unrealized loss at December 31, 2002 in relation to the total of all fixed maturity securities with an unrealized loss by contractual maturities.
The Company’s non-investment grade fixed maturity securities held as of December 31, 2002 that were in an unrealized loss position had a fair value of approximately $2 billion. As discussed previously, 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 table summarizes 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 December 31, 2002.
As part of the ongoing impairment monitoring process, the Impairment Committee has evaluated the facts and circumstances based on available information for each of these non-investment grade securities and determined that no further impairments were necessary at December 31, 2002. This determination was based on a number of factors that the 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 market 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.
Non investment-grade bonds, as presented in the tables 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.
Included in CNA’s general account fixed maturity securities at December 31, 2002 are $8,208 million of asset-backed securities, at fair value, consisting of approximately 67% in collateralized mortgage obligations (CMOs), 11% in corporate asset-backed obligations, 7% in U.S. Government agency issued pass-through certificates and 15% in corporate mortgage-backed pass-through certificates. The majority of CMOs held are actively traded in liquid markets and are priced by broker-dealers.
For the year ended December 31, 2001, net cash used for operating activities was $599 million as compared with net cash used of $1,345 million in 2000. The improvement related primarily to decreased paid claims.
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 year ended December 31, 2002, net cash provided from financing activities was $432 million as compared with $783 million in 2001.
For the year ended December 31, 2001, net cash provided from financing activities was $783 million as compared with $487 million of net cash used in 2000.
The Preferred Issue is senior to CNAF’s common stock as to the payment of dividends and amounts payable upon any liquidation, dissolution or winding up. No dividends may be declared on CNAF’s common stock until all cumulative dividends on the Preferred Issue have been paid. CNAF may not issue any equity securities ranking senior to or on par with the Preferred Issue without the consent of a majority of its stockholders. The Preferred Issue is non-voting and is not convertible into any other securities of CNAF. It may be redeemed only
upon the mutual agreement of CNAF and a majority of the stockholders of the preferred stock. The Preferred Issue is exempt from registration under Section 4(2) of the Securities Act of 1933.
CNA completed a common stock rights offering on September 26, 2001, successfully raising $1,006 million (40.3 million shares sold at $25 per share). Loews purchased 38.3 million shares issued in connection with the rights offering for $957 million, and an additional 0.8 million shares in the open market, increasing its ownership percentage of CNA to 88.8%. Additionally, CNAF borrowed $500 million against its bank credit facility. Partially offsetting these cash inflows were reductions to the Company’s commercial paper borrowings of $627 million.
The Company is closely managing the cash flows related to claims and reinsurance recoverables from the WTC event. It is anticipated that significant claim payments will be made prior to receipt of the corresponding reinsurance recoverables. The Company does not anticipate any liquidity problems resulting from these payments. As of March 14, 2003, the Company has paid $488 million in claims and recovered $237 million from reinsurers.
The Company has a $250 million three-year bank credit facility with an April 30, 2004 expiration date. The Company previously had a $250 million 364-day facility with an expiration date of April 29, 2002. An option to convert the 364-day facility to a one-year term loan was exercised in April of 2002. The term loan was subsequently prepaid on December 23, 2002.
The Company pays interest on any outstanding debt/borrowings under the three-year facility based on a rate determined using the long term debt ratings of the Company. The interest rate is equal to the London Interbank Offering Rate (LIBOR) plus 57.5 basis points. Further, if the Company has outstanding loans greater than 50% of the amounts available under the three-year facility, the Company will also pay a utilization fee of 12.5 basis points on such loans. At December 31, 2002 and 2001, the weighted-average interest rate on the borrowings under the facility, including facility fees and utilization fees, was 2.3% and 3.1%.
On September 30, 2002, CNA Surety, a 64% owned and consolidated subsidiary of CNA, entered into a $65 million credit agreement with one bank, which consisted of a $35 million 364-day revolving credit facility and a $30 million three-year term loan, payable semi-annually at a rate of $5 million. The credit agreement replaced a $130 million five-year revolving credit facility that terminated September 30, 2002. The new revolving credit facility was fully utilized at inception.
Under the new credit facility agreement, CNA Surety pays a facility fee of 12.5 basis points, interest at LIBOR plus 45.0 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 December 31, 2002, the weighted-average interest rate on the $60 million of outstanding borrowings under the credit agreement, including facility fees and utilization fees was 2.0%.
Under the former credit facility agreement, CNA Surety paid interest on outstanding borrowings based on, among other rates, LIBOR plus the applicable margin. The applicable margin was determined by the company’s leverage ratio (debt to total capitalization). At the termination date of the old facility, the applicable margin was 30.0 basis points, including the 10.0 basis point facility fee. At December 31, 2001, the weighted-average interest rate on the borrowings under the facility, including facility fees, was 2.6%.
levels. At December 31, 2002 and 2001, CNAF and CNA Surety were in compliance with all restrictive debt covenants.
In December of 2002 and January of 2003, CNAF provided loans in an aggregate amount of approximately $45 million to a large national contractor that undertakes projects for the construction of government and private facilities. CNA Surety has provided significant surety bond protection for projects by this contractor through surety bonds underwritten by CCC or its affiliates. The loans were provided by CNAF to help the contractor meet its liquidity needs. The loans are evidenced by demand notes and currently accrue interest at 10% until replaced by the credit facility described below. The contractor and certain of its affiliates have pledged to CNAF substantially all of their assets as collateral for these loans.
In March of 2003, CNAF entered into an agreement with the contractor to provide an $86.4 million credit facility, which amount includes the already advanced $45 million described above. The credit facility and all loans under it will mature in March of 2006. Advances under the credit facility, including the already funded $45 million, bear interest at the prime rate plus 6%. Payment of 3% of the interest 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 new 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.
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 and repayment of its borrowings under the credit facility, 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 future results of operations. If such failures occur, the Company estimates the surety loss, net of indemnification and subrogation recoveries, but before the effects of corporate aggregate reinsurance treaties, if any, and minority interest could be up to $200 million.
In the normal course of business, CNA has obtained letters of credit in favor of various unaffiliated insurance companies, regulatory authorities and other entities. At December 31, 2002 and 2001 there were approximately $222 million and $270 million of outstanding letters of credit.
In certain circumstances CNA provides guarantees of the indebtedness of certain of its independent insurance producers, which expire in 2003. 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 holds an interest in and 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 are approximately $7 million at December 31, 2002.
The Company holds an investment in a real estate joint venture that is accounted for on the equity basis of accounting. In the normal course of business, CNA on a joint and several basis with other unrelated insurance company shareholders have 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.
Ratings have become an increasingly 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. If those ratings were downgraded as a result, CNA’s results of operations or equity could be materially adversely impacted.
During the fourth quarter of 2002, A.M. Best and Fitch affirmed the existing financial strength ratings of each of the insurance pools and the debt ratings of CNAF, as noted in the above table.
In February of 2003, S&P affirmed the ratings of the property and casualty pools, CCC and CIC, and downgraded the life pool, CAC, by one notch from A+ to A. S&P cited that the downgrade of the life operations was primarily because S&P wanted to bring the ratings on all the companies in the group closer together and because the companies’ business profile has changed over the past two years.
Corporate bonds comprise a significant portion of the Company’s investment portfolio. The Company regularly reviews the market value of these securities, and challenges whether an other-than-temporary decline in value has occurred for securities that are trading below cost (see Investments section of MD&A). In light of the current volatility in the financial markets and the dramatic impact that several recent accounting scandals have had on specific issuers, the Company may be subject to future impairment losses that could materially adversely impact its results of operations. Any future impairment losses would not have a material impact on the Company’s overall equity. See the discussion of CNA’s impairment committee in the investment section of the MD&A.
of available dividend capacity, holding company liquidity and cash needs as well as the impact the dividends will have on the statutory surplus of the applicable insurance company.
CCC’s positive earned surplus at December 31, 2002 is contrasted to its negative earned surplus position at December 31, 2001. Prompted, in part, by the negative earned surplus position at December 31, 2001, the Company embarked on a capital realignment initiative within the CCC intercompany reinsurance pool (Pool) during 2002, the benefits of which included the restoration of CCC’s earned surplus to a positive position. This initiative involved the payment of dividends to CCC from its insurance subsidiaries during the fourth quarter of 2002. As a result of this distribution of the cumulative earnings of CCC’s insurance subsidiaries, CCC’s earned surplus was restored to a positive level at December 31, 2002, approximating $1,069 million.
In addition, by agreement with the New Hampshire Insurance Department, as well as certain other state insurance departments, dividend payments for the CIC pool are restricted to internal and external debt service requirements through September 2003 up to a maximum of $85 million annually, without the prior approval of the New Hampshire Insurance Department.
In September of 2000, the FASB issued Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 140). SFAS 140 supercedes SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures. The adoption of SFAS 140 on March 31, 2001 did not have a significant impact on the results of operations or equity of the Company.
Effective January 1, 2001, the Company accounts for derivatives and hedging activities in accordance with SFAS 133. The initial adoption of SFAS 133 did not have a significant impact on the equity of the Company; however, adoption of SFAS 133 resulted in an after-tax decrease to 2001 net income of $61 million. Of this transition amount, approximately $58 million related to investments and investment-related derivatives. Because the Company already carried its
investment and investment-related derivatives at fair value through other comprehensive income, there was an equal and offsetting favorable adjustment of $58 million to stockholders’ equity (accumulated other comprehensive income). The remainder of the transition adjustment is primarily attributable to collateralized debt obligation (CDOs) products that are classified as derivatives under SFAS 133.
On January 1, 2002, CNA adopted SFAS 142. SFAS 142 changed the accounting for goodwill and indefinite-lived intangible assets from an amortization method to an impairment-only approach. Amortization of goodwill and indefinite-lived intangible assets recorded in past business combinations ceased upon adoption of SFAS 142. Accordingly, net income for the year ended December 31, 2002 does not include amortization expense on goodwill or indefinite-lived intangible assets. Goodwill and indefinite-lived intangible assets are tested for impairment annually or when certain triggering events require such tests.
In November of 2002, the FASB issued FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (an interpretation of FASB Statements of Financial Accounting Standards No. 5, 57, and 107 and rescission of FASB Interpretation No. 34) (FIN 45). FIN 45 clarifies the requirements of FASB Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (SFAS 5) relating to a guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 provides for additional disclosure requirements related to guarantees, which are effective for financial periods ending after December 15, 2002. Additionally, FIN 45 outlines provisions for initial recognition and measurement of the liability incurred in providing a guarantee. These provisions are to be applied on a prospective basis to guarantees issued or modified after December 31, 2002. CNA has implemented the disclosure requirements of FIN 45 and will adopt the provisions for initial recognition and measurement for all guarantees issued or modified after December 31, 2002. The initial adoption for the recognition and measurement requirements of FIN 45 is not expected to have a significant impact on the results of operations or equity of the Company.
Financial statements issued after January 31, 2003 are required to disclose the nature, purpose, activities and size of the VIE and maximum exposure to loss as a result of its involvement with the VIE. The Company reviewed FIN 46 and is of the opinion that at the present time, the Company is neither a primary beneficiary of a VIE nor does it have a significant involvement with a VIE.
This 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 for asbestos, environmental pollution and mass tort claims; the Company’s expectations concerning its revenues, earnings, expenses and investment activities; expected cost savings and other results from the Company’s restructuring activities; and the Company’s proposed actions in response to trends in its business.
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;
exposure to liabilities due to claims made by insureds and others relating to asbestos remediation and health-based asbestos impairments, and exposure to liabilities for environmental pollution and mass tort claims;
the sufficiency of the Company’s loss reserves and the possibility of future increases in reserves;
the level of success in integrating acquired businesses and operations, and in consolidating existing ones;
the possibility of changes in the Company’s ratings by ratings agencies and changes in rating agency policies and practices; and
Insurance products include property and casualty coverages; life, accident and health insurance; retirement products and annuities; and property and casualty reinsurance. CNA services include risk management, information services, healthcare claims management, and claims administration. CNA’s products and services are marketed through independent agents, brokers, managing general agents and direct sales.
Property and casualty contracts that are retrospectively rated contain contract provisions that result in an adjustment to the initial policy premium depending on the contract provisions and loss experience of the insured during the experience period. For such contracts, the Company estimates the amount of ultimate premiums that the Company may earn upon completion of the experience period and recognizes either an asset or a liability for the difference between the initial policy premium and the estimated ultimate premium. The Company adjusts such estimated ultimate premium amounts during the course of the experience period based on actual results to date. The resulting adjustment is recorded as either a reduction of or an increase to the earned premiums for the period.
Workers compensation lifetime claim reserves and accident and health disability claim reserves are calculated using mortality and morbidity assumptions based on Company and industry experience, and are discounted at interest rates allowed by insurance regulators that range from 3.5% to 6.5%. At December 31, 2002 and 2001, such discounted reserves totaled $2,537 million and $2,384 million, net of discount of $974 million and $978 million.
Future policy benefits reserves: Reserves for traditional life insurance products (whole and term life products) and long term care products are computed using the net level premium method, which incorporates actuarial assumptions as to interest rates, mortality, morbidity, withdrawals and expenses. Actuarial assumptions generally vary by plan, age at issue and policy duration, and include a margin for adverse deviation. Interest rates range from 2.3% to 9.8%, and mortality, morbidity and withdrawal assumptions are based on Company and industry experience prevailing at the time of issue. Expense assumptions include the estimated effects of inflation and expenses to be incurred beyond the premium paying period. Reserves for interest-sensitive contracts are equal to the account balances that accrue to the benefit of the policyholders. Interest crediting rates ranged from 4.4% to 6.5% for the three years ended December 31, 2002.
Guaranty fund and other insurance-related assessments: Liabilities for guaranty fund and other insurance-related assessments are accrued when an assessment is probable, when it can be reasonably estimated, and when the event obligating the entity to pay an imposed or probable assessment has occurred. Liabilities for guaranty funds and other insurance-related assessments are not discounted and are included as part of other liabilities in the Consolidated Balance Sheets. As of December 31, 2002 and 2001, the liability balance was $63 million and $94 million. As of December 31, 2002 and 2001, included in other assets were $32 million and $24 million of related assets for premium tax offsets or policy surcharges. The related asset is limited to the amount that is determined based on future premium collections or policy surcharges from policies in force.
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 a receivable in the Consolidated Balance Sheets. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. 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.
Reinsurance contracts that do not meet the criteria for risk transfer are recorded using the deposit method of accounting, which requires that premium paid or received by the ceding company or assuming company be accounted for as a deposit asset or liability. The Company primarily records these deposits as either reinsurance receivables or other assets for ceded recoverables and reinsurance balances payable or other liabilities for assumed liabilities. At December 31, 2002 and 2001, the Company had approximately $618 million and $693 million recorded as deposit assets and $569 million and $511 million recorded as deposit liabilities.
Participating insurance: Policyholder dividends are accrued using an estimate of the amount to be paid based on underlying contractual obligations under policies and applicable state laws. When limitations exist on the amount of net income from participating life insurance contracts that may be distributed to stockholders, the policyholders’ share of net income on those contracts that cannot be distributed is excluded from stockholders’ equity by a charge to operations and the establishment of a corresponding liability.
For universal life and cash value annuity contracts, the amortization of deferred acquisition costs is recorded in proportion to the present value of estimated gross margins or profits. The gross margins or profits result from actual earned interest minus actual credited interest, actual costs of insurance (mortality) charges minus expected mortality, actual expense charges minus expected maintenance expenses and surrender charges. Amortization interest rates are based on rates in effect at the inception or acquisition of the contracts or the latest revised rate applied to the remaining benefit period, according to product line. Actual gross margins or profits can vary from the Company’s estimates resulting in increases or decreases in the rate of amortization. When appropriate, the Company revises its assumptions of the estimated gross margins or profits of these contracts, and the cumulative amortization is re-estimated and adjusted through current operations. To the extent that unrealized gains or losses on available-for-sale securities would result in an adjustment of deferred acquisition costs had they actually been realized, an adjustment is recorded to deferred acquisition costs and to unrealized investment gains or losses.
Deferred acquisition costs are recorded net of ceding commissions and other ceded acquisition costs. The Company evaluates deferred acquisition costs for recoverability; adjustments, if necessary, are recorded in current operations.
Investments in life settlement contracts and related revenue recognition: The Company has purchased investments in life settlement contracts. Under a life settlement contract, CNA obtains the rights of being the owner and beneficiary to an underlying life insurance policy. The carrying value of each contract at purchase and at the end of each reporting period is equal to the cash surrender value of the policy in accordance with Financial Accounting Standards Board (FASB) Technical Bulletin 85-4 Accounting for Purchases of Life Insurance (FTB 85-4). Amounts paid to purchase these contracts that are in excess of the cash surrender value, at the date of purchase, are expensed immediately. Periodic maintenance costs, such as premiums, necessary to keep the underlying policy inforce are expensed as incurred and included in other operating expenses. Revenue is recognized and included in other revenue in the Consolidated Statements of Operations when the life insurance policy underlying the life settlement contract matures.
CAC and VFL write investment and annuity contracts. The supporting assets and liabilities of certain of these contracts are legally segregated and reported as assets and liabilities of separate account business. CAC and VFL guarantee principal and a specified return to the contract holders on approximately 58% and 53% of the separate account business at December 31, 2002 and 2001. Substantially all assets of the separate account business are carried at fair value. Separate account liabilities are carried at contract values.
During July of 2002, the Company entered into an agreement, whereby The Phoenix Companies, Inc. (Phoenix) acquired the variable life and annuity business of VFL through a coinsurance arrangement, with modified coinsurance on the separate accounts. See Note P for further details of this agreement.
Mortgage loans are carried at unpaid principal balances, including unamortized premium or discount. Real estate is carried at depreciated cost. Policy loans are carried at unpaid balances. Short term investments are generally carried at amortized cost, which approximates fair value.
Limited partnerships are a relatively small portion of the Company’s overall investment portfolio. The majority of the limited partnerships invest in a substantial number of securities that are readily marketable. The Company is a passive investor in such partnerships and does not have influence over the partnerships’ management, who are committed to operate them according to established guidelines and strategies. These strategies may include the use of leverage and hedging techniques that potentially introduce more volatility and risk to the partnerships.
Investment gains and losses: All securities transactions are recorded on the trade date. Realized investment gains and losses are determined on the basis of the cost or amortized cost of the specific securities sold.
Equity in unconsolidated affiliates: CNA uses the equity method of accounting for investments in companies in which its ownership interest of the voting shares of an investee company enables CNA to influence the operating or financial decisions of the investee company, but CNA is without a controlling financial interest. CNA’s proportionate share of equity in net income of these unconsolidated affiliates is reported in other revenues.
SFAS 133 requires that all derivatives be accounted for on a fair value basis. The Company’s derivatives are reported as other invested assets, with the exception of CDOs and synthetic GICs, which are reported as other assets and/or other liabilities. Embedded derivative instruments subject to bifurcation are also accounted for on a fair value basis and reported together with the host contract. If certain criteria are met, a derivative may be specifically designated as a hedge of exposures to changes in fair value, cash flows or foreign currency exchange rates. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the nature of any hedge designation thereon.
The Company’s accounting for changes in the fair value of general account derivatives is as follows:
Credit exposure associated with non-performance by the counterparties to derivative instruments is generally limited to the gross fair value of the asset related to the instruments recognized in the Consolidated Balance Sheets. The Company mitigates the risk of non-performance by monitoring the creditworthiness of counterparties and diversifying derivatives to multiple counterparties. The Company generally requires collateral from its derivative investment counterparties depending on the amount of the exposure and the credit rating of the counterparty.
The contractual or notional amounts for derivatives are used to calculate the exchange of contractual payments under the agreements and are not representative of the potential for gain or loss on these instruments. Interest rates, equity prices and foreign currency exchange rates affect the fair value of derivatives. The fair values generally represent the estimated amounts that CNA would expect to receive or pay upon termination of the contracts at the reporting date. Dealer quotes are available for substantially all of CNA’s derivatives. For derivative instruments not actively traded, fair values are estimated using values obtained from independent pricing services, costs to settle or quoted market prices of comparable instruments.
The Company and its eligible subsidiaries are included in the consolidated federal income tax return of Loews and its eligible subsidiaries. The Company accounts for income taxes under the asset and liability method. Under the asset and liability method, deferred income taxes are recognized for temporary differences between the financial statement and tax return bases of assets
Property and equipment are carried at cost less accumulated depreciation. Depreciation is based on the estimated useful lives of the various classes of property and equipment and is determined principally on the straight-line method.
Goodwill in the amount of $154 million and $245 million as of December 31, 2002 and 2001 represents the excess of purchase price over fair value of the net assets of acquired entities. CNA adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142) on January 1, 2002. SFAS 142 changed the accounting for goodwill and indefinite-lived intangible assets from an amortization method to an impairment-only approach. Amortization of goodwill and indefinite-lived intangible assets recorded in past business combinations ceased upon adoption of SFAS 142. Accordingly, net income for the year ended December 31, 2002 does not include amortization expense on goodwill or indefinite-lived intangible assets. Goodwill and indefinite-lived intangible assets are tested for impairment annually or when certain triggering events require such tests.
Earnings (loss) per share available to common stockholders is based on weighted-average outstanding shares. The computation of earnings (loss) per share is as follows:
The Company has stock-based compensation plans which are detailed in Note J. The Company applies Accounting Policy 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.
In November of 2002, the FASB issued FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (an interpretation of FASB Statements of Financial Accounting Standards No. 5, 57, and 107 and rescission of FASB Interpretation No. 34) (FIN 45). FIN 45 clarifies the requirements of FASB Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (SFAS 5) relating to a guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 provides for additional disclosure requirements related to
In January of 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51 (ARB 51) (FIN 46). As a general rule, ownership by the parent, either directly or indirectly, of over 50% of the outstanding voting shares of a subsidiary is a condition requiring the preparation of consolidated financial statements of the parent and its subsidiary. FIN 46 clarifies the exceptions to this general rule, as enunciated in paragraph two of ARB 51. FIN 46 requires an entity to consolidate a variable interest entity (VIE) even though the entity does not, either directly or indirectly, own over 50% of the outstanding voting shares.
Investment securities are exposed to various risks, such as interest rate, market and credit. Due to the level of risk associated with certain investment securities and the level of uncertainty related to changes in the value of investment securities, it is possible that changes in these risk factors in the near term could have an adverse material impact on the Company’s results of operations or equity.
The Company’s investment policies for both the general and separate accounts 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.
The decision to impair a security incorporates both quantitative criteria and qualitative information. The Impairment Committee considers a number of factors including, but not limited to: (a) the length of time and the extent to which the market value has been less than book value, (b) the financial condition and near term prospects of the issuer, (c) the intent and ability of the Company to retain its investment for a period of time sufficient to allow for any anticipated recovery in value, (d) whether the debtor is current on interest and principal payments and (e) general market conditions and industry or sector specific factors.
In March of 2000, the Company entered into hedge agreements related to its investment in Global Crossing Ltd. common stock (Global Crossing). The unrealized appreciation on the
stock that was preserved by the hedge was reflected as an unrealized gain in accumulated other comprehensive income at December 31, 2000. The hedge agreements were closed out in 2001, resulting in the recognition of a realized gain of $962 million pretax.
Changes in the Company’s investment in Global Crossing, on a pretax basis, were as follows:
The following table summarizes fixed maturity securities, including embedded derivative financial instruments, by contractual maturity at December 31, 2002.
Actual maturities may differ from contractual maturities because certain securities may be called or prepaid with or without call or prepayment penalties.
As of December 31, 2002 and 2001, the Company had committed approximately $141 million and $152 million to future capital calls from various third-party limited partnership investments in exchange for an ownership interest in the related partnerships.
In the normal course of investing activities, CCC had committed approximately $51 million as of December 31, 2002 to future capital calls from certain of its unconsolidated affiliates in exchange for an ownership interest in such affiliates.
Cash and securities with carrying values of approximately $37 million and $30 million were deposited with financial institutions as collateral for letters of credit as of December 31, 2002 and 2001. See Note K further details.
During July of 2002, the Company entered into an agreement, whereby Phoenix acquired the variable life and annuity business of VFL through a coinsurance arrangement, with modified coinsurance on the separate accounts. Securities with carrying values of approximately $479 million continue to be held by the Company and are reported in separate account business in the assets section of the Consolidated Balance Sheet at December 31, 2002. See Note P for further details of this agreement.
Immediately following the adoption of SFAS 133 on January 1, 2001, which did not impact derivatives included in separate account investments, the Company’s general account derivative holdings were as follows:
The Company’s other hedging activities primarily involve hedging interest rate and foreign currency risks on various assets and liabilities. The ineffective portion of the fair value hedges resulted in a realized loss of approximately $4 million and $1 million for the years ended December 31, 2002 and 2001.
The following methods and assumptions were used by CNA in estimating the fair value for financial assets and liabilities.
The fair values for mortgage loans and policy loans were estimated using discounted cash flows utilizing interest rates currently offered for similar loans to borrowers of comparable credit quality. Loans with similar characteristics were aggregated for purposes of these calculations.
The carrying amount and estimated fair value of CNA’s financial instrument assets and liabilities are listed in the following table. Additional detail related to derivative financial instruments is also provided in a separate table. See Note C for further discussion.
CNA and its eligible subsidiaries (CNA Tax Group) are included in the consolidated federal income tax return of Loews and its eligible subsidiaries. Loews and CNA have agreed that for each taxable year, CNA will 1) be paid by Loews the amount, if any, by which the Loews consolidated federal income tax liability is reduced by virtue of the inclusion of the CNA Tax Group in the Loews consolidated federal income tax return or 2) pay to Loews an amount, if
In 2002, the inclusion of the CNA Tax Group in the consolidated federal income tax return of Loews resulted in an increased federal income tax liability for Loews. Accordingly, CNA has paid to Loews, or will pay to Loews, approximately $94 million for 2002. For 2001, the inclusion of the CNA Tax Group in the consolidated federal income tax return of Loews decreased the Loews federal income tax liability. Accordingly, Loews has paid CNA approximately $908 million for 2001. In 2000, the inclusion of the CNA Tax Group in the consolidated federal income tax return of Loews increased the Loews federal income tax liability. As a result, CNA paid Loews approximately $64 million for 2000.
A reconciliation between CNA’s federal income tax (expense) benefit at statutory rates and the recorded income tax (expense) benefit, after giving effect to minority interest, but before giving effect to discontinued operations and the cumulative effects of changes in accounting principles, is as follows:
The composition of CNA’s total income tax (expense) benefit allocated between operating results and realized investment gains and losses, excluding discontinued operations and the cumulative effects of changes in accounting principles, is as follows:
The gross deferred tax assets and liabilities amounted to approximately $2.0 billion and $1.3 billion at December 31, 2002 and $2.1 billion and $1.2 billion at December 31, 2001. Although realization of deferred tax assets is not assured, management believes it is more likely than not that deferred tax assets will be realized through future earnings, including but not limited to the generation of future operating income and reversal of existing temporary differences and available tax planning strategies. As a result, no valuation allowance was recorded at December 31, 2002 and 2001.
The net reserves were reduced by $1,316 million as a result of the sale of CNA Reinsurance Company Limited (CNA Re U.K.). See Note P for further discussion of the sale.
The changes in provision for insured events of prior years (reserve development) is composed of the following components. For the years ended December 31, 2002, 2001 and 2000, the net unfavorable reserve development was $35 million, $2,464 million and $427 million.
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 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 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.
and claim related adjustment expenses subject to documentation requirements as set forth in the terms of each specific agreement. The Company has evaluated these commitments and has established a $66 million reserve, net of reinsurance, to fund coverage in place agreements based on current projections of claims volumes and severities.
At December 31, 2002, the Company categorized active accounts as large or small accounts. CNA defined a large account as an active account with more than $100 thousand cumulative paid losses through December 31, 2002. CNA had 150 large accounts with a collective reserve of $220 million, net of reinsurance. Small accounts were defined as active accounts with $100 thousand or less cumulative paid losses through December 31, 2002. CNA had 939 small accounts with a collective reserve of $90 million, net of reinsurance.
Some asbestos-related defendants have asserted that their claims for insurance 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 such exposures by aggressive settlement strategies. Nevertheless, there can be no assurance any of these settlement efforts will be successful, or that any such claims can be settled on terms acceptable to CNA. Adverse developments with respect to such matters discussed in this paragraph could have a material adverse effect on CNA’s results of operations or equity.
CNA is engaged in insurance coverage litigation with Robert A. Keasbey Company (Keasbey) and associated claimants in New York state court (Continental Casualty Company vs. Robert A. Keasbey Company et al., Supreme Court State of New York - County of New York, No. 401621/02). Keasbey was a seller and installer of asbestos products in the New York and New Jersey area. CNA paid its full product liability limits to Keasbey in prior years. Claimants against Keasbey now claim CNA owes additional coverage under the operations section of policies
Policyholders have also initiated litigation directly against CNA and other insurers. CNA has been named in Adams v. Aetna, Inc., et al. (Circuit Court of Kanhwha 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. In addition, lawsuits have 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)). It is difficult to predict the outcome or financial exposure represented by this type of litigation in light of the broad nature of the relief requested and the novel theories asserted.
With respect to environmental and mass tort reserves, commencing in 2000 and continuing into the first and second quarters of 2001, CNA received a number of new reported claims, some of which involved declaratory judgment actions premised on court decisions purporting to expand insurance coverage for pollution claims. In these decisions, several courts adopted rules of insurance policy interpretation which established joint and several liability for insurers
consecutively on a risk during a period of alleged property damage; and in other instances adopted interpretations of the “absolute pollution exclusion,” which weakened its effectiveness in most circumstances. In addition to receiving new claims and declaratory judgment actions premised upon these unfavorable legal precedents, these court decisions also impacted CNA’s pending pollution and mass tort claims and coverage litigation. During the spring of 2001, CNA reviewed specific claims and litigation, as well as general trends, and concluded reserve strengthening in this area was necessary.
related principally to the property and casualty companies. A brief summary of these lines of business and the associated reserve development is discussed below.
The gross and net carried claim and claim adjustment expense reserves for Standard Lines were $12,854 million and $7,788 million at the beginning of the year of 2002.
Approximately $140 million of favorable prior year reserve development was attributable to participation in the Workers Compensation Reinsurance Bureau (WCRB), a reinsurance pool, and residual markets. The favorable prior year reserve development for WCRB was the result of information received from the WCRB that reported the results of a recent actuarial review. This information indicated that the Company’s net required reserves for accident years 1970 through 1996 were $60 million less than the carried reserves. In addition, during 2002, the Company commuted accident years 1965 through 1969 for a payment of approximately $5 million to cover carried reserves of approximately $13 million, resulting in further favorable reserve development of $8 million. The favorable residual market prior year reserve development was the result of lower than expected paid loss activity during recent periods for accident years dating back to 1984. The paid losses during 2002 on prior accident years were approximately 60% of the previously expected amount.
Offsetting these favorable reserve developments were approximately $70 million of unfavorable reserve development in programs written in CNA Excess & Surplus (E&S), approximately $30 million of unfavorable reserve development on a contractors account package policy program and approximately $20 million of unfavorable development on middle market general liability coverages.
Unfavorable prior year reserve development of approximately $180 million was recorded for CNA HealthPro in 2002 and was driven principally by medical malpractice excess products provided to hospitals and physicians and coverages provided to long term care facilities, principally national for-profit nursing homes. Approximately $100 million of the prior year unfavorable reserve development was related to assumed excess products and loss portfolio transfers, and was primarily driven by unexpected increases in the number of excess claims in accident years 1999 and 2000. The percentage of total claims greater than $1 million has increased by 33%, from less than 3% of all claims to more than 4% of all claims. CNA HealthPro no longer writes assumed excess products and loss portfolio transfers.
Approximately $50 million of the prior year unfavorable reserve development was related to long term care facilities. The development principally impacted accident years 1997 through 2000. The average value of claims closed during the first several months of 2002 increased by more than 50% when compared to claims closed during 2001. In response to those trends, CNA HealthPro has reduced its writings of national for-profit nursing home chains. Excess products provided to healthcare institutions and physician coverages in a limited number of states was responsible for the remaining development in CNA HealthPro. The unfavorable reserve development on excess products provided to institutions for accident years 1996 through 1999 resulted from increases in the size of claims experienced by these institutions. Due to the increase in the size of claims, more claims were exceeding the point at which these excess products apply. The unfavorable reserve development on physician coverages was recorded for accident years 1999 through 2001 in Oregon, California, Arizona and Nevada. The average claim size in these states has increased by 20%, driving the change in losses.
The marine business recorded unfavorable reserve development of approximately $65 million during 2002. Approximately $50 million of this unfavorable reserve development was due to participation in voluntary pools. About half of the reserve development was recorded in accident years 1999 and 2000 with the remainder attributable to accident years prior to 1999. The reserves were based on recommendations provided by the pools. Participation in many of these pools has been discontinued. The remaining reserve development for the Marine business was due principally to unfavorable reserve development on hull and liability coverages from accident years 1999 and 2000 offset by favorable reserve development on cargo coverages recorded for accident year 2001. Reviews completed during 2002 showed additional reported losses on individual large accounts and other bluewater business that drove the unfavorable hull and liability reserve development. These additional losses during the first nine months of 2002 for accident years 1999 and 2000 were almost 75% higher than the provision that had been established at the end of 2001.
Offsetting the unfavorable reserve development was favorable reserve development in CNA Pro and for Enron-related exposures. Programs providing professional liability coverage to accountants, lawyers and realtors primarily drove favorable prior year reserve development of approximately $110 million in CNA Pro. Reviews of this business completed during 2002 have shown little activity for older accident years (principally prior to 1999), which reduced the need for reserves on these years. The reported losses on these programs for accident years prior to 1999 increased by approximately $5 million during 2002. This increase compared to the total reserve at the beginning of 2002 of approximately $180 million, net of reinsurance. Additionally, favorable reserve development of $20 million was associated with the Enron settlement. The Company had established a $20 million reserve for accident year 2001 for an excess layer associated with Enron related surety losses; however the case has settled for less than the attachment point of this excess layer.
The gross and net carried claim and claim adjustment expense reserves for the Corporate and Other segment, excluding the gross and net carried claim and claim adjustment expense reserves for APMT, were $2,562 million and $225 million for the beginning of the year of 2002.
Personal insurance recorded unfavorable reserve development of $35 million on accident years 1997 through 1999. These losses were subject to a retroactive ceded reinsurance agreement with Allstate that covers losses occurring prior to October 1, 1999. This ceded reinsurance agreement was entered into as part of the sale of the Company’s personal insurance business to Allstate. The unfavorable reserve development was principally due to continuing policyholder defense costs associated with remaining open claims. At the end of 2002, approximately 4,800 claims remain open. It was anticipated these claims would be closed more quickly, eliminating further defense coverage costs.
The unfavorable reserve development on personal insurance was offset by favorable reserve development on other runoff business driven principally by financial and mortgage guarantee
coverages from accident years 1997 and prior. The favorable reserve development on financial and mortgage guarantee coverages resulted from a review of the underlying exposures and the outstanding losses. This review showed that salvage and subrogation continues to be collected on these types of claims, thereby reducing estimated future losses net of anticipated reinsurance recoveries.
An analysis of assumed reinsurance business written by CNA Re showed that the paid and reported losses for recent accident years were higher than expectations, which resulted in management recording net unfavorable development on prior year loss reserves of approximately $690 million. The gross and net claim and claim adjustment expense reserves at the beginning of 2001 for CNA Re were $4,238 million and $2,735 million. Because of the long and variable reporting pattern associated with assumed reinsurance as well as uncertainty regarding possible changes in the reporting methods of the ceding companies, the carried reserves for assumed reinsurance was based mainly on the pricing assumptions until experience emerges to show that the pricing assumptions are no longer valid. The reviews completed during the second quarter of 2001, including analysis at the individual treaty level, showed that the pricing assumptions were no longer appropriate. The classes of business with the most significant changes included excess of loss liability, professional liability and proportional and retrocessional property. Approximately $470 million of the total unfavorable development was from accident years 1998 through 2000, and approximately $150 million was from accident years 1996 and 1997. The remaining $70 million of unfavorable development was attributable to accident years prior to 1996.
Approximately $300 million of adverse loss development was due to adverse experience in all other lines, primarily in coverages provided to healthcare-related entities written by CNA HealthPro. The gross and net claim and claim adjustment expense reserve at the beginning of 2001 for Specialty Lines were $4,813 million and $3,429 million. The level of paid and reported losses associated with coverages provided to national long term care facilities were higher than expected. The long term care facility business had traditionally been limited to local facilities. In recent years, the Company began to provide coverage to large chains of long term care facilities. Original assumptions were that these chains would exhibit loss ratios similar to the local facilities. The most recent review of these large chains indicated an overall loss ratio in excess of 500% versus approximately 100% for the remaining business. In addition, the average size of claims resulting from coverages provided to physicians and institutions providing healthcare related services increased more than expected. The review indicated that the average loss had increased to over $330 thousand. Prior to this review, the expectation for the average loss was approximately $250 thousand. Unfavorable reserve development of $240 million was recorded for accident years 1997 through 2000. The remaining unfavorable reserve development was attributable to accident years prior to 1997.
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
Amounts receivable from reinsurers were $12,696 million and $13,823 million at December 31, 2002 and 2001. Of these amounts, $957 million and $838 million were billed to reinsurers as of December 31, 2002 and 2001, as reinsurance contracts generally require payment of claims by the ceding company before the amount can be billed to the reinsurer. The remaining receivable
The Company has reinsurance receivables from several reinsurers who have recently experienced multiple downgrades of their financial strength ratings, have announced that they will no longer accept new business and are placing their books of business into run-off. The Company’s principal credit exposures from these recent events arise from reinsurance receivables from Gerling Global (Gerling), Trenwick and Commercial Risk insurance groups. At December 31, 2002, the Company had approximately $926 million of reinsurance receivables from these reinsurers, of which $384 million was not supported by collateral. The majority of the uncollateralized receivables were due from U.S.-domiciled insurers. Of the $384 million of reinsurance receivables unsupported by collateral, $170 million relates to Gerling. Gerling has stated that the Company transfer approximately $204 million of funds withheld balances on three treaties relating to CNA HealthPro to a trust established by Gerling for the benefit of the Company, or in the absence of such transfer, that these treaties be commuted. CNA has taken Gerling’s statement under advisement.
Insurance claims and policyholders’ benefits reported in the Consolidated Statements of Operations are net of reinsurance recoveries of $4,164 million, $7,221 million and $3,755 million for 2002, 2001 and 2000.
The impact of reinsurance on life insurance inforce at December 31, 2002, 2001 and 2000 is shown in the following table.
For 2002, the Company entered into a corporate aggregate reinsurance treaty covering substantially all of the Company’s property and casualty lines of business (the 2002 Cover). Ceded premium related to the reinsurer’s margin of $10 million was recorded in 2002. No losses were ceded during 2002 under this contract, and the 2002 Cover was commuted as of December 31, 2002.
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 $760 million of ceded losses. The ceded premiums are a percentage of ceded losses. The ceded premium related to full utilization of the $760 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. Losses of $618 million have been ceded under the CCC Cover through December 31, 2002.
A Moody’s Investors Service (Moody’s) downgrade of the CNAF senior debt rating from Baa2 to Baa3 would increase the facility fee on the three-year component of the facility from 17.5 basis points to 25.0 basis points. The applicable interest rate would increase from LIBOR plus 57.5 basis points to LIBOR plus 75.0 basis points. The utilization fee would remain unchanged on the three-year facility at 12.5 basis points.
In 2000, employees of CCC (approximately 79% of CNA’s employees) who were employed at December 31, 1999, and were still employed at April 24, 2000, were required to make a choice regarding their continued participation in the defined benefit pension plan. These employees were given two choices: 1) to continue earning additional benefits in the defined benefit pension
The Company has limited its share of the health care trend rate to a cost-of-living adjustment not to exceed 4% per year. The assumed healthcare cost trend rate used in measuring the accumulated postretirement benefit obligation was 4% per year in 2002. The healthcare cost trend rate assumption has a significant effect on the amount of the benefit obligation and periodic cost reported. An increase in the assumed healthcare cost trend rate of 1% in each year would have no impact on the accumulated postretirement benefit obligation or the aggregate net periodic postretirement benefit cost for 2002 as the cost-of-living adjustment is estimated to be 4% which is the maximum. A decrease in the assumed healthcare cost trend rate of 1% in each year would decrease the accumulated postretirement benefit obligation as of December 31, 2002 by $13 million and the aggregate net periodic postretirement benefit cost for 2002 by $1 million.
CNA sponsors savings plans, which are generally contributory plans that allow most employees, including employees of RSKCoSM, a subsidiary of CNA that provides total risk management
Benefit expense for the Company’s savings plans was $51 million, $53 million and $51 million in 2002, 2001 and 2000.
The following table presents activity under the LTI Plan during 2002, 2001 and 2000.
The weighted-average remaining contractual life of options outstanding as of December 31, 2002, was eight years, and the range of exercise prices on those options was $26.39 to $37.45.
CNA Surety has reserved shares of its common stock for issuance to directors, officers and employees of CNA Surety through incentive stock options, non-qualified stock options and stock appreciation rights under separate plans (CNA Surety Plans). The CNA Surety Plans have an aggregate number of 0.9 million shares available for which options may be granted. At December 31, 2002, approximately 1.7 million options were outstanding under these plans.
CNA occupies office facilities under lease agreements that expire at various dates. CNA’s home office is partially situated on grounds under leases expiring in 2058. In addition, data processing, office and transportation equipment is leased under agreements that expire at various dates through 2006. Most leases contain renewal options that provide for rent increases based on prevailing market conditions. Lease expense for the years ended December 31, 2002, 2001 and 2000 was $78 million, $89 million and $83 million. Lease and sublease revenues for the years ended December 31, 2002, 2001 and 2000 were $9 million, $21 million and $45 million.
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
The Preferred Issue accrues cumulative dividends at an initial rate of 8% per year, compounded annually. It will be adjusted quarterly to a rate equal to 400 basis points above the ten-year U.S. Treasury rate beginning with the quarterly dividend after the first triggering event to occur of either (i) an increase by two intermediate ratings levels of the financial strength rating of CCC from its current rating by any of A.M. Best Company, Standard & Poor’s or Moody’s or (ii) one year following an increase by one intermediate ratings level of the financial strength rating of CCC by any one of those rating agencies. Accrued but unpaid cumulative dividends cannot be paid on the Preferred Issue unless and until one of the two triggering events described above has occurred. Beginning with the quarter following an increase of one intermediate ratings level in CCC’s financial strength rating, however, current (but not accrued cumulative) quarterly dividends can be paid.
During 2001, CNA issued and sold 40,324,363 shares of common stock for $25 per share through a rights offering to stockholders of record on August 23, 2001. The net proceeds from
During 2000, CNA sold 126,342 shares of common stock that were held in treasury to certain senior officers of CNA, at the average of the highest and lowest sale prices on the New York Stock Exchange composite transactions, for the dates of the sales. Each of these purchases by senior officers was financed by collateralized loans from CNA that, at origination, amounted to $4 million for the year ended December 31, 2000. The loans are ten-year notes, which bear interest at the applicable federal rate for the month in which they originated, compounding semiannually and due at maturity along with accrued interest. The interest rates range from 5.23% to 6.14% at December 31, 2002. No shares of common stock were sold to senior officers of CNA during 2002 or 2001.
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 National Association of Insurance Commissioners (NAIC) as well as state laws, regulations and general administrative rules. The Company’s insurance subsidiaries follow one significant permitted accounting practice at December 31, 2002, related to discounting of certain non-tabular workers compensation claims. The impact of this permitted practice was to increase statutory surplus by approximately $24 million and $47 million at December 31, 2002 and 2001. This practice was followed by an acquired company, and CNA received permission to eliminate the effect of the permitted practice over a ten-year period, which ends in 2003.
This initiative involved a change to the underwriting structure of CCC and eight of its subsidiaries from the Pool structure to a structure in which CCC assumes 100% of the net underwriting risks of the group of companies formerly comprising the pool. This is the Company’s first step in a multi-year project to reduce duplicative legal entities, thereby facilitating more efficient operations and cost savings.
In addition, by agreement with the New Hampshire Insurance Department, as well as certain other state insurance departments, dividend payments for the CIC pool are restricted to internal and external debt service requirements through September of 2003 up to a maximum of $85 million annually, without the prior approval of the New Hampshire Insurance Department.
CNA’s domestic insurance subsidiaries are subject to risk-based capital requirements. Risk-based capital is a method developed by the NAIC to determine the minimum amount of statutory capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The formula for determining the amount of risk-based capital specifies various factors, weighted based on the perceived degree of risk, which are applied to certain financial balances and financial activity. The adequacy of a company’s actual capital is evaluated by a comparison to the risk-based capital results, as determined by the formula. Companies below minimum risk-based capital requirements are classified within certain levels, each of which requires specified corrective action. As of December 31, 2002 and 2001, all of CNA’s domestic insurance subsidiaries exceeded the minimum risk-based capital requirements.
Combined statutory capital and surplus and net income (loss), determined in accordance with accounting practices prescribed or permitted by the regulations and statutes of various insurance regulators for the property and casualty and the life and group insurance subsidiaries, were as follows.
Surplus includes the property and casualty companies’ equity ownership of the life and group insurance subsidiaries.
CNA Re operates primarily in the United States and in select global markets as a reinsurer in the broker market for treaty products and in the direct market for facultative products. CNA Re markets products in the following treaty business segments: standard lines, global catastrophe, specialty surplus lines, and financial reinsurance. In addition, CNA Re markets property and casualty facultative products directly to clients.
Group Operations provides group life, group health insurance and investment products and services to employers, affinity groups, and other entities that purchase insurance as a group. Group Operations includes three principal business units: Group Benefits, Institutional Markets, and Federal Markets.
The Corporate and Other segment is principally comprised of losses and expenses related to the centralized adjusting and settlement of APMT claims, certain run-off insurance operations and other operations including interest expense on corporate borrowings, asbestos claims related to Fibreboard Corporation and eBusiness initiatives.
All significant intrasegment income and expense has been eliminated. Standard Lines’ other revenues and expenses include revenues for services provided by RSKCoSM to other units within the Standard Lines segment that are eliminated at the consolidated level. Intrasegment
Approximately 3.5%, 4.8% and 8.2% of CNA’s gross written premiums were derived from outside the United States, primarily the United Kingdom, for the years ended December 31, 2002, 2001 and 2000. In third quarter of 2001, the decision was made to cease new and renewal business writings in CNA Re U.K. Gross written premiums from the United Kingdom were approximately 1.7%, 3.3%, and 5.3% of CNA’s premiums for the years ended December 31, 2002, 2001 and 2000. Gross written premiums from any individual foreign country, other than the United Kingdom, were not significant.
In connection with the IT Plan, after the write-off of impaired assets, the Company accrued $30 million of restructuring and other related charges in 2001 (the IT Plan Initial Accrual). These charges primarily related to $29 million of workforce reductions of approximately 260 positions gross and net and $1 million of other costs.
As summarized in the following table, during 2001, the Company incurred $189 million pretax, or $125 million after-tax, of restructuring and other related charges for the 2001 Plan. During 2002, $32 million pretax, or $21 million after-tax, of this accrual was reduced.
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
The 2001 Plan charges incurred and accrued by Specialty Lines were $7 million in 2001, related entirely to employee termination and related benefit costs for planned reductions in the workforce of 177 positions gross and net, of which $5 million related to severance and outplacement costs and $2 million related to other salary costs. Through December 31, 2002, approximately 126 employees net were released due to the 2001 Plan. Approximately 26% of these employees were administrative, technology or financial support staff; approximately 63% of these employees were underwriters, claim adjusters and related insurance services staff; and approximately 11% of these employees were in various other positions. During December of 2002, the accrual was reduced by $1 million. An accrual of $1 million remained at December 31, 2002 relating to employee termination costs which will be paid in 2003.
The 2001 Plan charges incurred and accrued by Life Operations were $12 million. Costs related to employee termination and related benefit costs for planned reductions in workforce of 207 positions gross and net, amounted to $3 million, which related primarily to severance and outplacement costs. Through December 31, 2002, approximately 144 employees net were released due to the 2001 Plan. Approximately 23% of these employees were administrative, technology or financial support staff; approximately 65% of these employees were underwriters, claim adjusters and related insurance services staff; and approximately 12% of these employees were in various other positions. Life Operations incurred and accrued $9 million of impaired asset charges related to software in 2001. In December of 2002, the remaining $1 million of this accrual was reduced.
The 2001 Plan charges incurred and accrued by the Corporate and Other segment were $82 million. Costs related to employee termination and related benefit costs for planned reductions in the workforce of 194 positions gross and net, amounted to $9 million, of which $6 million related to severance and outplacement costs and $3 million related to other salary costs. Through December 31, 2002, 157 employees net were released due to the 2001 Plan. Approximately 63% of these employees were administrative, technology or financial support staff; approximately 28% of these employees were underwriters, claim adjusters and related insurance services staff; and approximately 9% of these employees were in various other positions. In December of 2002, $1 million of the accrual was reduced for employee termination and related benefit costs. The Corporate and Other segment also incurred $73 million of lease termination and asset impairment charges related to office closure and consolidation decisions not within the control of the other segments affected. Additionally, $7 million was reversed and included in 2002 net income relating to lease obligations and $14 million relating to impaired asset charges. The Company’s original plan contained a timeline to consolidate and reduce the number of office locations. Due to unfavorable conditions in the commercial real estate market, certain office relocations and consolidations occurred later than planned. As a result of such delays, a portion of the planned leasehold write-offs and vacant office space were expensed as period costs, resulting in an excess initial accrual.
In July of 2002, the Company entered into an agreement, whereby Phoenix acquired the variable life and annuity business of VFL through a coinsurance arrangement, with modified coinsurance on the separate accounts.
During the second quarter of 2002, the Company sold Claims Administration Corporation and transferred the National Postal Handlers Union group benefits plan (the Mail Handlers Plan) to First Health Group Corporation. As a result of this transaction, the Company recognized a $7 million pretax realized loss on the sale of Claims Administration Corporation and $15 million of pretax non-recurring fee income related to the transfer of the Mail Handlers Plan.
The assets and liabilities of Claims Administration Corporation and the Mail Handlers Plan were $352 million and $350 million at December 31, 2001. The revenues of Claims Administration Corporation and the Mail Handlers Plan were $1,151 million, $2,231 million and $2,081 million for the years ended December 31, 2002, 2001 and 2000.
CNA Vida’s assets and liabilities at December 31, 2001 were $442 million and $337 million. CNA Vida’s net earned premiums were $24 million, $77 million, and $86 million for the years ended December 31, 2002, 2001 and 2000. Net income was $2 million, $11 million, and $5 million for the years ended 2002, 2001 and 2000. CNA Vida’s results of operations, including the loss on sale, are presented as discontinued operations in all periods presented.
MARC assumed approximately $294 million of liabilities (primarily future policy benefits and claim reserves) and approximately $209 million in assets (primarily uncollected premiums and deferred acquisition costs). The net gain of approximately $2 million from the reinsurance transaction has been recorded as deferred revenue and will be recognized in income as CNA Life Re’s assumed contracts are novated to MARC.
The Company regularly updates its impairment analyses and adjusts its loss as necessary. Based on these updated analyses the impairment loss was reduced by approximately $170 million after-tax in the fourth quarter of 2001, primarily because the net assets of the businesses had been significantly diminished by their operating losses, including adverse loss reserve development recognized by CNA Re U.K. in the fourth quarter of 2001. The reduction of the impairment was included in realized investment gains/losses in the Consolidated Statements of Operations.
The statutory surplus of CNA Re U.K. was below the required regulatory minimum surplus level at December 31, 2001. CCC contributed $120 million of capital on March 25, 2002 bringing the capital above the regulatory minimum.
On October 31, 2002, the Company completed the sale of CNA Re U.K. to Tawa UK Limited (Tawa), a subsidiary of Artemis Group, a diversified French-based holding company. The sale includes business underwritten since inception by CNA Re U.K., except for certain risks retained by CCC as discussed below. In October, the sale was approved in the United Kingdom by the Financial Services Authority (FSA) and by the Illinois Insurance Department. This sale does not impact CNA Re’s on-going U.S.-based operations.
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
As of December 10, 2001, Allstate and CNA agreed to modify a number of the original terms of the transaction. The following is an overview of the significant modifications to the terms of the original agreement:
The $75 million ten-year equity-linked note issued by Allstate in October of 1999 was redeemed by Allstate at par plus accrued interest.
CNA recognized an after-tax realized loss of approximately $39 million in 1999 related to the transaction, consisting primarily of the accrual of lease obligations and the write-down of assets that related specifically to the Personal Insurance lines of business. The $120 million ceding commission related to the prospective portion of the transaction has been recognized in proportion to the recognition of the unearned premium reserves to which it relates. Ceding commission earned was $69 million and $51 million in 2000 and 1999. Royalty fees earned in 2002, 2001 and 2000 were approximately $27 million, $26 million and $27 million.
The following tables set forth unaudited quarterly financial data for the years ended December 31, 2002 and 2001.
During the third quarter of 2002, the Company completed its initial goodwill impairment test and recorded a $57 million after-tax impairment charge. The impairment charge was recorded as a cumulative effect of a change in accounting principle as of January 1, 2002.
CNA reimburses Loews, or pays directly, for management fees, travel and related expenses and expenses of investment facilities and services provided to CNA. The amounts reimbursed or paid by CNA were approximately $19 million, $18 million and $14 million for the years ended December 31, 2002, 2001 and 2000. In addition, CNAF and its eligible subsidiaries are included in the consolidated federal income tax return of Loews and its eligible subsidiaries. See Note E for a detailed description of the income tax agreement and tax payments made between the Company and Loews. Also, CNA writes, at standard rates, a limited amount of insurance for Loews and its affiliates. The total premiums from Loews and its affiliates were $4 million, $6 million and $5 million for the years ended December 31, 2002, 2001 and 2000.
CNA previously sponsored a stock ownership plan whereby the Company financed the purchase of Company 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. See Note L for a detailed discussion of this plan.
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 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. Reinsurance balances payable under this stop loss contract were approximately $22 million as of December 31, 2001. There were no reinsurance balances payable under this stop loss contract as of December 31, 2002.
Subsequent to the issuance of the Company’s 2001 Consolidated Financial Statements and, as a result of a routine review of the Company’s periodic filings by the Division of Corporation Finance of the SEC, the Company has revised the historical accounting for its investment in life settlement contracts and the related revenue recognition. The Company has restated its previously reported financial statements as of December 31, 2001 and for the years ended December 31, 2001 and 2000 as well as its interim financial data for the first three quarters of 2002 and all interim periods of 2001.
operating expense. Revenue is recognized and included in other revenue in the Consolidated Statements of Operations when the life insurance policy underlying the life settlement contract matures. The Company’s historical accounting was to record an asset for the amount paid to acquire the life settlement contract along with other direct acquisition costs, and to recognize revenue over the period the contract was held. Additionally, the Consolidated Statements of Stockholders' Equity reflect a decrease in the Company's retained earnings of $215 million as of January 1, 2000.
We have audited the accompanying consolidated balance sheets of CNA Financial Corporation (an affiliate of Loews Corporation) and subsidiaries (the Company) as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of CNA Financial Corporation and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.