The 333 S. Wabash Avenue building, located in Chicago, Illinois and owned by Continental Assurance Company (CAC), a wholly-owned subsidiary of CCC, serves as our home office. Our subsidiaries own or lease office space in various cities throughout the United States and in other countries. The following table sets forth certain information with respect to our principal office locations:
Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data of this Form 10-K.
Unfavorable net prior year development of $185 million was recorded in 2006, including $251 million of unfavorable claim and allocated claim adjustment expense reserve development and $66 million of favorable premium development. Unfavorable net prior year development of $807 million, including $945 million of unfavorable claim and allocated claim adjustment expense reserve development and $138 million of favorable premium development, was recorded in 2005. Further information on Net Prior Year Development for 2006 and 2005 is included in Note F of the Consolidated Financial Statements included under Item 8.
Net earned premiums increased $34 million in 2006 as compared with 2005, including an $80 million increase related to the Specialty Lines segment and a $3 million increase related to the Standard Lines segment. Net earned premiums for the Life and Group Non-Core segment decreased $63 million. See the Segment Results section of this MD&A for further discussion.
Loss from discontinued operations was $29 million for the year ended December 31, 2006. Results in 2006 reflect a $29 million impairment loss on the anticipated sale of a portion of the run-off business. Further information on this impairment loss is included in Note Q of the Consolidated Financial Statements included under Item 8. Also, the 2006 results were impacted by an increase in unallocated loss adjustment expense reserves and bad debt provision for reinsurance receivables. These items were partially offset by the release of tax reserves and net investment income.
Net income decreased $161 million in 2005 as compared with 2004, due to decreased net operating income partially offset by improved net investment results. See the Investments section of this MD&A for further discussion of net investment results.
Unfavorable net prior year development of $807 million was recorded in 2005, including $945 million of unfavorable claim and allocated claim adjustment expense reserve development and $138 million of favorable premium development. Unfavorable net prior year development of $134 million, including $250 million of unfavorable claim and allocated claim adjustment expense reserve development and $116 million of favorable premium development, was recorded in 2004. Further information on Net Prior Year Development for 2005 and 2004 is included in Note F of the Consolidated Financial Statements included under Item 8.
Net realized investment results, after-tax, improved $143 million in 2005 as compared with 2004. Net results in 2004 included a loss on the sale of the individual life insurance business of $389 million after-tax, which was partly offset by the 2004 gain of $105 million after-tax on the sale of our investment in Canary Wharf Group PLC (Canary Wharf), a London-based real estate company.
Our investment portfolio is subject to market declines below book value that may be other-than-temporary. We have an Impairment Committee, which reviews the investment portfolio on a quarterly basis, with ongoing analysis as new information becomes available. Any decline that is determined to be other-than-temporary is recorded as an other-than-temporary impairment loss in the results of operations in the period in which the determination occurred. Further information on our process for evaluating impairments is included in Note B of the Consolidated Financial Statements included under Item 8.
We make a significant number of assumptions in estimating the liabilities and costs related to our pension and postretirement benefit obligations to employees under our benefit plans. The assumptions that most impact these costs are the discount rate, the expected return on plan assets and the rate of compensation increases. These assumptions are evaluated relative to current market factors such as inflation, interest rates and fiscal and monetary policies. Changes in these assumptions can have a material impact on pension obligations and pension expense.
In determining the discount rate assumption, we utilized current market information, including a discounted cash flow analysis of our pension and postretirement obligations and general movements in the current market environment. In particular, the basis for our discount rate selection was fixed income debt securities that receive one of the two highest ratings given by a recognized rating agency. In 2006 and historically, the Moody’s Aa Corporate Bond Index was the benchmark for discount rate selection. The index is used as the basis for the change in discount rate from the last measurement date. Additionally, we have supplemented our discount rate decision with a yield curve analysis. The yield curve was applied to expected future retirement plan payments to adjust the discount rate to reflect the cash flow characteristics of the plans. The yield curve is a hypothetical double A yield curve represented by a series of annualized discount rates reflecting bond issues having a rating of Aa or better by Moody’s Investors Service, Inc. or a rating of AA or better by Standard & Poor’s. Based on all available information, it was determined that 5.750% and 5.625% were the appropriate discount rates as of December 31, 2006 to calculate our accrued pension and postretirement liabilities, respectively. Accordingly, the 5.750% and 5.625% rates will also be used to determine our 2007 pension and postretirement expense. At December 31, 2005, the discount rates used to calculate our accrued pension and postretirement liabilities were 5.625% and 5.500% respectively.
We maintain reserves to cover our estimated ultimate unpaid liability for claim and claim adjustment expenses, including the estimated cost of the claims adjudication process, for claims that have been reported but not yet settled
(case reserves) and claims that have been incurred but not reported (IBNR). Claim and claim adjustment expense reserves are reflected as liabilities and are included on the Consolidated Balance Sheets under the heading “Insurance Reserves.” Adjustments to prior year reserve estimates, if necessary, are reflected in the results of operations in the period that the need for such adjustments is determined. The carried case and IBNR reserves are provided in the Segment Results section of this MD&A and in Note F of the Consolidated Financial Statements included under Item 8.
Traditional actuarial methods and techniques employed to estimate the ultimate cost of claims for more traditional property and casualty exposures are less precise in estimating claim and claim adjustment reserves for APMT, particularly in an environment of emerging or potential claims and coverage issues that arise from industry practices and legal, judicial and social conditions. Therefore, these traditional actuarial methods and techniques are necessarily supplemented with additional estimation techniques and methodologies, many of which involve significant judgments that are required of management. For APMT, we regularly monitor our exposures, including reviews of loss activity, regulatory developments and court rulings. In addition, we perform a comprehensive ground up analysis on our exposures annually. Our actuaries, in conjunction with our specialized claim unit, use various modeling techniques to estimate our overall exposure to known accounts. We use this information and additional modeling techniques to develop loss distributions and claim reporting patterns to determine reserves for accounts that will report APMT exposure in the future. Estimating the average claim size requires analysis of the impact of large losses and claim cost trend based on changes in the cost of repairing or replacing property, changes in the cost of legal fees, judicial decisions, legislative changes, and other factors. Due to the inherent uncertainties in estimating reserves for APMT claim and claim adjustment expenses and the degree of variability due to, among other things, the factors described above, we may be required to record material changes in our claim and claim adjustment expense reserves in the future, should new information become available or other developments emerge.
See the APMT Reserves section of this MD&A and Note F of the Consolidated Financial Statements included under Item 8 for additional information relating to APMT claims and reserves.
increases in the number and size of claims relating to injuries from medical products;
at which policyholders report claims to us, the impact of judicial decisions, the impact of underwriting changes and other factors. Estimating the ultimate average loss requires analysis of the impact of large losses and claim cost trend based on changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors.
Our recorded reserves reflect our best estimate as of a particular point in time based upon known facts, current law and our judgment. The carried reserve may differ from the actuarial point estimate as the result of our consideration of the factors noted above as well as the potential volatility of the projections associated with the specific product being analyzed and other factors impacting claims costs that may not be quantifiable through actuarial analysis. This process results in management’s best estimate which is then recorded as the loss reserve.
Our recorded reserves are management’s best estimate. In order to provide an indication of the variability associated with our net reserves, the following discussion provides a sensitivity analysis that shows the approximate estimated impact of variations in the most significant factor affecting our reserve estimates for particular types of business. These significant factors are the ones that could most likely materially impact the reserves. This discussion covers the major types of business for which we believe a material deviation to our reserves is reasonably possible. There can be no assurance that actual experience will be consistent with the current assumptions or with the variation indicated by the discussion. In addition, there can be no assurance that other factors and assumptions will not have a material impact on our reserves.
For Standard Lines workers’ compensation, since many years will pass from the time the business is written until all claim payments have been made, claim cost inflation on claim payments is the most significant factor affecting workers’ compensation reserve estimates. Workers’ compensation claim cost inflation is driven by the cost of medical care, the cost of wage replacement, expected claimant lifetimes, judicial decisions, legislative changes and other factors. If estimated workers’ compensation claim cost inflation increases by one point for the entire period over which claim payments will be made, we estimate that our net reserves would increase by approximately $500 million. If estimated workers’ compensation claim cost inflation decreases by one point for the entire period over which claim payments will be made, we estimate that our net reserves would decrease by approximately $450 million. Our net reserves for Standard Lines workers’ compensation were approximately $4.4 billion at December 31, 2006.
Within Specialty Lines, we believe a material deviation to our net reserves is reasonably possible for the US Specialty Lines group. This group provides professional liability coverages to various professional firms, including architects, realtors, small and mid-sized accounting firms, law firms and technology firms. US Specialty Lines also provide D&O, employment practices, fiduciary and fidelity coverages. US Specialty Lines also offers insurance products to serve the healthcare delivery system. The most significant factor affecting US Specialty Lines reserve estimates is claim severity. Claim severity for US Specialty Lines is driven by the cost of medical care, the cost of wage replacement, legal fees, judicial decisions, legislation and other factors. Underwriting and claim handling decisions such as the classes of business written and individual claim settlement decisions can also impact claim severity. If the estimated claim severity for US Specialty Lines increases by 7%, we estimate that US Specialty Lines net reserves would increase by approximately $270 million. If the estimated claim severity for US Specialty Lines decreases by 3%, we estimate that US Specialty net reserves would decrease by approximately $110 million. Our net reserves for US Specialty Lines were approximately $3.9 billion at December 31, 2006.
For APMT, the most significant factor affecting reserve estimates is overall account size trend. Overall account size trend for APMT reflects the combined impact of economic trends (inflation), changes in the types of defendants involved, the expected mix of asbestos disease types, judicial decisions, legislation and other factors. If the estimated overall account size trend for APMT increases by 4 points, we estimate that our APMT net reserves would increase by approximately $700 million. If the estimated overall account size trend for APMT decreases by 4 points, we estimate that our APMT net reserves would decrease by approximately $400 million. Our net reserves for APMT were approximately $1.9 billion at December 31, 2006.
In 2001, we entered into a one-year corporate 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 CCC Cover was fully utilized in 2003. In 2006, we commuted our CCC Cover. This commutation had no impact on the Consolidated Statements of Operations for the year ended December 31, 2006.
Also, in 2006, we commuted several reinsurance treaties, including several finite treaties, with a European reinsurance group. This commutation resulted in a pretax loss, net of allowance for uncollectible reinsurance, of $48 million. We received $35 million of cash in connection with this significant commutation.
As of December 31, 2006 and 2005, there were one and thirteen ceded reinsurance treaties inforce respectively that we consider to be finite reinsurance. In 2003, we discontinued purchases of such contracts. The remaining treaty at December 31, 2006 provides reinsurance protection for the 1999 accident year on specified portions of our domestic property and casualty business and is fully utilized. Therefore, we do not expect to cede any additional losses under finite reinsurance contracts in future periods nor incur interest costs.
We and the insurance industry incurred substantial losses related to the 2001 World Trade Center event. The Terrorism Risk Insurance Act of 2002 (TRIA) established a program within the Department of the Treasury under which insurers are required to offer terrorism insurance and the federal government will share the risk of loss by commercial property and casualty insurers arising from future terrorist attacks. Although TRIA expired on December 31, 2005, the Terrorism Risk Insurance Extension Act of 2005 (TRIEA) extended this program through December 31, 2007 with changes such as the lines of business covered, the deductible amount that must be paid by the insurance company and the aggregate industry loss prior to federal government assistance becoming available.
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
Property provides standard and excess property coverage, as well as marine coverage and boiler and machinery to a wide range of businesses.
Casualty provides standard casualty insurance products such as workers’ compensation, general and product liability and commercial auto coverage through traditional products to a wide range of businesses. Most insurance programs are provided on a guaranteed cost basis; however, Casualty has the capability to offer specialized, loss-sensitive insurance programs to those customers viewed as higher risk and less predictable in exposure.
CNA Global consists of subsidiaries operating in Europe, Latin America, Canada and Hawaii. These affiliates offer property and casualty insurance to small and medium size businesses and capitalize on strategic indigenous opportunities.
Standard Lines averaged flat rates for 2006, as compared to average rate decreases of 1% for 2005 for the contracts that renewed during those periods. Retention rates of 81% and 77% were achieved for those contracts that were up for renewal in each period.
Net results increased $704 million in 2006 as compared with 2005. This increase was attributable to increases in net operating results and net realized investment gains. See the Investments section of this MD&A for further discussion of net investment income and net realized investment gains.
Unfavorable net prior year development of $69 million was recorded in 2006, including $157 million of unfavorable claim and allocated claim adjustment expense reserve development and $88 million of favorable premium development. Unfavorable net prior year development of $452 million, including $559 million of unfavorable claim and allocated claim adjustment expense reserve development and $107 million of favorable premium development, was recorded in 2005. Further information on Standard Lines Net Prior Year Development for 2006 and 2005 is included in Note F of the Consolidated Financial Statements included under Item 8.
During 2006 and 2005, we commuted several significant reinsurance contracts that resulted in unfavorable development of $110 million and $285 million, which is included in the development above, and which was partially offset by the release of previously established allowance for uncollectible reinsurance. These commutations resulted in an unfavorable after-tax impact of $31 million and $173 million in 2006 and 2005. Several of the commuted contracts contained interest crediting provisions. The interest charges associated with the reinsurance contracts commuted were $9 million after-tax and $35 million after-tax in 2006 and 2005. The 2005 amount includes the interest charges associated with the contract commuted in 2006. There will be no further interest crediting charges related to these commuted contracts in future periods.
premium in 2005 related to catastrophe losses and decreased rates as discussed further below. Net earned premiums decreased $507 million in 2005 as compared with 2004. This decrease was primarily driven by the decline in premiums written. The lower premium is consistent with our strategy of portfolio optimization. Our priority is a diversified portfolio in profitable classes of business.
Net results decreased $391 million in 2005 as compared with 2004. This decrease was attributable to declines in both net operating results and net realized investment results. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.
Net operating results decreased $261 million in 2005 as compared with 2004. This decrease was due primarily to increased unfavorable net prior year development of $282 million after-tax including $185 million after-tax related to significant commutations in 2005, a $135 million after-tax increase in catastrophe losses, the decreased earned premium as discussed above and decreased current accident year results. These unfavorable items were partially offset by a $271 million increase in net investment income and a decrease in the provision for insurance bad debt.
The combined ratio increased 14.7 points in 2005 as compared with 2004. The loss ratio increased 16.7 points in 2005 as compared with 2004. These increases were primarily due to increased net prior year development, increased catastrophe losses and decreased current accident year results. Catastrophe losses of $470 million and $260 million were recorded in 2005 and 2004.
US Specialty Lines provides management and professional liability insurance and risk management services, primarily in the United States. This group provides professional liability coverages to various professional firms, including architects, realtors, small and mid-sized accounting firms, law firms and technology firms. US Specialty Lines also provides directors and officers (D&O), employment practices, fiduciary and fidelity coverages. Specific areas of focus include small and mid-size firms as well as privately held firms and not-for-profit organizations where tailored products for this client segment are offered. Products within US Specialty Lines are distributed through brokers, agents and managing general underwriters.
US Specialty Lines, through CNA HealthPro, also offers insurance products to serve the healthcare delivery system. Products, which include professional liability as well as associated standard property and casualty coverages, are distributed on a national basis through a variety of channels including brokers, agents and managing general underwriters. Key customer segments include long term care facilities, allied healthcare providers, life sciences, dental professionals and mid-size and large healthcare facilities and delivery systems.
Specialty Lines averaged flat rates for 2006, as compared to average rate increases of 1% for 2005 for the contracts that renewed during those periods. Retention rates of 87% and 86% were achieved for those contracts that were up for renewal in each period.
The combined ratio improved 4.2 points in 2006 as compared with 2005. The loss ratio improved 4.8 points, due to improved current accident year impacts and decreased net prior year development as discussed below. The 2005 loss ratio was unfavorably impacted by surety losses of $110 million, before the impacts of minority interest, related to a national contractor as discussed above. Partially offsetting this favorable impact was less favorable current accident year loss ratios across several other lines of business in 2006.
Net income decreased $30 million in 2005 as compared with 2004. This decrease was due primarily to a $42 million decrease in net realized investment gains partially offset by increased net operating income. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.
Net operating income increased $12 million in 2005 as compared with 2004. This increase was primarily driven by an increase in net investment income and increased earned premiums. These increases to operating income were partially offset by decreased current accident year results. Additionally, 2004 results were favorably impacted by the release of a previously established reinsurance bad debt allowance as the result of a significant commutation. Catastrophe impacts were $16 million after-tax and $11 million after-tax for the years ended December 31, 2005 and 2004.
The Life and Group Non-Core segment primarily includes the results of the life and group lines of business that have either been sold or placed in run-off. We sold our individual life business on April 30, 2004 and our specialty medical business on January 6, 2005. The segment includes operating results for these businesses in periods prior to the sales, the realized gain/loss from the sales and the effects of the shared corporate overhead expenses which continue to be allocated to the segment. We continue to service our existing individual long term care commitments, our payout annuity business and our pension deposit business. We also manage a block of group reinsurance and life settlement contracts. These businesses are being managed as a run-off operation. Our group long term care and Index 500 products, while considered non-core, continue to be actively marketed.
Net results increased $23 million in 2006 as compared with 2005, driven by increased net investment income. A significant portion of the increase in net investment income was offset by a corresponding increase in the policyholders’ funds reserves supported by the trading portfolio. The portion not offset by the policyholders’ funds reserves increased by $25 million. Also impacting net results was $15 million of income related to the resolution of contingencies and the absence of a $17 million provision recorded in 2005 for estimated indemnification liabilities related to the sold individual life business. Partially offsetting these favorable impacts were increased net realized investment losses and the absence of income related to agreements with buyers of sold businesses which ended as of December 31, 2005. In addition, the 2005 net results included a change in estimate, which reduced a prior accrual of state premium taxes. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.
Net results improved by $344 million in 2005 as compared with 2004. The improvement in net results related primarily to a $389 million realized loss on the sale of the individual life business in 2004. Also contributing to the improvement in net results was the reduction in 2005 of significant 2004 items related to certain assumed reinsurance exposures. Additionally, 2005 results included $13 million income related to a service agreement with a purchaser for sold businesses. These agreements have expired. These results were partially offset by a decline in net investment income of $99 million. This included a decrease of approximately $64 million from the trading portfolio which was largely offset by a corresponding decrease in the policyholders’ funds reserves supported by the trading portfolio. In addition, it included the absence of favorable results from sold insurance operations. Also unfavorably impacting the 2005 results was a $17 million provision increase for estimated indemnification liabilities related to the sold individual life business and unfavorable results related to the long term care business. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.
Corporate and Other Non-Core includes the results of certain property and casualty lines of business placed in run-off. CNA Re, formerly a separate property and casualty operating segment, is in run-off and is included in the Corporate and Other Non-Core segment. This segment also includes the results related to the centralized adjusting and settlement of APMT claims, as well as the results of our participation in voluntary insurance pools and various non-insurance operations. Other operations also include interest expense on corporate borrowings and intercompany eliminations.
Revenues decreased $6 million in 2006 as compared with 2005. Revenues in 2006 and 2005 included interest income related to federal income tax settlements of $4 million and $121 million as further discussed in Note E to the Consolidated Financial Statements included under Item 8. This decrease was substantially offset by increased net investment income and improved realized investment results. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.
Unfavorable net prior year development of $88 million was recorded during 2006, including $86 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development and $2 million of unfavorable premium development. Unfavorable net prior year development of $306 million was recorded in 2005, including $291 million of unfavorable net prior year claim and allocated claim adjustment expense reserve
Net results decreased $126 million in 2005 as compared with 2004. The decrease in net results was primarily due to a $139 million after-tax increase in unfavorable net prior year development related primarily to commutations and reserve strengthening, a $51 million decrease in net realized investment results and a decrease in the provision recorded for uncollectible reinsurance. Net realized investment results for the year ended December 31, 2005 and 2004 included a $22 million after-tax and $36 million after-tax impairment related to a national contractor. See Note S to the Consolidated Financial Statements included under Item 8 for additional information regarding the national contractor. Partially offsetting these decreases was a $115 million after-tax benefit related to a federal income tax settlement and release of federal income tax reserves.
Unfavorable net prior year development of $306 million was recorded during 2005, including $291 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development and $15 million of unfavorable premium development. Unfavorable net prior year development of $93 million was recorded in 2004, including $84 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development and $9 million of unfavorable premium development. Further information on Corporate and Other Non-Core’s Net Prior Year Development for 2005 and 2004 is included in Note F of the Consolidated Financial Statements included under Item 8.
Our property and casualty insurance subsidiaries have actual and potential exposures related to asbestos, environmental pollution and mass tort (APMT) claims.
In addition to the difficulties described above, estimating the ultimate cost of both reported and unreported APMT claims is subject to a higher degree of variability due to a number of additional factors, including among others: the number and outcome of direct actions against us; coverage issues, including whether certain costs are covered under the policies and whether policy limits apply; allocation of liability among numerous parties, some of whom may be in bankruptcy proceedings, and in particular the application of “joint and several” liability to specific insurers on a risk; inconsistent court decisions and developing legal theories; continuing aggressive tactics of plaintiffs’ lawyers; the risks and lack of predictability inherent in major litigation; enactment of state and federal legislation to address asbestos claims; the potential for increases and decreases in asbestos, environmental pollution and mass tort claims which cannot now be anticipated; the potential for increases and decreases in costs to defend asbestos, pollution and mass tort claims; the possibility of expanding theories of liability against our policyholders in environmental and mass tort matters; possible exhaustion of underlying umbrella and excess coverage; and future developments pertaining to our ability to recover reinsurance for asbestos, pollution and mass tort claims.
We have annually performed ground up reviews of all open APMT claims to evaluate the adequacy of our APMT reserves. In performing our comprehensive ground up analysis, we consider input from our professionals with direct responsibility for the claims, inside and outside counsel with responsibility for our representation and our actuarial staff. These professionals consider, among many factors, the policyholder’s present and predicted future exposures, including such factors as claims volume, trial conditions, prior settlement history, settlement demands and defense costs; the impact of asbestos defendant bankruptcies on the policyholder; facts or allegations regarding the policies we issued or are alleged to have issued, 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 policyholders’ allegations; the existence of other insurance; and reinsurance arrangements.
In the past several years, we experienced, at certain points in time, significant increases in claim counts for asbestos-related claims. The factors that led to these increases included, among other things, intensive advertising campaigns by lawyers for asbestos claimants, mass medical screening programs sponsored by plaintiff lawyers and the addition of new defendants such as the distributors and installers of products containing asbestos. In recent years, the rate of new filings has decreased. Various challenges to mass screening claimants have been successful. Historically, the majority of asbestos bodily injury claims have been filed by persons exhibiting few, if any, disease symptoms. Studies have concluded that the percentage of unimpaired claimants to total claimants ranges between 66% and up to 90%. Some courts and some state statutes mandate that so-called “unimpaired” claimants may not recover unless at some point the claimant’s condition worsens to the point of impairment. Some plaintiffs classified as “unimpaired” continue to challenge those orders and statutes. Therefore, the ultimate impact of the orders and statutes on future asbestos claims remains uncertain.
Several factors are, in our view, negatively impacting asbestos claim trends. Plaintiff attorneys who previously sued entities that are now bankrupt continue to seek other viable targets. As a result, companies with few or no previous asbestos claims are becoming targets in asbestos litigation and, although they may have little or no liability, nevertheless must be defended. Additionally, plaintiff attorneys and trustees for future claimants are demanding that policy limits be paid lump-sum into the bankruptcy asbestos trusts prior to presentation of valid claims and medical proof of these claims. Various challenges to these practices have succeeded in litigation, and are continuing to be litigated. Plaintiff attorneys and trustees for future claimants are also attempting to devise claims payment procedures for bankruptcy trusts that would allow asbestos claims to be paid under lax standards for injury, exposure and causation. This also presents the potential for exhausting policy limits in an accelerated fashion. Challenges to these practices are being mounted, though the ultimate impact or success of these tactics remains uncertain.
As a result of bankruptcies and insolvencies, we had in the past observed an increase in the total number of policyholders with current asbestos claims as additional defendants are added to existing lawsuits and are named in new asbestos bodily injury lawsuits. During the last few years the rate of new bodily injury claims had moderated and most recently the new claims filing rate has decreased although the number of policyholders claiming coverage for asbestos related claims has remained relatively constant in the past several years.
In 1985, 47 asbestos producers and their insurers, including The Continental Insurance Company (CIC), executed the Wellington Agreement. The agreement was intended to resolve all issues and litigation related to coverage for asbestos exposures. Under this agreement, signatory insurers committed scheduled policy limits and made the limits available to pay asbestos claims based upon coverage blocks designated by the policyholders in 1985, subject to extension by policyholders. CIC was a signatory insurer to the Wellington Agreement.
We categorize active asbestos accounts as large or small accounts. We define a large account as an active account with more than $100 thousand of cumulative paid losses. We have made closing large accounts a significant management priority. Small accounts are defined as active accounts with $100 thousand or less of cumulative paid losses. Approximately 80% and 81% of our total active asbestos accounts are classified as small accounts at December 31, 2006 and 2005.
The tables below depict our overall pending environmental pollution accounts and associated reserves at December 31, 2006 and 2005.
Net investment income increased by $520 million for 2006 compared with 2005. The improvement was primarily driven by interest rate increases across fixed maturity securities and short term investments, an increase in the overall invested asset base resulting from improved cash flow and a reduction of interest expense on funds withheld and other deposits. During 2006 and 2005, we commuted several significant finite reinsurance contracts which contained interest crediting provisions and as a result, interest expense on funds withheld has declined significantly. No further interest expense is due on the funds withheld on the commuted contracts. The pretax interest expense on funds withheld related to these significant commuted contracts was $14 million, $84 million and $146 million for December 31, 2006, 2005 and 2004, and was reflected as a component of Net investment income in our Consolidated Statements of Operations. The 2005 and 2004 amounts include the interest charges associated with the contract commuted in 2006. See Note H of the Consolidated Financial Statements included under Item 8 for additional information for interest costs on funds withheld and other deposits. Also impacting net investment income was increased income from the trading portfolio of approximately $56 million. The increased income from the trading portfolio was largely offset by a corresponding increase in the policyholders’ funds reserves supported by the trading portfolio, which is included in Insurance claims and policyholders’ benefits on the Consolidated Statements of Operations.
Net investment income increased by $212 million for 2005 compared with 2004. This increase was due to the reduced interest expense on funds withheld and other deposits discussed above and improved results across all other available-for-sale asset classes, especially short term investments, due to the improved period over period yields. This improvement was partly offset by decreases in investment income from the trading portfolio.
The components of net realized investment results for available-for-sale securities are presented in the following table.
The Consolidated Financial Statements include the accounts of CNA Financial Corporation (CNAF) and its controlled subsidiaries. Collectively, CNAF and its subsidiaries are referred to as CNA or the Company. CNA’s property and casualty and the remaining life and group insurance operations are primarily conducted by Continental Casualty Company (CCC), The Continental Insurance Company (CIC) and Continental Assurance Company (CAC). Loews Corporation (Loews) owned approximately 89% of the outstanding common stock of CNAF as of December 31, 2006.
The Company’s individual life insurance business, including its previously wholly-owned subsidiary Valley Forge Life Insurance Company (VFL), was sold on April 30, 2004 to Swiss Re Life & Health America Inc. (Swiss Re). The results of the individual life insurance business sold through the date of sale are included in the Consolidated Statement of Operations for the year ended December 31, 2004. See Note P for further information.
The accompanying Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). All significant intercompany amounts have been eliminated. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. The amounts presented on the December 31, 2005 Consolidated Balance Sheet related to Insurance receivables and Other liabilities have been corrected from $1,866 million and $2,283 million to $2,096 million and $2,513 million, to conform to the 2006 presentation. The correction of $230 million relates to balances payable to insureds that were previously reflected as a deduction from insurance receivables and are currently reflected as liabilities. The balances are principally related to amounts deposited with the Company by customers, such as amounts related to the funding of deductible obligations.
CNA’s core property and casualty insurance operations are reported in two business segments: Standard Lines and Specialty Lines. CNA’s non-core operations are managed in two segments: Life and Group Non-Core and Corporate and Other Non-Core.
Claim and claim adjustment expense reserves: Claim and claim adjustment expense reserves, except reserves for structured settlements not associated with asbestos and environmental pollution and mass tort (APMT), workers’ compensation lifetime claims, accident and health claims and certain claims associated with discontinued operations, are not discounted and are based on 1) case basis estimates for losses reported on direct business, adjusted in the aggregate for ultimate loss expectations; 2) estimates of incurred but not reported losses; 3) estimates of losses on assumed reinsurance; 4) estimates of future expenses to be incurred in the settlement of claims; 5) estimates of salvage and subrogation recoveries and 6) estimates of amounts due from insureds related to losses under high deductible policies. Management considers current conditions and trends as well as past Company and industry experience in establishing these estimates. The effects of inflation, which can be significant, are implicitly considered in the reserving process and are part of the recorded reserve balance. Ceded claim and claim adjustment expense reserves are reported as a component of Reinsurance receivables in the Consolidated Balance Sheets. See Note Q for further information on claim and claim adjustment expense reserves for discontinued operations.
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, 2006 and 2005, the liability balances were $189 million and $185 million. As of December 31, 2006 and 2005, included in other assets were $7 million and $10 million of related assets for premium tax offsets. The related asset is limited to the amount that is able to be assessed on future premium collections from business written or committed to be written.
Reinsurance: Amounts recoverable from reinsurers are estimated in a manner consistent with claim and claim adjustment expense reserves or future policy benefits reserves and are reported as receivables in the Consolidated Balance Sheets. The cost of reinsurance is primarily accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. The ceding of insurance does not discharge the primary liability of the Company. An estimated allowance for doubtful accounts is recorded on the basis of periodic evaluations of balances due from reinsurers, reinsurer solvency, management’s experience and current economic conditions. The expenses incurred related to uncollectible reinsurance receivables are presented as a component of Insurance claims and policyholders’ benefits in the Consolidated Statements of Operations.
Reinsurance contracts that do not effectively transfer the underlying economic risk of loss on policies written by the Company 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. At December 31, 2006 and 2005, the Company had approximately $104 million and $171 million recorded as deposit assets and $71 million and $111 million recorded as deposit liabilities.
Anticipated investment income is considered in the determination of the recoverability of deferred acquisition costs. 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 results of operations.
Periodic maintenance costs, such as premiums, necessary to keep the underlying policy inforce are expensed as incurred and are 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. See the Accounting Pronouncements section of this note for further discussion of Financial Accounting Standards Board (FASB) Staff Position No. 85-4-1, Accounting for Life Settlement Contracts by Third-Party Investors.
Other invested assets include certain derivative securities and real estate investments. Investments in derivative securities are carried at fair value with changes in fair value reported as a component of realized gains or losses or other comprehensive income, depending on their hedge designation. Changes in the fair value of derivative securities which are not designated as hedges, are reported as a component of realized gains or losses. Real estate investments are carried at the lower of cost or market value. Short term investments are generally carried at cost, which approximates fair value.
The Company’s use of derivatives is limited by statutes and regulations promulgated by the various regulatory bodies to which it is subject, and by its own derivative policy. The derivative policy limits the authorization to initiate derivative transactions to certain personnel. Derivatives entered into for hedging, regardless of the choice to designate hedge accounting, shall have a maturity that effectively correlates to the underlying hedged asset or liability. The policy prohibits the use of derivatives containing greater than one-to-one leverage with respect to changes in the underlying price, rate or index. The policy also prohibits the use of borrowed funds, including funds obtained through securities lending, to engage in derivative transactions.
The Company has exposure to credit risk arising from the uncertainty associated with a financial instrument obligor’s ability to make timely principal and/or interest payments. The Company attempts to mitigate this risk by limiting credit concentrations, practicing diversification, and frequently monitoring the credit quality of issuers and counterparties. In addition the Company may utilize credit derivatives such as credit default swaps to modify the credit risk inherent in certain investments. Credit default swaps involve a transfer of credit risk from one party to another in exchange for periodic payments. The Company infrequently designates these types of instruments as hedges against specific assets.
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.
Earnings per share available to common stockholders is based on weighted average outstanding shares. Basic earnings per share excludes dilution and is computed by dividing net income attributable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
Cash payments made for interest were $109 million, $139 million and $123 million for the years ended December 31, 2006, 2005 and 2004. Cash payments made for federal income taxes were $173 million and $164 million for the years ended December 31, 2006 and 2005. Cash refunds received for federal income taxes amounted to $627 million for the year ended December 31, 2004.
In December of 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R), that amends SFAS 123, as originally issued in May of 1995. SFAS 123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS 123R supercedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). After the effective date of this standard, entities are not permitted to use the intrinsic value method specified in APB 25 to measure compensation expense and generally are required to measure compensation expense using a fair-value based method. The Company applied the modified prospective transition method. The modified prospective method requires a company to (a) record compensation expense for all awards it grants, modifies, repurchases or cancels after the date it adopts the standard and (b) record compensation expense for the unvested portion of previously granted awards that remain outstanding at the date of adoption. SFAS 123R was effective for the Company as of January 1, 2006. The Company applied the alternative transition method in calculating its pool of excess tax benefits available to absorb future tax deficiencies as provided by FSP FAS 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards. Adoption of SFAS 123R decreased net income by $2 million for the year ended December 31, 2006. Prior to 2006, the Company applied the intrinsic value method under 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 was recognized, as the exercise price of the granted options equaled the market price of the underlying stock at the grant date.
obligations as of the date of the fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. Adoption of SFAS 158 decreased equity by $46 million at December 31, 2006. The Company has included the required additional disclosures in Note J.
In March 2006, the FASB issued FSP No. 85-4-1, Accounting for Life Settlement Contracts by Third-Party Investors (FSP 85-4-1). A life settlement contract for purposes of FSP 85-4-1 is a contract between the owner of a life insurance policy (the policy owner) and a third-party investor (investor). The previous accounting guidance, FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance (FTB 85-4), required the purchaser of life insurance contracts to account for the life insurance contract at its cash surrender value. Because life insurance contracts are purchased in the secondary market at amounts in excess of the policies’ cash surrender values, the application of guidance in FTB 85-4 created a loss upon acquisition of the policy. FSP 85-4-1 provides initial and subsequent measurement guidance and financial statement presentation and disclosure guidance for investments by third-party investors in life settlement contracts. FSP 85-4-1 allows an investor to elect to account for its investments in life settlement contracts using either the investment method or the fair value method. The election shall be made on an instrument-by-instrument basis and is irrevocable. FSP 85-4-1 is effective for fiscal years beginning after June 15, 2006. The Company has elected to account for its investment in life settlement contracts using the fair value method and the initial expected impact upon adoption under the fair value method will be an increase to retained earnings as of January 1, 2007 of approximately $38 million.
In July 2006, FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. FIN 48 states that a tax benefit from an uncertain position may be recognized only if it is “more likely than not” that the position is sustainable, based on its technical merits. The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information. FIN 48 is effective for fiscal years beginning after December 15, 2006. The impact on retained earnings as of January 1, 2007 from the adoption of FIN 48 is expected to be approximately $5 million.
There was no change in net unrealized gains (losses) on trading securities included in net investment income for the year ended December 31, 2006. The change in net unrealized gains (losses) on trading securities included in net investment income was $(7) million and $2 million for the years ended December 31, 2005 and 2004.
The Company’s investment policies 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.
Realized investment losses included $173 million, $107 million and $93 million of other-than-temporary impairment (OTTI) losses for the years ended December 31, 2006, 2005 and 2004. The 2006, 2005 and 2004 OTTI losses were recorded across various sectors. The increase in OTTI losses for 2006 was primarily driven by an increase in interest rate related OTTI losses on securities for which the Company did not assert an intent to hold until an anticipated recovery in value. The 2005 and 2004 OTTI losses included $34 million and $56 million related to loans made under a credit facility to a national contractor, that are classified as fixed maturity securities. See Note S for additional information on loans to the national contractor.
The following tables provide a summary of fixed maturity and equity securities investments.
The Impairment Committee’s decision to record an OTTI loss is primarily based on whether the security’s fair value is likely to recover to its book value in light of all of the factors considered. For securities considered to be OTTI, the security is adjusted to fair value and the resulting losses are recognized in Realized investment gains (losses) on the Consolidated Statements of Operations.
At December 31, 2006, the carrying value of the general account fixed maturities was $35,851 million, representing 81% of the total investment portfolio. The net unrealized position associated with the fixed maturity portfolio included $208 million in gross unrealized losses, consisting of asset-backed securities which represented 83%, corporate bonds which represented 8%, municipal securities which represented 3%, and all other fixed maturity securities which represented 6%. The gross unrealized loss for any single issuer was no greater than 0.1% of the carrying value of the total general account fixed maturity portfolio. The total fixed maturity portfolio gross unrealized losses included 1,491 securities which were, in aggregate, approximately 1% below amortized cost.
Cash and securities with carrying values of approximately $2.5 billion and $2.4 billion were deposited by the Company’s insurance subsidiaries under requirements of regulatory authorities as of December 31, 2006 and 2005.
The Company entered into one transaction that was designated as a cash flow hedge for accounting purposes, hedging interest rate risk on the forecasted payment of interest resulting from the issuance of fixed rate debt obligations during 2004. Ineffectiveness resulting from this hedge was recorded in realized gains or losses and was insignificant. For cash flow hedges of this type, gains and losses on derivative contracts that are reclassified from Accumulated other comprehensive income to current period earnings are included as part of the interest cost over the forecasted life of the debt. The cash flow hedge resulted in a loss of $4 million which was recorded in Accumulated other comprehensive income at December 31, 2004. The Company reclassified $0.3 million and $0.3 million of the deferred net loss recorded in Accumulated other comprehensive income into earnings during 2006 and 2005. The Company did not enter into any transaction that was designated as a cash flow hedge during 2006 or 2005. The
Company expects that $0.3 million of the deferred net loss recorded in Accumulated other comprehensive income will be reclassified into earnings during 2007.
The Company’s derivative activities that are not designated as a hedge for accounting purposes primarily involve hedging interest rate, foreign currency and credit rate risks on various assets as part of its overall portfolio management strategy. This activity may include entering into interest rate swaps, credit default swaps, currency forwards and commitments to purchase securities. It may also include buying or selling interest rate futures and options and purchasing warrants. These products are entered into as part of a macro hedging strategy and while they may be linked to specific assets or a pool of assets, the Company does not seek hedge accounting treatment on them.
The Company’s derivative trading activities are associated with one of its consolidated separate accounts in which all investments are held for trading purposes. The derivatives segregated in this separate account are carried at fair value with the gains and losses included within net investment income. The Company is exposed to equity price risk in this separate account associated with its indexed group annuity contracts. The Company purchases Standard and Poor’s 500® (S&P500®) index futures contracts in a notional amount equal to the contract holders liability. Other derivatives held in the separate account may include currency forwards, interest rate futures, options written and purchased and forward purchase commitments, among others.
The results of the Company’s Separate Account derivative trading activity is included within Other revenues in the Consolidated Statements of Operations. The Company utilizes written options to enhance income in separate accounts.
The carrying amounts reported on the Consolidated Balance Sheets for Cash, Short term investments, Accrued investment income, Receivables for securities sold, Federal income taxes recoverable/payable, Collateral on loaned securities, Payables for securities purchased, and certain other assets and other liabilities approximate fair value because of the short term nature of these items. These assets and liabilities are not listed in the following tables.
separate account business assets consisted of discounting cash flows, obtaining quoted market prices of the investments and comparing the investments to similar instruments or to the underlying assets of the investments.
For the years ended December 31, 2006 and 2005, CNA paid Loews $120 million and $146 million related to federal income taxes. CNA’s consolidated federal income taxes payable at December 31, 2006 reflects a $38 million payable to Loews and a $2 million payable related to affiliates less than 80% owned. At December 31, 2005, CNA’s consolidated federal income taxes recoverable included a $68 million recoverable from Loews and a $6 million payable related to affiliates less than 80% owned which settle their income taxes directly with the Internal Revenue Service (IRS).
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, is as follows:
At December 31, 2005, a valuation allowance of $30 million related to certain foreign subsidiaries remained outstanding, due to uncertainty in the ability of the foreign subsidiaries to generate sufficient future income. During 2006, the Company reconsidered the need for this allowance in light of recent earnings levels and anticipated future earnings and determined the allowance was no longer required. Therefore, the allowance was released in 2006. Although realization of deferred tax assets is not assured, management believes it is more likely than not that the recognized net deferred tax asset will be realized through future earnings, including but not limited to future income from continuing operations, reversal of existing temporary differences, and available tax planning strategies.
In 2006, net payments were decreased by $935 million due to the impact of significant commutations. In 2005, net payments were decreased by $1,581 million due to the impact of significant commutations. See Note H for further discussion related to commutations.
The following tables summarize the gross and net carried reserves as of December 31, 2006 and 2005.
CNA’s property and casualty insurance subsidiaries have actual and potential exposures related to APMT claims.
CNA has annually performed ground up reviews of all open APMT claims to evaluate the adequacy of the Company’s APMT reserves. In performing its comprehensive ground up analysis, the Company considers input from its professionals with direct responsibility for the claims, inside and outside counsel with responsibility for representation of the Company and its actuarial staff. These professionals review, among many factors, the policyholder’s present and predicted future exposures, including such factors as claims volume, trial conditions, prior settlement history, settlement demands and defense costs; the impact of asbestos defendant bankruptcies on the policyholder; the policies issued by CNA, including such factors as aggregate or per occurrence limits, whether the policy is primary, umbrella or excess, and the existence of policyholder retentions and/or deductibles; the existence of other insurance; and reinsurance arrangements.
The following table provides data related to CNA’s APMT claim and claim adjustment expense reserves.
CNA is engaged in insurance coverage litigation in New York State Court, filed in 2003, with a defendant class of underlying plaintiffs who have asbestos bodily injury claims against the former Robert A. Keasbey Company (Keasbey) (Continental Casualty Co. v. Employers Ins. of Wausau et al., No. 601037/03 (N.Y. County)). Keasbey, a currently dissolved corporation, was a seller and installer of asbestos-containing insulation products in New York and New Jersey. Thousands of plaintiffs have filed bodily injury claims against Keasbey; however, Keasbey’s involvement at a number of work sites is a highly contested issue. Therefore, the defense disputes the percentage of valid claims against Keasbey. CNA issued Keasbey primary policies for 1970-1987 and excess policies for 1972-1978. CNA has paid an amount substantially equal to the policies’ aggregate limits for products and completed operations claims in the confirmed CNA policies. Claimants against Keasbey allege, among other things, that CNA owes coverage under sections of the policies not subject to the aggregate limits, an allegation CNA vigorously contests in the lawsuit. In the litigation, CNA and the claimants seek declaratory relief as to the interpretation of various policy provisions. The court dismissed a claim alleging bad faith and seeking unspecified damages on March 21, 2004; that ruling was affirmed on March 31, 2005 by Appellate Division, First Department. The trial in the Keasbey coverage action commenced on July 13, 2005; closing arguments concluded on October 28, 2005. The Court reopened the record in January 2006 for additional evidentiary submissions and briefing, and additional closing arguments were held March 27, 2006. It is unclear when the Company will have a decision from the trial court. With respect to this litigation in particular, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include, among others: (a) whether the Company has any further responsibility to compensate claimants against Keasbey under its policies and, if so, under which policies; (b) whether the Company’s responsibilities extend to a particular claimant’s entire claim or only to a limited percentage of the claim; (c) whether the Company’s responsibilities under its policies are limited by the occurrence limits or other provisions of the policies; (d) whether certain exclusions in some of the policies apply to exclude certain claims; (e) the extent to which claimants can establish exposures to asbestos materials as to which Keasbey has any responsibility; (f) the legal theories which must be pursued by such claimants to establish the liability of Keasbey and whether such theories can, in fact, be established; (g) the diseases and damages alleged by such claimants; and (h) the extent that such liability would be shared with
CCC was named in Adams v. Aetna, Inc., et al. (Circuit Court of Kanawha County, West Virginia, Nos, 0-2C-1708 to -1719, filed June 28, 2002), a purported class action against CCC and other insurers, alleging that the defendants violated West Virginia’s Unfair Trade Practices Act (“UTPA”) in handling and resolving asbestos claims against
As of December 31, 2006 and 2005, CNA carried approximately $416 million and $423 million of claim and claim adjustment expense reserves, net of reinsurance recoverables, for reported and unreported environmental pollution and mass tort claims. There was $63 million, $53 million and $1 million of unfavorable environmental pollution and mass tort net claim and claim adjustment expense reserve development recorded for the years ended December 31, 2006, 2005 and 2004. The Company recorded $40 million, $20 million and $15 million of current accident year losses related to mass tort for the years ended December 31, 2006, 2005 and 2004. The Company paid environmental pollution-related claims and mass tort-related claims, net of reinsurance recoveries, of $110 million, $147 million and $96 million for the years ended December 31, 2006, 2005 and 2004.
In addition to mass tort claims arising from exposure to asbestos as discussed above, the Company also has exposure arising from other mass tort claims. Such claims typically involve allegations by multiple plaintiffs alleging injury resulting from exposure to or use of similar substances or products over multiple policy periods. Examples include, but are not limited to, lead paint claims, hardboard siding, polybutylene pipe, mold, silica, latex gloves, benzene products, welding rods, diet drugs, breast implants, medical devices, and various other toxic chemical exposures. During the Company’s 2006 ground up review, the Company noted adverse development in various mass tort accounts. The adverse development results primarily from increases related to defense costs in a small number of
accounts arising out of various substances and products. As a result, the Company increased mass tort reserves for prior accident years by $63 million in 2006.
The Company noted adverse development in various pollution accounts in its 2005 ground up review. In the course of its review, the Company did not observe a negative trend or deterioration in the underlying pollution claims environment. Rather, individual account estimates changed due to changes in liability and/or coverage circumstances particular to those accounts. As a result, the Company increased pollution reserves for prior accident years by $50 million in 2005.
In 2005 and 2004, the Company recorded favorable or unfavorable premium and claim and claim adjustment expense reserve development related to the corporate aggregate reinsurance treaties as movements in the claim and allocated claim adjustment expense reserves for the accident years covered by the corporate aggregate reinsurance treaties indicated such development was required. While the available limit of these treaties was fully utilized in 2003, the ceded premiums and losses for an individual segment changed in subsequent years because of the re-estimation of the subject losses or commutations of the underlying contracts. In 2005, the Company commuted a significant corporate aggregate reinsurance treaty and in 2006, the Company commuted its remaining corporate aggregate reinsurance treaty. See Note H for further discussion of the corporate aggregate reinsurance treaties.
The following tables and discussion include the net prior year development recorded for Standard Lines, Specialty Lines and Corporate and Other Non-Core for the years ended December 31, 2006, 2005 and 2004. Unfavorable net prior year development of $13 million was recorded in the Life and Group Non-Core segment for the year ended December 31, 2006. Favorable net prior year development of $5 million and $7 million was recorded in the Life and Group Non-Core segment for the years ended December 31, 2005 and 2004.
Approximately $119 million of unfavorable claim and allocated claim adjustment expense reserve development was due to reinsurance commutation activity that took place in the fourth quarter of 2006. Approximately $82 million of unfavorable claim and allocated claim adjustment expense reserve development was related to casualty lines of business, primarily workers’ compensation, due to continued claim cost inflation in older accident years, primarily 2002 and prior. The primary drivers of the continuing claim cost inflation are medical inflation and advances in medical care.
Approximately $60 million of favorable claim and allocated claim adjustment expense reserve development was due to improved claim severity and claim frequency in the healthcare professional liability business, primarily in dental, nursing home liability, physicians and other healthcare facilities. The improved severity and frequency are due to underwriting changes. The Company no longer writes large national nursing home chains and focuses on smaller insureds in selected areas of the country. These changes have resulted in business that experiences fewer large claims.
Approximately $15 million of unfavorable claim and allocated claim adjustment expense reserve development was primarily related to increased severity on individual large claims from large law firm errors and omissions (E&O), and directors and officers (D&O) coverages. These increases result in higher ultimate loss projections from the average loss methods used by the Company’s actuaries.
The majority of the unfavorable claim and allocated claim adjustment expense reserve development was related to the Company’s exposure arising from other mass tort claims. Such claims typically involve allegations by multiple plaintiffs alleging injury resulting from exposure to or use of similar substances or products over multiple policy periods. Examples include, but are not limited to, lead paint claims, hardboard siding, polybutylene pipe, mold,
silica, latex gloves, benzene products, welding rods, diet drugs, breast implants, medical devices, and various other toxic chemical exposures. During the Company’s 2006 ground up review, the Company noted adverse development in various mass tort accounts. The adverse development results primarily from increases related to defense costs in a small number of accounts arising out of various substances and products.
Approximately $126 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development resulted from increased severity trends for workers’ compensation, primarily in accident year 2002 and prior. The primary drivers of the higher severity trends were increasing medical inflation and advances in medical care. Medical inflation increases the cost of medical services, and advances in medical care extend the life expectancies of claimants resulting in additional costs to be covered by the Company.
Approximately $76 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development was attributed to increased severity in liability coverages for large account policies. These increases are driven by increasing medical inflation and larger verdicts than anticipated, both of which increase the severity of these claims.
Additionally, there was approximately $25 million of favorable net prior year claim and allocated claim adjustment expense reserve development and $19 million of unfavorable premium development related to the corporate aggregate reinsurance treaties in 2005, excluding the impact of a corporate aggregate reinsurance commutation as discussed above.
Approximately $157 million of unfavorable claim and allocated claim adjustment expense reserve development was attributable to the Company’s assumed reinsurance operations, driven by a significant increase in large claim activity during 2005 across multiple accident years. This development was concentrated in the proportional liability, excess of loss liability, and professional liability businesses, which impact underlying coverages that include general liability, umbrella, E&O and D&O. The Company’s assumed reinsurance operations were put in run-off in 2003.
Approximately $56 million of unfavorable claim and allocated claim adjustment expense reserve development recorded in 2005 was a result of a second quarter commutation of a finite reinsurance contract put in place in 1992. CNA recaptured $400 million of losses and received $344 million of cash. The commutation was economically attractive because of the reinsurance agreement’s contractual interest rate and maintenance charges.
Approximately $190 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded during 2004 resulted from increased severity trends for workers’ compensation on large account policies primarily in accident years 2002 and prior. The primary drivers of the higher severity trends were increasing medical inflation and advances in medical care. Medical inflation increases the cost of medical services, and advances in medical care extend the life expectancies of claimants resulting in additional costs to be covered by the Company. Favorable premium development on retrospectively rated large account policies of $50 million was recorded in relation to this unfavorable net prior year claim and allocated claims adjustment expense reserve development.
Approximately $60 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development was recorded in involuntary pools in which the Company’s participation is mandatory and primarily based on premium writings. Approximately $15 million of this unfavorable net prior year claim and allocated claim adjustment expense reserve development was related to the Company’s share of the National Workers’ Compensation Reinsurance Pool (NWCRP). During 2004, the NWCRP reached an agreement with a former pool member to settle their pool liabilities at an amount less than their established share. The result of this settlement is a higher allocation to the remaining pool members, including the Company. The remainder of this unfavorable net prior year claim and allocated claim adjustment expense reserve development was primarily due to increased severity trends for workers’ compensation exposures in older years.
driven by excess liability, liquor liability and coverages provided to apartment and condominium complexes. These severity changes were driven primarily by judicial decisions and settlement activities on individual cases.
On August 1, 2005, CNAF and several of its insurance subsidiaries were joined as defendants, along with other insurers and brokers, in multidistrict litigation pending in the United States District Court for the District of New Jersey, In re Insurance Brokerage Antitrust Litigation, Civil No. 04-5184 (FSH). The plaintiffs in this litigation allege improprieties in the payment of contingent commissions to brokers and bid rigging in connection with the sale of various lines of insurance. The plaintiffs further allege the existence of a conspiracy and assert claims for federal and state antitrust law violations, for violations of the federal Racketeer Influenced and Corrupt Organizations Act and for recovery under various state common law theories. By an order entered on October 3, 2006, the Court required the plaintiffs to supplement their pleadings with a statement setting forth the details of their claims. The Company believes it has meritorious defenses to this action and intends to defend the case vigorously.
denied in part CCC’s motion to dismiss the Estate Representative’s Amended Complaint. CCC believes it has meritorious defenses to the remaining claims in this action and intends to defend the case vigorously.
CNA has instituted arbitration proceedings against John Hancock in which CNA is seeking rescission of the Treaties as well as access to and the right to inspect the books and records relating to the Treaties. Discovery is ongoing in that arbitration proceeding and a hearing is currently scheduled for April 2007. Based on information known at this time, CNA believes it has strong grounds to successfully challenge its alleged exposure derived from John Hancock through the ongoing arbitration proceedings. CNA has also undertaken legal action seeking to avoid portions of the remaining exposure arising out of the IGI Program.
CNA has established reserves for its estimated exposure under the IGI Program, other than that derived from John Hancock, and an estimate for recoverables from retrocessionaires. CNA has not established any reserve for any exposure derived from John Hancock because, as indicated, CNA believes the contract will be rescinded. Although the results of the Company’s various loss mitigation strategies with respect to the entire IGI Program to date support the recorded reserves, the estimate of ultimate losses is subject to considerable uncertainty due to the complexities described above, and the Company’s inability to guarantee any outcome in the arbitration proceedings. As a result of these uncertainties, the results of operations in future periods may be adversely affected by potentially significant reserve additions. However, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time. Management does not believe that any such reserve additions would be material to the equity of the Company. The Company’s position in relation to the IGI Program was unaffected by the sale of CNA Re Ltd. in 2002.
CNA cedes insurance to reinsurers to limit its maximum loss, provide greater diversification of risk, minimize exposures on larger risks and to exit certain lines of business. The ceding of insurance does not discharge the primary liability of the Company. Therefore, a credit exposure exists with respect to property and casualty and life reinsurance ceded to the extent that any reinsurer is unable to meet its obligations or to the extent that the reinsurer disputes the liabilities assumed under reinsurance agreements. Property and casualty reinsurance coverages are tailored to the specific risk characteristics of each product line and CNA’s retained amount varies by type of coverage. Reinsurance contracts are purchased to protect specific lines of business such as property, workers’ compensation and professional liability. Corporate catastrophe reinsurance is also purchased for property and
workers’ compensation exposure. Most reinsurance contracts are purchased on an excess of loss basis. CNA also utilizes facultative reinsurance in certain lines. In addition, CNA assumes reinsurance as a member of various reinsurance pools and associations.
The following table summarizes the amounts receivable from reinsurers at December 31, 2006 and 2005.
Ceded claim and claim adjustment expense related reinsurance receivables were reduced by $1,162 million and $2,007 million in 2006 and 2005 due to the impact of commutations. The funds withheld liability, which is included in Reinsurance balances payable on the Consolidated Balance Sheets, had a corresponding reduction of $942 million and $1,126 million in 2006 and 2005. See further discussion related to commutations below.
CNA’s largest recoverables from a single reinsurer at December 31, 2006, including prepaid reinsurance premiums, were approximately $1,574 million from subsidiaries of Swiss Reinsurance Group, $1,013 million from subsidiaries of The Hartford Life Group Insurance Company, $911 million from subsidiaries of Muenchener
Rueckversicherungs, $574 million from The Allstate Corporation (Allstate), and $535 million from syndicates of Equitas.
Prior to the April 2004 sale of its individual life and annuity business to Swiss Re, CNA had reinsured a portion of this business through coinsurance, yearly renewable term and facultative programs to various reinsurers. As a result of the sale of the individual life and annuity business, 100% of the net reserves were reinsured to Swiss Re. As of December 31, 2006 and 2005, CNA ceded $891 million and $968 million of future policy benefits to Swiss Re. Subject to certain exceptions, Swiss Re assumed the credit risk of the business that was previously reinsured to other carriers. As of December 31, 2006 and 2005, the assumed credit risk was $28 million.
Included in the direct and ceded earned premiums for the years ended December 31, 2006, 2005 and 2004 are $1,489 million, $3,306 million and $3,293 million related to business that is 100% reinsured as a result of business dispositions and a significant captive program.
Reinsurance accounting allows for contractual cash flows to be reflected as premiums and losses, as compared to deposit accounting, which requires cash flows to be reflected as assets and liabilities. To qualify for reinsurance accounting, reinsurance agreements must include risk transfer. To meet risk transfer requirements, a reinsurance contract must include both insurance risk, consisting of underwriting and timing risk, and a reasonable possibility of a significant loss for the assuming entity. Reinsurance contracts that include both significant risk sharing provisions, such as adjustments to premiums or loss coverage based on loss experience, and relatively low policy limits as evidenced by a high proportion of maximum premium assessments to loss limits, may require considerable judgment to determine whether or not risk transfer requirements are met. For such contracts, often referred to as finite products, the Company assesses risk transfer for each contract generally by developing quantitative analyses at contract inception which measure the present value of reinsurer losses as compared to the present value of the related premium. In 2003, the Company discontinued purchases of finite contracts.
the premiums ceded under the reinsurance contract not remitted in cash was recorded as funds withheld liabilities. The Company was 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 was 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 was exhausted, interest crediting would cease and additional claim payments would be recoverable from the reinsurer. The funds withheld liability is recorded in Reinsurance balances payable on the Consolidated Balance Sheets.
The following table summarizes the pretax impact of contracts accounted for on a funds withheld basis, including the commuted Aggregate and CCC Covers discussed above.
In July of 2005, CNA Surety, a 63% owned and consolidated subsidiary of CNA, refinanced $30 million of outstanding borrowings under its $50 million credit agreement with a new credit facility (the “2005 Credit Facility”). The 2005 Credit Facility provides a $50 million revolving credit facility that matures on June 30, 2008. In November of 2005, CNA Surety repaid $10 million of outstanding borrowings. During 2006, the outstanding 2005 Credit Facility balance of $20 million was repaid. Subsequently, CNA Surety reduced the available aggregate revolving credit facility to $25 million in borrowings.
In November of 2006, CNAF retired its $250 million 6.75% senior notes. A portion of the proceeds from the public offering discussed below were used to repay these notes.
In August of 2006, CNAF sold $400 million of 6.0% five-year senior notes and $350 million of 6.5% ten-year senior notes in a public offering.
The combined aggregate maturities for debt at December 31, 2006 are presented in the following table.
In 2000, approximately 60% of CCC’s eligible employees elected to forego earning additional benefits in the CNA Retirement Plan, a defined benefit pension plan. These employees maintain an “accrued pension account” within the defined benefit pension plan that is credited with interest annually at the 30-year treasury rate. Instead, employees who elected to discontinue accruing benefits in the defined benefit pension plan receive certain enhanced employer contributions in the CNA Savings and Capital Accumulation Plan discussed below. Employees hired on or after January 1, 2000 are not eligible to participate in the CNA Retirement Plan.
CNA provides certain healthcare and life insurance benefits to eligible retired employees, their covered dependents and their beneficiaries. The funding for these plans is generally to pay covered expenses as they are incurred.
In September of 2004, the Company announced significant changes to the CNA Retiree Health and Group Benefits plan affecting current and future retirees. Benefit changes were effective January 1, 2005 and included elimination of dental plan subsidy and elimination of various medical plan options. These changes resulted in a substantial unrecognized prior service cost benefit.
The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for the pension plans with accumulated benefit obligations in excess of plan assets as of December 31, 2006 and 2005 are presented in the following table.
As discussed in Note A, the Company adopted SFAS 158 as of December 31, 2006. The incremental effect of applying SFAS 158 on individual line items in the Consolidated Balance Sheet is presented in the following table.
Weighted average actuarial assumptions used at December 31, 2006 and 2005 to determine benefit obligations are set forth in the following table.
The table below presents the estimated amounts to be recognized from accumulated other comprehensive income into net periodic benefit cost during 2007.
The table below presents the estimated future minimum benefit payments to participants at December 31, 2006.
Benefit expense for the Company’s savings plans was $55 million, $24 million and $49 million in 2006, 2005 and 2004.
The following table presents activity under the LTI Plan during 2006, 2005 and 2004.
During 2006, the Company awarded SARs totaling 327,000 shares. The SARs balance at December 31, 2006 was 319,000 shares with 8,000 shares forfeited.
The fair value of granted options and SARs was estimated at the grant date using the Black-Scholes option-pricing model. The Black-Scholes model incorporates a risk free rate of return and various assumptions regarding the underlying common stock and the expected life of the securities granted. Different interest rates and assumptions were used for each grant, as appropriate at that date. The risk free interest rates used ranged from 2.7% to 4.6%. The estimates of the underlying common stock’s volatility ranged from 22.3% to 25.2%, and the expected dividend yield was 0% for all valuations. The expected life of the securities granted ranged from 5.0 to 6.3 years.
The Company recorded stock-based compensation expense of $3.2 million and $336 thousand for the years ended December 31, 2006 and 2005. The related income tax benefit recognized was $1.1 million and $118 thousand. These amounts also include compensation in the form of restricted stock grants awarded by the Company and expense recorded by CNA Surety for these periods. At December 31, 2006, the compensation cost related to nonvested awards not yet recognized was $4.2 million and the weighted average period over which it is expected to be recognized is 1.27 years.
At December 31, 2006, the Company’s non-vested portion of a restricted stock grant totaled 28,329 shares with a grant-date fair value of $842 thousand.
The table below presents the future minimum lease payments to be made under non-cancelable operating leases along with future minimum sublease receipts to be received on owned and leased properties at December 31, 2006.
The Company holds an investment in a real estate joint venture. In the normal course of business, CNA, on a joint and several basis with other unrelated insurance company shareholders, has committed to continue funding the operating deficits of this joint venture. Additionally, CNA and the other unrelated shareholders, on a joint and several basis, have guaranteed an operating lease for an office building, which expires in 2016.
In the event that the other parties to the joint venture are unable to meet their commitments in funding the operations of this joint venture, the Company would be required to assume the obligation for the entire office building operating lease. The maximum potential future lease payments at December 31, 2006 that the Company could be required to pay under this guarantee are approximately $239 million. If CNA were required to assume the entire lease obligation, the Company would have the right to pursue reimbursement from the other shareholders and would have the right to all sublease revenues.
In the normal course of business, CNA has provided letters of credit in favor of various unaffiliated insurance companies, regulatory authorities and other entities. At December 31, 2006 and 2005, there were approximately $27 million and $30 million of outstanding letters of credit.
The Company has entered into a limited number of guaranteed payment contracts, primarily relating to telecommunication and software services, amounting to approximately $15 million at December 31, 2006. Estimated future minimum payments under these contracts are as follows: $12 million in 2007 and $3 million in 2008.
In connection with the issuance of preferred securities by CNA Surety Capital Trust I, CNA Surety issued a guarantee of $75 million to guarantee the payment by CNA Surety Capital Trust I of annual dividends of $1.5 million over 30 years and redemption of $30 million of preferred securities.
CNAF’s ability to pay dividends and other credit obligations is significantly dependent on receipt of dividends from its subsidiaries. The payment of dividends to CNAF by its insurance subsidiaries without prior approval of the insurance department of each subsidiary’s domiciliary jurisdiction is limited by formula. Dividends in excess of these amounts are subject to prior approval by the respective state insurance departments.
Dividends from CCC are subject to the insurance holding company laws of the State of Illinois, the domiciliary state of CCC. Under these laws, ordinary dividends, or dividends that do not require prior approval of the Illinois Department of Financial and Professional Regulation - Division of Insurance (the Department), may be paid only from earned surplus, which is calculated by removing unrealized gains from unassigned surplus. As of December 31, 2006, CCC is in a positive earned surplus position, enabling CCC to pay approximately $556 million of dividend payments during 2007 that would not be subject to the Department’s prior approval. The actual level of dividends paid in any year is determined after an assessment 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.
CNAF’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, 2006 and 2005, all of CNAF’s domestic insurance subsidiaries exceeded the minimum risk-based capital requirements.
The accounting policies of the segments are the same as those described in Note A. The Company manages most of its assets on a legal entity basis, while segment operations are conducted across legal entities. As such, only insurance and reinsurance receivables, insurance reserves and deferred acquisition costs are readily identifiable by individual segment. Distinct investment portfolios are not maintained for each segment; accordingly, allocation of assets to each segment is not performed. Therefore, net investment income and realized investment gains or losses are allocated primarily based on each segment’s net carried insurance reserves, as adjusted.
Income taxes have been allocated on the basis of the taxable income of the segments.
Approximately 7.1%, 6.1% and 5.0% of CNA’s gross written premiums were derived from outside the United States, primarily the United Kingdom, for the years ended December 31, 2006, 2005 and 2004. Gross written premiums from the United Kingdom were approximately 3.2%, 2.8% and 2.3% of CNA’s premiums for the years ended December 31, 2006, 2005 and 2004. Gross written premiums from any individual foreign country, other than the United Kingdom, were not significant.
The second plan related to restructuring the property and casualty segments and Life and Group Non-Core segment, discontinuation of the variable life and annuity business and consolidation of real estate locations. During the second quarter of 2006, management reevaluated the sufficiency of the remaining accrual, which related to lease termination costs, and determined that the liability is no longer required as the Company has completed its lease obligations. As a result, the excess remaining accrual was released in 2006, resulting in pretax income of $13 million for the year ended December 31, 2006. During 2005 and 2004, approximately $1 million and $5 million of costs were paid. The initial restructuring and other related charges amounted to $189 million in 2001.
On January 6, 2005, the Company completed the sale of its specialty medical business to Aetna Inc. As a result of the sale, CNA recorded a realized gain of approximately $9 million in 2005. The revenues of the business sold were $17 million and $166 million for the years ended December 31, 2005 and 2004. Net income related to this business was $18 million and $16 million for the years ended December 31, 2005 and 2004.
On April 30, 2004, the Company completed the sale of its individual life insurance business to Swiss Re. The business sold included term, universal and permanent life insurance policies and individual annuity products. CNA’s individual long term care and structured settlement businesses were excluded from the sale. Swiss Re acquired VFL and CNA’s Nashville, Tennessee insurance servicing and administration building as part of the sale. In connection with the sale, CNA entered into a reinsurance agreement in which CAC ceded its individual life insurance business to Swiss Re on a 100% indemnity reinsurance basis. Subject to certain exceptions, Swiss Re assumed the credit risk of the business that was previously reinsured to other carriers. As a result of this reinsurance agreement with Swiss Re, approximately $1 billion of future policy benefit reserves were ceded to Swiss Re. CNA received consideration of approximately $700 million and recorded a realized investment loss of $622 million pretax ($389 million after-tax).
The revenues of the individual life business through the sale date were $151 million for the year ended December 31, 2004. The net results for this business through the sale date were a net loss of $6 million for the year ended December 31, 2004.
The Company has initiated and is actively pursuing a plan to sell a portion of the discontinued operations. The Company expects a sale to be completed in 2007.
The results for 2006 reflect an impairment loss of approximately $29 million related to the anticipated sale of a portion of the discontinued operations. The assets and liabilities that would be subject to a sale were $239 million and $157 million at December 31, 2006. Excluding the impairment loss on the anticipated sale, net loss for this business was $1 million and $3 million for the years ended December 31, 2006 and 2004, and net income was $13 million for the year ended December 31, 2005. The Company’s subsidiary, The Continental Corporation, provides a guarantee for a portion of the subject liabilities related to certain marine products. Any sale is expected to include provisions that would significantly limit the Company’s exposure related to this guarantee.
The Accumulated other comprehensive income, net of tax, reported on the Consolidated Balance Sheets includes $1 million and $11 million related to unrealized gains and $15 million and $6 million related to the cumulative foreign currency translation adjustment for discontinued operations as of December 31, 2006 and 2005.
The following tables set forth unaudited quarterly financial data for the years ended December 31, 2006 and 2005.
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 $27 million, $23 million and $21 million for the years ended December 31, 2006, 2005 and 2004. The CNA Tax Group is 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 with Loews. In addition, CNA writes, at standard rates, a limited amount of insurance for Loews and its subsidiaries. The total related premiums for the year ended December 31, 2006 were $1 million. The total related premiums for the years ended December 31, 2005 and 2004 were less than $1 million.
CNA Surety has provided significant surety bond protection for a large national contractor that undertakes projects for the construction of government and private facilities, a substantial portion of which have been reinsured by CCC. In order to help this contractor meet its liquidity needs and complete projects which had been bonded by CNA Surety, commencing in 2003 CNAF provided loans to the contractor through a credit facility. Due to reduced operating cash flow at the contractor these loans were fully impaired through realized investment losses in 2004 and 2005. For the years ended December 31, 2005 and 2004, the Company recorded a pretax impairment charge of $34 million and $56 million. The Company no longer provides additional liquidity to the contractor and has not recognized interest income related to the loans since June 30, 2005.
CCC provides reinsurance protection to CNA Surety for losses in excess of an aggregate of $60 million associated with the contractor. This treaty provides coverage for the life of bonds either in force or written from January 1, 2005 to December 31, 2005. CCC and CNA Surety agreed by addendum to extend this contract for twenty four months, expiring on December 31, 2007.
CCC and CNA Surety continue to engage in periodic discussions with insurance regulatory authorities regarding the level of surety bonds provided for this contractor and will continue to apprise those authorities of the status of their ongoing exposure to this account.
CNAF has also guaranteed or provided collateral for the contractor’s letters of credit. As of December 31, 2006 and December 31, 2005, these guarantees and collateral obligations aggregated $9 million and $13 million.
CCC provided an excess of loss reinsurance contract to the insurance subsidiaries of CNA Surety over a period that expired on December 31, 2000 (the stop loss contract). The stop loss contract limits the net loss ratios for CNA Surety with respect to certain accounts and lines of insurance business. In the event that CNA Surety’s accident year net loss ratio exceeds 24% for 1997 through 2000 (the contractual loss ratio), the stop loss contract requires CCC to pay amounts equal to the amount, if any, by which CNA Surety’s actual accident year net loss ratio exceeds the contractual loss ratio multiplied by the applicable net earned premiums. The minority shareholders of CNA Surety do not share in any losses that apply to this contract.
As discussed in Note A to the consolidated financial statements, the Company changed its method of accounting for defined benefit pension and other postretirement plans in 2006.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 22, 2007 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that CNA Financial Corporation (an affiliate of Loews Corporation) and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2006 of the Company and our report dated February 22, 2007 expresses an unqualified opinion on those financial statements and financial statement schedules and includes an explanatory paragraph concerning a change in method of accounting for defined benefit pension and other postretirement plans in 2006.