The following table presents selected financial data. On July 2, 2012, we acquired Hardy Underwriting Bermuda Limited and its subsidiaries. The results of Hardy are included from the date of acquisition. The table should be read in conjunction with
Net income increased $309 million in 2013 as compared with 2012, driven by higher net operating income.
Net operating income increased $330 million in 2013 as compared with 2012. Net operating income increased $427 million for our core segments, CNA Specialty, CNA Commercial and Hardy. This increase was primarily due to improved current accident year underwriting results and higher net investment income. These favorable items were partially offset by lower favorable net prior year development. Catastrophe losses were $111 million after-tax in 2013 as compared to catastrophe impacts of $270 million after-tax in 2012 as further discussed below. Net operating results decreased $97 million for our non-core segments, primarily driven by results in our Corporate & Other Non-Core segment related to retroactive reinsurance accounting. See the Life & Group Non-Core and Corporate & Other Non-Core sections of this MD&A for further discussion of our non-core results.
A prolonged period during which interest rates remain at levels lower than those anticipated in our reserving discount rate assumption could result in shortfalls in investment income on assets supporting our obligations under long term care policies and payout annuity contracts, which may also require changes to our reserves.
We make a significant number of assumptions in estimating the liabilities and costs related to our pension and postretirement benefit obligations under our benefit plans. The assumptions that most impact these costs are the discount rate and the expected long term rate of return on plan assets. These assumptions are evaluated relative to current economic 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.
uncertainty in future medical costs in workers' compensation. In particular, medical cost inflation could be greater than expected due to new treatments, drugs, and devices; increased healthcare utilization; and/or the future costs of healthcare facilities. In addition, the relationship between workers' compensation and government and private healthcare providers could change, potentially shifting costs to workers' compensation;
transaction with NICO, a subsidiary of Berkshire Hathaway Inc., under which substantially all of our legacy A&EP liabilities were ceded to NICO effective January 1, 2010 (Loss Portfolio Transfer).
In developing claim and claim adjustment expense (“loss” or “losses”) reserve estimates, our actuaries perform detailed reserve analyses that are staggered throughout the year. The data is organized at a “product” level. A product can be a line of business covering a subset of insureds such as commercial automobile liability for small or middle market customers, it can encompass several lines of business provided to a specific set of customers such as dentists, or it can be a particular type of claim such as construction defect. Every product is reviewed at least once during the year. The analyses generally review losses gross of ceded reinsurance and apply the ceded reinsurance terms to the gross estimates to establish estimates net of reinsurance. In addition to the detailed analyses, we review actual loss emergence for all products each quarter.
Most of our business can be characterized as long-tail. For long-tail business, it will generally be several years between the time the business is written and the time when all claims are settled. Our long-tail exposures include commercial automobile liability, workers' compensation, general liability, medical professional liability, other professional liability and management liability coverages, assumed reinsurance run-off and products liability. Short-tail exposures include property, commercial automobile physical damage, marine and warranty. CNA Specialty and CNA Commercial contain both long-tail and short-tail exposures. Hardy contains primarily short-tail exposures. Corporate & Other Non-Core contains long-tail exposures.
For many products, paid loss data for recent periods may be too immature or erratic for accurate predictions. This situation often exists for long-tail exposures. In addition, changes in the factors described above may result in inconsistent payment patterns. Finally, estimating the paid loss pattern subsequent to the most mature point available in the data analyzed often involves considerable uncertainty for long-tail products such as workers' compensation.
The Bornhuetter-Ferguson method using incurred loss is similar to the Bornhuetter-Ferguson method using paid loss except that it uses case incurred losses. The use of case incurred losses instead of paid losses can result in development patterns that are less variable than paid patterns. However, the inclusion of case reserves can lead to distortions if changes in case reserving have taken place, and the method typically requires analysis of the same factors that need to be reviewed for the loss ratio and incurred development methods.
Currently, our recorded reserves are modestly higher than the actuarial point estimate. For CNA Commercial, CNA Specialty and Hardy, the difference between our reserves and the actuarial point estimate is primarily driven by uncertainty with respect to immature accident years, claim cost inflation, changes in claims handling, changes to the tort environment which may adversely impact claim costs, and the effects from the economy. For Corporate & Other Non-Core, the difference between our reserves and the actuarial point estimate is primarily driven by the potential tail volatility of run-off exposures.
Within CNA Specialty, we believe a material deviation to our net reserves is reasonably possible for professional liability and management liability products and Surety products. This includes professional liability coverages provided to various professional firms, including architects, real estate agents, small and mid-sized accounting firms, law firms and other professional firms. This also includes directors and officers (D&O), employment practices, fiduciary, fidelity and surety coverages, as well as insurance products serving the healthcare delivery system. The most significant factor affecting reserve estimates for these products is claim severity. Claim severity is driven by the cost of medical care, the cost of wage replacement, legal fees, judicial decisions, legislative changes 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 increases by 9%, we estimate that the net reserves would increase by approximately $550 million. If the estimated claim severity decreases by 3%, we estimate that net reserves would decrease by approximately $200 million. Our net reserves for these products were approximately $5.9 billion at December 31, 2013.
Within CNA Commercial, the two types of business for which we believe a significant deviation to our net reserves is reasonably possible are workers' compensation and general liability.
For CNA Commercial 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 100 basis points for the entire period over which claim payments will be made, we estimate that our net reserves would increase by approximately $400 million. If estimated workers' compensation claim cost inflation decreases by 100 basis points for the entire period over which claim payments will be made, we estimate that our net reserves would decrease by approximately $400 million. Our net reserves for CNA Commercial workers' compensation were approximately $4.6 billion at December 31, 2013.
We calculate and maintain reserves for policyholder claims and benefits for our Life & Group Non-Core segment based on actuarial assumptions. The determination of these reserves is fundamental to our financial results and requires management to make assumptions about expected investment and policyholder experience over the life
Annually, management assesses the adequacy of its GAAP reserves by product group by performing premium deficiency testing. In this test, reserves computed using best estimate assumptions as of the date of the test without provisions for adverse deviation are compared to the recorded reserves. If reserves determined based on management's current best estimate assumptions are greater than the existing net GAAP reserves (i.e. reserves net of any Deferred acquisition costs asset), the existing net GAAP reserves would be increased to the greater amount. Any such increase would be reflected in our results of operations in the period in which the need for such adjustment is determined, and could materially adversely affect our results of operations, equity and business and insurer financial strength and corporate debt ratings.
It should be noted that our current GAAP payout annuity reserves contain a level of margin in excess of management's current best estimates. Any required increase in the net GAAP reserves resulting from the hypothetical revisions in the table below would first reduce the margin before they would affect results of operations. The estimated impacts to results of operations in the table below are after consideration of the existing margin.
Long term care policies provide benefits for nursing home, assisted living and home health care subject to various daily and lifetime caps. Policyholders must continue to make periodic premium payments to keep the policy in force. Generally we have the ability to increase policy premiums, subject to state regulatory approval.
The actuarial assumptions that management believes are subject to the most variability are discount rate, morbidity, and persistency, which can be affected by policy lapses and death. There is limited historical data and industry data available to us for these reserves, as only a small portion of the long term care policies which have been written to date are in claims paying status and trends in morbidity and mortality change over time. As a result, our long term care reserves may be subject to material increases if these trends develop adversely to our expectations.
We utilize the net operating income financial measure to monitor our operations. Net operating income (loss) is calculated by excluding from net income (loss) attributable to CNA the after-tax effects of 1) net realized investment gains or losses, 2) income or loss from discontinued operations and 3) any cumulative effects of changes in accounting guidance. See further discussion regarding how we manage our business in Note O to the Consolidated Financial Statements included under Item 8. In evaluating the results of our CNA Specialty, CNA Commercial and Hardy segments, we utilize the loss ratio, the expense ratio, the dividend ratio and the combined ratio. These ratios are calculated using GAAP financial results. The loss ratio is the percentage of net incurred claim and claim adjustment expenses to net earned premiums. The expense ratio is the percentage of insurance underwriting and acquisition expenses, including the amortization of deferred acquisition costs, to net earned premiums. The dividend ratio is the ratio of policyholders' dividends incurred to net earned premiums. The combined ratio is the sum of the loss, expense and dividend ratios.
CNA Specialty provides management and professional liability and other coverages through property and casualty products and services, both domestically and abroad, through a network of brokers, independent agencies and managing general underwriters. CNA Specialty provides solutions for managing the risks of its clients, including architects, lawyers, accountants, health care professionals, financial intermediaries and public and private companies. Product offerings also include surety and fidelity bonds and warranty services.
Net written premiums for CNA Specialty increased $167 million in 2013 as compared with 2012, primarily driven by increased rate. Net earned premiums increased $106 million in 2013 as compared with 2012, consistent with increases in net written premiums.
Net income increased $188 million in 2013 as compared with 2012. This increase was driven by higher net operating income.
Net operating income increased $203 million in 2013 as compared with 2012, primarily due to improved underwriting results and higher net investment income.
Favorable net prior year development of $247 million and $150 million was recorded in 2013 and 2012. Further information on net prior year development is included in Note F to the Consolidated Financial Statements included under Item 8.
Favorable net prior year development of $150 million and $245 million was recorded in 2012 and 2011. Further information on net prior year development is included in Note F to the Consolidated Financial Statements included under Item 8.
Net written premiums for CNA Commercial decreased $61 million in 2013 as compared with 2012 primarily driven by previous underwriting actions taken in certain business classes. These underwriting actions were partially offset by continued strong rate increases. Net earned premiums increased $44 million in 2013 as compared with 2012 consistent with increased net written premiums in earlier periods.
CNA Commercial's average rate increased 8% in 2013, as compared with an increase of 7% in 2012 for the policies that renewed in each period. Retention of 74% and 77% was achieved in each period.
Net operating income increased $191 million in 2013 as compared with 2012. This increase was primarily due to improved current accident year underwriting results, higher net investment income, and a settlement benefit of $31 million after-tax. These favorable items were partially offset by the unfavorable impact of net prior year development.
The expense ratio improved 1.1 points in 2013 as compared with 2012, primarily due to decreased expenses including favorable changes in estimates of insurance assessment liabilities.
CNA Commercial's average rate increased 7% in 2012, as compared with an increase of 2% in 2011 for the policies that renewed in each period. Retention of 77% and 78% was achieved in each period.
Net income decreased $77 million in 2012 as compared with 2011. This decrease was due to lower net operating income, partially offset by improved net realized investment results.
Favorable net prior year development of $81 million and $183 million was recorded in 2012 and 2011. Further information on net prior year development is included in Note F to the Consolidated Financial Statements included under Item 8.
Non-Marine Property comprises direct and facultative property, including construction insurance of industrial and commercial risks (heavy industry, general manufacturing, commercial property portfolios), together with residential and small commercial risks.
The results below reflect Hardy's share of Syndicate 382's results. Third-party capital providers provided 7.5% of the syndicate's capital for the 2011 year of account and 25% for the 2012 year of account. We provided all of the syndicate's capital for the 2013 year of account.
The combined ratio improved 24.1 points in 2013 as compared with 2012. The loss ratio improved 15.5 points, primarily due to the impact of Storm Sandy in 2012. Catastrophe losses related to Storm Sandy were $17 million, or 17.3 points of the loss ratio and 21.4 points of the combined ratio in 2012, reflecting the impact of reinstatement premiums. Catastrophe losses in 2013 were $5 million, or 1.3 points of the loss ratio. The expense ratio improved 8.6 points in 2013 as compared with 2012, primarily due to the higher net earned premium base.
On February 10, 2014, we entered into a definitive agreement to sell the majority of our run-off annuity and pension deposit business. Further information on the sale is set forth in Note R to the Consolidated Financial Statements included under Item 8.
Net loss increased $125 million in 2013 as compared with 2012, primarily driven by the impact of a $123 million after-tax deferred gain under retroactive reinsurance accounting related to the Loss Portfolio Transfer, as further discussed in Note F to the Consolidated Financial Statements included under Item 8.
Net investment income for the year ended December 31, 2013 increased $168 million as compared with the same period in 2012. The increase was primarily driven by a significant increase in limited partnership investment income, partially offset by a decrease in fixed maturity securities income. Limited partnership results were positively impacted by more favorable equity market returns. The decrease in fixed maturity securities income was due to the effect of reinvesting at lower market interest rates, partially offset by a higher invested asset base.
Net investment income increased $228 million in 2012 as compared with 2011. The increase was primarily driven by a significant increase in limited partnership investment income, increased trading portfolio income and an increase in fixed maturity securities income. The increase in fixed maturity securities income was driven by a higher invested asset base and the favorable net impact of changes in estimates of prepayments for asset-backed securities. These favorable impacts were partially offset by the effect of investing at lower market interest rates.
Our fixed maturity portfolio consists primarily of high quality bonds, 92% of which were rated as investment grade (rated BBB- or higher) at December 31, 2013 and 2012. The classification between investment grade and non-investment grade is based on a ratings methodology that takes into account ratings from S&P and Moody's, in that order of preference. If a security is not rated by these agencies, we formulate an internal rating. At December 31, 2013 and 2012, approximately 99% and 98% of the fixed maturity portfolio was rated by S&P or Moody's, or was issued or guaranteed by the U.S. Government, Government agencies or Government-sponsored enterprises.
Non-investment grade fixed maturity securities, as presented in the table below, include high-yield securities rated below BBB- by bond rating agencies and other unrated securities that, according to our analysis, are below investment grade. Non-investment grade securities generally involve a greater degree of risk than investment grade securities. The amortized cost of our non-investment grade fixed maturity bond portfolio was $3,097 million and $3,355 million at December 31, 2013 and 2012. The following table summarizes the ratings of this portfolio at fair value.
The following table summarizes available-for-sale fixed maturity securities in a gross unrealized loss position by ratings distribution as of December 31, 2013.
The Consolidated Financial Statements include the accounts of CNA Financial Corporation (CNAF) and its subsidiaries. Collectively, CNAF and its subsidiaries are referred to as CNA or the Company. Loews Corporation (Loews) owned approximately 90% of the outstanding common stock of CNAF as of December 31, 2013.
On July 2, 2012, the Company completed the acquisition of all outstanding shares of Hardy, a specialized Lloyd's of London (Lloyd's) underwriter. Through Lloyd's Syndicate 382, Hardy underwrites primarily short-tail exposures in marine and aviation, non-marine property, specialty lines and property treaty reinsurance. The results of Hardy from July 2, 2012 are included in the results of our core property and casualty insurance operations as a separate segment.
Claim and claim adjustment expense reserves: Claim and claim adjustment expense reserves, except reserves for structured settlements not associated with asbestos and environmental pollution (A&EP), workers' compensation lifetime claims, and accident and health claims, 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 (IBNR) 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 on the Consolidated Balance Sheets.
Claim and claim adjustment expense reserves are presented net of anticipated amounts due from insureds related to losses under deductible policies of $1.3 billion as of December 31, 2013 and 2012. A significant portion of these amounts are supported by collateral. The Company has an allowance for uncollectible deductible amounts, which is presented as a component of the allowance for doubtful accounts included in Insurance receivables on the Consolidated Balance Sheets.
Policyholders' funds reserves: Policyholders' funds reserves primarily include reserves for investment contracts without life contingencies. For these contracts, policyholder liabilities are generally equal to the accumulated policy account values, which consist of an accumulation of deposit payments plus credited interest, less withdrawals and amounts assessed through the end of the period.
Deferred acquisition costs related to long term care contracts are amortized over the premium-paying period of the related policies using assumptions consistent with those used for computing future policy benefit reserves for such contracts. Assumptions are made at the date of policy issuance or acquisition and are consistently applied during the lives of the contracts. Deviations from estimated experience are included in results of operations when they occur. For these contracts, the amortization period is typically the estimated life of the policy. At December 31, 2013 and 2012, Deferred acquisition costs were presented net of Shadow Adjustments, as defined later in this note, of $342 million and $369 million.
The increase (decrease) in fair value recognized for the years ended December 31, 2013, 2012 and 2011 on contracts still being held was $(2) million, $11 million and $5 million. The gains recognized during the years ended December 31, 2013, 2012 and 2011 on contracts that settled were $15 million, $42 million and $28 million.
A number of separate account pension deposit contracts guarantee principal and an annual minimum rate of interest. If aggregate contract value in the separate account exceeds the fair value of the related assets, an additional Policyholders' funds liability is established. Certain of these contracts are subject to a fair value adjustment if terminated by the policyholder.
Significant judgment is required in the determination of whether an OTTI loss has occurred for a security. The Company follows a consistent and systematic process for determining and recording an OTTI loss. The Company has established a committee responsible for the OTTI process. This committee, referred to as the Impairment Committee, is made up of three officers appointed by the Company’s Chief Financial Officer. The Impairment Committee is responsible for evaluating all securities in an unrealized loss position on at least a quarterly basis.
Foreign currency translation gains and losses are reflected in Stockholders' equity as a component of Accumulated other comprehensive income. The Company's foreign subsidiaries' balance sheet accounts are translated at the exchange rates in effect at each reporting date and income statement accounts are either translated at the exchange rate on the date of the transaction or at the average exchange rates. Foreign currency transaction gains of $2 million, $12 million and $4 million were included in determining net income (loss) for the years ended December 31, 2013, 2012 and 2011.
Goodwill is tested for impairment annually or when certain triggering events require such tests. As a result of reviews completed for the year ended December 31, 2013, the Company determined that the estimated fair value of the reporting units were in excess of their carrying value including Goodwill. Changes in future periods in assumptions about the level of economic capital, business growth, earnings projections or the weighted average cost of capital could result in a goodwill impairment.
Intangible assets are reported within Other assets. Finite-lived intangible assets are amortized over their estimated useful lives. Indefinite-lived intangible assets are tested for impairment annually or when certain triggering events require such tests.
Earnings (loss) per share attributable to the Company's common stockholders is based on weighted average number of outstanding common shares. Basic earnings (loss) per share excludes the impact of dilutive securities and is computed by dividing Net income (loss) attributable to CNA by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) 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.
For the years ended December 31, 2013, 2012 and 2011, approximately 552 thousand, 417 thousand and 290 thousand potential shares attributable to exercises under stock-based employee compensation plans were included in the calculation of diluted earnings per share. For those same periods, approximately 111 thousand, 730 thousand and 1.1 million potential shares attributable to exercises under stock-based employee compensation plans were not included in the calculation of diluted earnings per share because the effect would have been antidilutive.
As of December 31, 2013, the Company held no non-income producing fixed maturity securities. As of December 31, 2012, the Company held nine non-income producing fixed maturity securities aggregating $1 million of fair value. As of December 31, 2013 and 2012, no investments in a single issuer exceeded 10% of stockholders' equity, other than investments in securities issued by the U.S. Treasury and obligations of government-sponsored enterprises.
The following table summarizes the activity for the years ended December 31, 2013, 2012 and 2011 related to the pretax credit loss component reflected in Retained earnings on fixed maturity securities still held at December 31, 2013, 2012 and 2011 for which a portion of an OTTI loss was recognized in Other comprehensive income.
The carrying value of limited partnerships as of December 31, 2013 and 2012 was $2,720 million and $2,462 million, which includes undistributed earnings of $969 million and $768 million. Limited partnerships comprising 67% of the total carrying value are reported on a current basis through December 31, 2013 with no reporting lag, 16% are reported on a one month lag and the remainder are reported on more than a one month lag. As of December 31, 2013 and 2012, the Company had 87 and 79 active limited partnership investments. The number of limited partnerships held and the strategies employed provide diversification to the limited partnership portfolio and the overall invested asset portfolio.
Of the limited partnerships held, 74% and 80% at December 31, 2013 and 2012 employ hedge fund strategies that generate returns through investing in securities that are marketable while engaging in various management techniques primarily in public fixed income and equity markets. These hedge fund strategies include both long and short positions in fixed income, equity and derivative instruments. The hedge fund strategies may seek to generate gains from mispriced or undervalued securities, price differentials between securities, distressed investments, sector rotation, or various arbitrage disciplines. Within hedge fund strategies, approximately 51% were equity related, 28% pursued a multi-strategy approach, 17% were focused on distressed investments and 4% were fixed income related at December 31, 2013.
Limited partnerships representing 22% and 16% at December 31, 2013 and 2012 were invested in private debt and equity. The remaining were invested in various other partnerships including real estate. The ten largest limited partnership positions held totaled $1,471 million and $1,309 million as of December 31, 2013 and 2012. Based
Securities with carrying values of approximately $3.3 billion and $3.6 billion were deposited by the Company’s insurance subsidiaries under requirements of regulatory authorities and others as of December 31, 2013 and 2012.
The Company may enter into interest rate swaps, futures and commitments to purchase securities to manage interest rate risk. Credit derivatives such as credit default swaps (CDS) are entered into to modify the credit risk inherent in certain investments. The Company may use foreign currency forward contracts to manage foreign currency risk.
Credit exposure associated with non-performance by the counterparties to derivative instruments is generally limited to the uncollateralized fair value of the asset related to the instruments recognized on the Consolidated Balance Sheets. The Company generally requires that all over-the-counter derivative contracts be governed by an International Swaps and Derivatives Association Master Agreement, and exchanges collateral under the terms of these agreements with its derivative investment counterparties depending on the amount of the exposure and the credit rating of the counterparty. Gross estimated fair values of derivative positions are presented in Other invested assets and Other liabilities on the Consolidated Balance Sheet. The Company does not offset derivative positions against the fair value of collateral provided or positions subject to netting arrangements. There would be no significant difference in the balance included in such accounts if the estimated fair values were presented net for the periods ended December 31, 2013 and 2012. There was no cash collateral provided by the Company at December 31, 2013. The fair value of cash collateral provided by the Company was $1 million at December 31, 2012. There was no cash collateral received from counterparties held at December 31, 2013 or 2012.
Level 1 - Quoted prices for identical instruments in active markets.
Securities shown in the Level 3 tables on the previous pages may be transferred in or out of Level 3 based on the availability of observable market information used to determine the fair value of the security. The availability of observable market information varies based on market conditions and trading volume and may cause securities to move in and out of Level 3 from reporting period to reporting period. There were no transfers between Level 1 and Level 2 during the year ended December 31, 2013. There were $106 million of transfers from Level 2 to Level 1 and $72 million of transfers from Level 1 to Level 2 during the year ended December 31, 2012. The Company's policy is to recognize transfers between levels at the beginning of quarterly reporting periods.
Fixed maturity securities are valued using methodologies that model information generated by market transactions involving identical or comparable assets, as well as discounted cash flow methodologies. Common inputs include: prices from recently executed transactions of similar securities, broker/dealer quotes, benchmark yields, spreads off benchmark yields, interest rates, and U.S. Treasury or swap curves. Specifically for asset-backed securities, key inputs include prepayment and default projections based on past performance of the underlying collateral and current market data.
For the year ended December 31, 2013, the Company paid $89 million to Loews related to federal income taxes. For the years ended December 31, 2012 and 2011, the Company received from Loews $75 million and $10 million related to federal income taxes.
The Company recognizes interest accrued related to: 1) unrecognized tax benefits in Interest expense and 2) tax refund claims in Other revenues on the Consolidated Statements of Operations. The Company recognizes penalties (if any) in Income tax (expense) benefit on the Consolidated Statements of Operations. During 2013, the Company did not recognize any interest or penalties. During 2012, the Company recognized $2 million of interest income and no penalties. During 2011, the Company did not recognize any interest or penalties. There were no amounts accrued for interest or penalties at December 31, 2013 or 2012.
At December 31, 2013, the CNA Tax Group had no loss carryforwards or tax credit carryforwards.
Establishing claim and claim adjustment expense reserves, including claim and claim adjustment expense reserves for catastrophic events that have occurred, is an estimation process. Many factors can ultimately affect the final settlement of a claim and, therefore, the necessary reserve. Changes in the law, results of litigation, medical costs, the cost of repair materials and labor rates can all affect ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably estimable than long-tail claims, such as workers' compensation, general liability and professional liability claims. Adjustments to prior year reserve estimates, if necessary, are reflected in the results of operations in the period that the need for such adjustments is determined. There can be no assurance that the Company's ultimate cost for insurance losses will not exceed current estimates.
For the year ended December 31, 2013, favorable premium development for Hardy was recorded related to a commutation as discussed later in this note.
Overall, favorable development for other professional liability and management liability was primarily due to better than expected loss emergence in accident years 2003 through 2007. Unfavorable development was recorded in our lawyer coverages in accident years 2010 and 2011 primarily due to increased frequency and severity.
Favorable development for surety coverages was primarily due to a decrease in the estimated loss on a large national contractor in accident year 2005 and better than expected loss emergence in accident years 2009 and prior.
Unfavorable development for workers' compensation includes the Company's response to legislation enacted during 2013 related to the New York Fund for Reopened Cases. The law change necessitated an increase in reserves as re-opened workers' compensation claims can no longer be turned over to the state for handling and payment after December 31, 2013. Additional unfavorable development was recorded in accident year 2012 related to increased frequency and severity on claims related to Defense Base Act contractors and in accident year 2010 due to higher than expected large losses and increased severity in the state of California.
Favorable development for commercial auto coverages was due to lower than expected severity on bodily injury claims and favorable claim emergence on umbrella policies in accident years 2006 and prior.
The following table provides further detail of the development recorded for the Hardy segment for the years ended December 31, 2013 and 2012.
Favorable development for specialty was primarily due to favorable outcomes on several large losses and favorable claim emergence.
The commutation of a third-party capital provider's 15% participation in the 2012 year of account resulted in recognition of the 15% share of year of account premiums, losses and expenses.
The effects of reinsurance on earned premiums and written premiums for the years ended December 31, 2013, 2012 and 2011 are shown in the following tables.
The impact of reinsurance on life insurance inforce at December 31, 2013, 2012 and 2011 is shown in the following table.
The Company's remaining debt obligations contain customary covenants for investment grade issuers. The Company is in compliance with all covenants as of and for the year ended December 31, 2013.
The combined aggregate maturities for debt at December 31, 2013 are presented in the following table.
The following table provides a reconciliation of benefit obligations and plan assets for the years ended December 31, 2013 and 2012.
The accumulated benefit obligation for all defined benefit pension plans was $2,889 million and $3,187 million at December 31, 2013 and 2012.
Actuarial assumptions used for the CNA Retirement Plan and CNA Health and Group Benefits Program to determine net cost or benefit are set forth in the following table.
The CNA Health and Group Benefits Program has limited its share of the health care trend rate to a cost-of-living adjustment of 4% per year. For all participants, the employer subsidy on health care costs will not increase by more than 4% per year. As a result, the assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation for the CNA Health and Group Benefits Program was 4% per year in 2013, 2012 and 2011.
The tables below present a reconciliation for all pension plan assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2013 and 2012.
The table below presents the estimated future minimum benefit payments to participants at December 31, 2013.
In 2014, CNA expects to contribute $56 million to its pension plans and $5 million to its postretirement health care benefit plans.
The CNA Savings and Capital Accumulation Plan allows employees to make contributions to an investment fund that is supported in part by an investment contract purchased from CAC. CAC will not accept any further deposits under this contract. The liability to the CNA Savings and Capital Accumulation Plan is included in Separate account liabilities on the Consolidated Balance Sheets, and was $129 million and $256 million at December 31, 2013 and 2012.
Benefit expense for the Company's savings plans was $71 million, $70 million and $60 million for the years ended December 31, 2013, 2012 and 2011.
The following table presents activity for stock options and SARs under the Plan in 2013.
The following table presents activity for restricted shares, performance-based RSUs and performance share units under the Plan in 2013.
The Company occupies office facilities under lease agreements that expire at various dates. In addition, data processing, office and transportation equipment is leased under agreements that expire at various dates. Most leases contain renewal options that provide for rent increases based on prevailing market conditions. Lease expenses for the years ended December 31, 2013, 2012 and 2011 were $46 million, $52 million and $50 million. Sublease revenues for the years ended December 31, 2013, 2012 and 2011 were $3 million, $2 million and $2 million.
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 Company does not believe it is likely that it will be required to do so. However, the maximum potential future lease payments and other related costs at December 31, 2013 that the Company could be required to pay under this guarantee, in excess of amounts already recorded, were approximately $84 million. If the Company were required to assume the entire lease obligation, the Company would have the right to pursue reimbursement from the other shareholders and the right to all sublease revenues.
In the course of selling business entities and assets to third parties, the Company has agreed to indemnify purchasers for losses arising out of breaches of representation and warranties with respect to the business entities or assets being sold, including, in certain cases, losses arising from undisclosed liabilities or certain named litigation. Such indemnification agreements may include provisions that survive indefinitely. As of December 31, 2013, the aggregate amount of quantifiable indemnification agreements in effect for sales of business entities, assets and third-party loans was $702 million.
In addition, the Company has agreed to provide indemnification to third-party purchasers for certain losses associated with sold business entities or assets that are not limited by a contractual monetary amount. As of December 31, 2013, the Company had outstanding unlimited indemnifications in connection with the sales of certain of its business entities or assets that included tax liabilities arising prior to a purchaser's ownership of an entity or asset, defects in title at the time of sale, employee claims arising prior to closing and in some cases losses arising from certain litigation and undisclosed liabilities. These indemnification agreements survive until the applicable statutes of limitation expire or until the agreed upon contract terms expire.
As of December 31, 2013 and 2012, the Company had recorded liabilities of approximately $7 million related to indemnification agreements and management believes that it is not likely that any future indemnity claims will be significantly greater than the amounts recorded.
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 by the Department, may be paid only from earned surplus, which is calculated by removing unrealized gains from unassigned surplus. As of December 31, 2013, CCC is in a positive earned surplus position, enabling CCC to pay approximately $715 million of dividend payments during 2014 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.
Represents the combined statutory surplus of CCC and its subsidiaries, including the life company.
The statutory capital and surplus presented above for CCC was approximately 265% and 240% of company action level RBC at December 31, 2013 and 2012. Company action level RBC is the level of RBC which triggers a heightened level of regulatory supervision. The statutory capital and surplus of the Company's foreign insurance subsidiaries, which is not significant to the overall statutory capital and surplus, also met or exceeded their respective regulatory and other capital requirements.
The Hardy insurance entities are not owned by CCC, therefore their regulatory capital is not included in the Statutory Capital and Surplus of the Combined Continental Casualty Companies presented in the table above. At December 31, 2013, Hardy's portion of Syndicate 382's capital requirement included $148 million of capital provided by CCC which is included in Combined Continental Casualty Companies' Statutory Capital and Surplus above.
The table below displays the changes in Accumulated other comprehensive income (loss) by component for the year ended December 31, 2013.
The amount of pretax net unrealized gains (losses) on available-for-sale securities with OTTI losses reclassified out of AOCI into earnings was $(28) million and $(83) million for the years ended December 31, 2012 and 2011, with related tax benefit of $10 million and $29 million. The amount of pretax net unrealized gains (losses) on other available-for-sale securities reclassified out of AOCI into earnings was $89 million and $60 million for the years ended December 31, 2012 and 2011, with related tax (expense) benefit of $(31) million and $(21) million.
The Company's non-core operations are managed in two segments: Life & Group Non-Core and Corporate & Other Non-Core. Life & Group Non-Core primarily includes the results of the life and group lines of business that are in run-off. Corporate & Other Non-Core primarily includes certain corporate expenses, including interest on corporate debt, and the results of certain property and casualty business in run-off, including CNA Re and A&EP.
The Company reimburses Loews, or pays directly, for management fees, travel and related expenses, software fees, and expenses of investment facilities and services provided to the Company. The amounts reimbursed or paid by the Company were $39 million for the years ended December 31, 2013 and 2012, and $38 million for the year ended December 31, 2011. 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, the Company writes, at standard rates, a limited amount of insurance for Loews and its subsidiaries. The earned premiums for the years ended December 31, 2013, 2012 and 2011 were $2 million in each year.
On February 10, 2014, the Company entered into a definitive agreement to sell the majority of its run-off annuity and pension deposit business, through the sale of the common stock of CAC, and a 100% coinsurance agreement on a separate small block of annuity business outside of CAC.
The business being sold is currently reported within the Life & Group Non-Core segment. As of December 31, 2013, gross insurance reserves for this business were approximately $3.4 billion. Results for this business were net income of approximately $31 million and $8 million for the years ended December 31, 2013 and 2012, and a net loss of approximately $124 million for the year ended December 31, 2011.
The sale is subject to regulatory approvals and other customary closing conditions and is expected to close in the first half of 2014. An impairment loss of approximately $220 million, after-tax, will be recorded in the first quarter of 2014. This business will be reported as discontinued operations in the first quarter of 2014.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
CNAF management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2013. In making this assessment, it has used the criteria set forth by the 1992 Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on those criteria and our assessment we believe that, as of December 31, 2013, the Company's internal control over financial reporting was effective.
CNAF's independent registered public accountant, Deloitte & Touche LLP, has issued an audit report on the Company's internal control over financial reporting. This report appears on page 125.