CNA Plaza, owned by CAC, serves as the home office for CNAF and its subsidiaries. CNAF’s 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 the principal office buildings owned or leased by CNAF’s subsidiaries:
The following discussion highlights significant factors impacting the consolidated operations and financial condition of CNA Financial Corporation (CNAF) and its controlled subsidiaries (collectively CNA or the Company). CNA is one of the largest insurance organizations in the United States and based on 2001 statutory net written premiums, is the ninth largest property and casualty company and the 51st largest life insurance company.
During 2002, CNA underwent management changes and strategic realignment. These events have changed the way CNA manages its operations and makes business decisions and, therefore, necessitated a change in the Company’s reportable segments. The financial results for the following segment changes are reflected throughout the Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A).
The SEC concluded that FASB Technical Bulletin 85-4 Accounting for Purchases of Life Insurance (FTB 85-4) should have been applied to the Company’s investment in life settlement contracts. Under FTB 85-4, the carrying value of each contract at purchase and at the end of each reporting period is equal to the cash surrender value of the policy. Amounts paid to purchase these contracts that are in excess of the cash surrender value, at the date of purchase, are expensed immediately. Periodic maintenance costs, such as premiums, necessary to keep the underlying policy inforce are expensed as incurred and included in other operating expense. Revenue is recognized and included in other revenue in the Consolidated Statements of Operations when the life insurance policy underlying the life settlement contract matures. The Company’s historical accounting was to record an asset for the amount paid to acquire the life settlement contract along with other direct acquisition costs, and to recognize revenue over the period the contract was held.
The adjustment related to life settlement contracts reduced both net operating income and net income for the year ended December 31, 2002 by $9 million. The comparable impact in the prior period increased both net operating income and net income by $2 million for the year ended December 31, 2001. For the year ended December 31, 2000, net operating income and net income decreased $32 million as a result of the adjustment related to life settlement contracts. Additionally, the Consolidated Statements of Stockholders’ Equity reflects a decrease in the Company’s retained earnings of $215 million as of January 1, 2000. The MD&A gives effect to the restatement of the Consolidated Financial Statements for the years ended December 31, 2001 and 2000.
CNA’s consolidated financial statements and accompanying notes have been prepared in accordance with GAAP and have been applied on a consistent basis. CNA continually evaluates the accounting policies and estimates used to prepare the consolidated financial statements. In general, management’s estimates are based on historical experience, evaluation of current trends, information from third party professionals and various other assumptions that are believed to be reasonable under the known facts and circumstances.
The accounting policies discussed below are considered by management to be critical to an understanding of CNA’s financial statements as their application places the most significant demands on management’s judgment. Due to the inherent uncertainties involved with this type of judgment, actual results could differ significantly from estimates and have a material adverse impact on the Company’s results of operations or equity.
Amounts recoverable from reinsurers are estimated in a manner consistent with claim and claim adjustment expense reserves or future policy benefits reserves and are reported as a receivable in the Consolidated Balance Sheets. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. The ceding of insurance does not discharge the primary liability of the Company. An estimated allowance for doubtful accounts is recorded on the basis of periodic evaluations of balances due from reinsurers, reinsurer solvency, management’s experience and current economic conditions. Further information on reinsurance is provided in the Reinsurance section of the MD&A.
The Company’s investment portfolio is subject to market declines below book value that may be other-than-temporary. The Company has an Impairment Committee (the 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 impairment loss in the period in which the determination occurred. Further information on the Company’s investments is provided in the Investments section of the MD&A.
The discussion of underwriting results and ratios reflect the underlying business results of CNA’s property and casualty insurance subsidiaries. Underwriting results are net earned premiums less net incurred claims and the cost incurred to settle these claims, acquisition expenses and underwriting expenses. Underwriting ratios are industry measures of property and casualty underwriting results. The loss and loss adjustment expense ratio is the percentage of net incurred claim and claim adjustment expenses to net earned premiums. The expense ratio is the percentage of underwriting and acquisition expenses, including the amortization of deferred acquisition costs, to net earned premiums. The dividend ratio is the ratio of dividends incurred to net earned premiums. The combined ratio is the sum of the loss and loss adjustment expense, expense and dividend ratios.
The following discussion of operating results focuses on “net operating income (loss).” Net operating income (loss) is calculated by deducting net realized investment gains or losses (investment gains or losses after deduction of related income taxes and participating policyholders’ and minority interest), gains or losses from discontinued operations, net of tax, and the cumulative effect of a change in accounting principle, net of tax, from net income. Net operating income (loss), as defined above, is used in management’s discussion of the results of operations because net realized investment gains or losses, other than investment impairment losses, related to the Company’s available-for-sale investment portfolio are largely discretionary,
Net income in 2002 was $155 million, as compared with a net loss of $1,642 million for 2001. Excluding the 2001 significant items noted in the preceding paragraph, net income decreased $751 million due primarily to an increase in net realized losses from investing activities, partially offset by the improvements in net operating income noted above. Net realized investment gains (losses) decreased $965 million in 2002 as compared with 2001 due primarily to significant realized gains from equity securities in 2001 and increased investment write-downs of fixed maturity and equity securities across various market sectors in 2002. See the Investments section of the MD&A for further details. Loss from discontinued operations, net of tax, of $35 million for 2002 and income from discontinued operations, net of tax, of $11 million for 2001 related to the results of CNA Vida, CNA’s Chilean-based life insurer, which was sold during 2002. Net income for 2002 includes a charge of $57 million, net of tax, for the cumulative effect of a change in accounting principle related to the adoption of Statement of Financial Accounting Standards No. 142 Goodwill and Other Intangible Assets (SFAS 142). Net income for 2001
includes a charge of $61 million, net of tax, for the cumulative effect of a change in accounting principle related to the adoption of Statement of Financial Accounting Standards No. 133 Accounting for Derivative Instruments and Hedging Activities (SFAS 133).
Net earned premiums increased $925 million in 2002 as compared with 2001. Included in the 2001 net earned premiums were $1,334 million of ceded premiums related to corporate aggregate reinsurance treaties, additional ceded premiums and a change in estimate for retrospective premium accruals arising from the second quarter 2001 reserve strengthening and a change in estimate for involuntary market premium accruals, partially offset by reinstatement and additional premiums related to the WTC event. Excluding these 2001 significant premium items, net earned premiums decreased $409 million due primarily to the transfer of the National Postal Mail Handlers Union (the Mail Handlers Plan) in 2002 and decreased net earned premiums in CNA Re resulting from the 2001 decision to cease writing new and renewal business at CNA Reinsurance Company Limited (CNA Re U.K.). Net earned premium for the Mail Handlers Plan was $1,151 million in 2002 as compared with $2,218 million in 2001. These decreases were partially offset by strong rate increases, increased new business and decreased use of reinsurance in the property and casualty segments.
The net operating loss was $2,408 million in 2001 as compared with net operating income of $508 million in 2000. The decline in net operating results was due principally to reserve strengthening of $2,079 million after-tax recorded in the second quarter of 2001 related to a change in estimate of prior year net loss reserves and retrospective premium accruals; estimated losses related to the WTC event of $304 million after-tax, and the related corporate aggregate reinsurance treaties benefit; and restructuring and other related charges of $165 million after-tax. Excluding these 2001 significant items, net operating results decreased $368 million due primarily to a $160 million after-tax charge primarily to strengthen prior underwriting year loss reserves for CNA Re U.K. Additionally, the underwriting results for the London-based commercial and marine operations were unfavorable in 2001. Net operating income also decreased $52 million after-tax from losses related to the bankruptcy filing by certain Enron entities and $159 million after-tax due to a decline in limited partnership income.
Net earned premiums decreased $2,100 million in 2001 as compared with 2000. Included in the 2001 net earned premiums were $1,334 million of ceded premium related to corporate aggregate reinsurance treaties, additional ceded premiums and a change in estimate for retrospective premium accruals arising from the second quarter 2001 reserve strengthening and a change in estimate for involuntary market premium accruals, partially offset by reinstatement and additional premiums related to the WTC event. Excluding these 2001 significant premium items, net earned premiums decreased $766 million due primarily to increased ceded premiums and decreased net earned premiums in CNA Re resulting from the decision made in 2001 to cease writing new and renewal business in CNA Re U.K. In addition, net earned premiums declined in Group Operations, related primarily to the sale of Life Reinsurance, CNA’s individual
The 2001 net operating loss included the following, which are described in more detail on the following pages.
In the second quarter of 2001, the Company recorded an after-tax charge of $2,079 million ($3,182 million pretax) related to a change in estimate of prior year net loss reserves and retrospective premium accruals. This amount included the impact of net reserve strengthening, the related increase in the accrual for insurance-related assessments and the ceded premiums and interest cost of the corporate aggregate reinsurance treaty that attached due to the reserve strengthening. Further details related to the reserve strengthening are discussed below as well as in the individual segment discussions of operations.
During 2001, the Company recorded after-tax restructuring and other related charges of $165 million related to workforce reductions and asset write-offs resulting from changes in the Company’s organization, which are discussed in more detail below.
During the third quarter of 2001, the Company recorded estimated incurred losses of $468 million pretax, net of reinsurance, related to the WTC event. The loss estimate was based on a total industry loss of $50 billion and included all lines of insurance. This estimate took into account CNA’s substantial reinsurance agreements, including its catastrophe reinsurance program and corporate reinsurance programs. The Company has closely monitored reported losses as well as the collection of reinsurance on WTC event claims. As of December 31, 2002, the Company believes its recorded reserves, net of reinsurance, for the WTC event are adequate.
$500 million of ceded losses reduced by $230 million of ceded premiums and $47 million of interest charges.
With respect to environmental and mass tort reserves, commencing in 2000 and continuing into the first and second quarters of 2001, CNA received a number of new reported claims, some of which involved declaratory judgment actions premised on court decisions purporting to expand insurance coverage for pollution claims. In these decisions, several courts adopted rules of insurance policy interpretation which established joint and several liability for insurers consecutively on a risk during a period of alleged property damage; and in other instances adopted interpretations of the “absolute pollution exclusion,” which weakened its effectiveness in most circumstances. In addition to receiving new claims and declaratory judgment actions premised upon these unfavorable legal precedents, these court decisions also impacted CNA’s pending pollution and mass tort claims and coverage litigation. During the spring of 2001, CNA reviewed specific claims and litigation, as well as general trends, and concluded reserve strengthening in this area was necessary.
the first half of 2001. CNA’s reserve increase in the second quarter of 2001 was caused in part by this increased area of exposure.
The non-APMT adverse reserve development in 2001 was the result of analyses of several lines of business. This development related principally to commercial insurance coverages including automobile liability and multiple-peril, as well as assumed reinsurance and healthcare-related coverages. A brief summary of these lines of business and the associated reserve development is discussed below.
The commercial automobile liability analysis indicated increased ultimate claim and claim adjustment expense across several accident years due to higher paid and reported claim and claim adjustment expense resulting from several factors. These factors include uninsured/underinsured motorists coverage in Ohio, a change in the rate at which the average claim size was increasing and a lack of improvement in the ratio of the number of claims per exposure unit, the frequency. First, Ohio courts had significantly broadened the population covered through the uninsured/underinsured motorists’ coverage. The broadening of the population covered by this portion of the policy, and the retrospective nature of this broadening of coverage, resulted in additional claims for older years. Second, in recent years, the average claim size had been increasing at less than a 2% annual rate. The available data indicated that the rate of increase was closer to 8% with only a portion of this increase explainable by a change in mix of business. Finally, the review completed during the second quarter of 2001 indicated that the frequency for the 2000 accident year was 6% higher than 1999. Expectations were that the 2000 frequency would show an improvement from the 1999 level.
Approximately $320 million of adverse loss development was due to adverse experience in all other lines, primarily in coverages provided to healthcare-related entities written by CNA HealthPro. The gross and net claim and claim adjustment expense reserves at the beginning of 2001 for Specialty Lines was approximately $4,813 million and $3,429 million. The level of paid and reported losses associated with coverages provided to national long term care facilities were higher than expected. The long term care facility business had traditionally been limited to local facilities. In recent years, the Company began to provide coverage to large chains of long
Approximately $188 million of this amount resulted from a change in estimate in premiums related to involuntary market facilities, which had an offsetting impact on net losses and therefore had no impact on the net operating results. More than one-half of the change in estimate in premiums was attributable to accident years 1997 through 1999 with the remainder attributable to accident years prior to 1992. Accruals for ceded premiums related to other reinsurance treaties increased $83 million due to the reserve strengthening. This increase in accruals for ceded premiums was principally recorded in accident year 2000. The remainder of the decrease in premium accruals relates to the change in estimate of the amount of retrospective premium receivables as discussed above, which were principally recorded in accident years prior to 1999.
Interest cost on these contracts is credited during all periods in which a funds withheld liability exists. Interest cost, which is included in other net investment income, was $239 million, $241 million and $87 million in 2002, 2001 and 2000. The amount subject to interest crediting rates on such contracts was $2,766 million and $2,724 million at December 31, 2002 and 2001.
The Company has reinsurance receivables from several reinsurers who have recently experienced multiple downgrades of their financial strength ratings, have announced that they
exceeds certain thresholds, additional premiums may be payable and the rate at which interest charges are accrued would increase to 8.25% per annum commencing in 2006.
The coverage under the second section of the Aggregate Cover was triggered for the 2001 accident year. As a result of losses related to the WTC event, the limit under this section was exhausted. Additionally, as a result of the significant reserve additions recorded in the second quarter of 2001, the $500 million limit on the 1999 accident year under the first section was also fully utilized. No losses have been ceded to the remaining $500 million of aggregate limit on accident years 2000 and 2001 under the first section of the Aggregate Cover.
The impact by operating segment of the Aggregate Cover and the CCC Cover on pretax operating results was as follows:
Impact of Aggregate Cover and CCC Cover on Pretax Operating Results
These charges primarily related to $29 million of workforce reductions of approximately 260 positions gross and net and $1 million of other costs.
Through December 31, 2002, 249 employees were released due to the IT Plan, nearly all of whom were technology support staff. In December of 2002, the accrual was reduced by $4 million in the Corporate and Other segment primarily related to employee termination costs. The remaining $5 million of the accrual relating to employee termination and related benefit costs is expected to be paid through 2005.
The Company’s current Insurance Reserve levels reflect management’s best estimate of the Company’s ultimate claims and claim adjustment expenses and future policy benefits at December 31, 2002, based upon known facts and current law. However, in light of the many uncertainties associated with making the estimates and assumptions necessary to establish reserve levels, the Company reviews its reserve estimates on a regular and ongoing basis and makes changes as experience develops. The Company may in the future determine that its recorded Insurance Reserves are not sufficient and may increase its reserves by amounts that may be material, which could materially adversely affect the Company’s business and financial
CNA and the insurance industry incurred substantial losses related to the WTC event. For the most part, the Company believes the industry was able to absorb the loss of capital from these losses, but the capacity to withstand the effect of any additional terrorism events was significantly diminished.
On November 26, 2002, the President of the United States of America, George W. Bush, signed into law the Terrorism Risk Insurance Act of 2002 (the Act), which establishes a program within the Department of the Treasury under which the Federal Government will share the risk of loss from future terrorist attacks with the insurance industry. The Act terminates on December 31, 2005. Each participating insurance company must pay a deductible before Federal Government assistance becomes available. This deductible is based on a percentage of direct earned premiums for commercial insurance lines from the previous calendar year, and rises from 1%
While the Act provides the property and casualty industry with an increased ability to withstand the effect of a terrorist event during the next three years, given the unpredictability of the nature, targets, severity or frequency of potential terrorist events, the Company’s results of operations or equity could nevertheless be materially adversely impacted by them. The Company is attempting to mitigate this exposure through its underwriting practices, policy terms and conditions (where applicable) and the use of reinsurance. In addition, under state laws, the Company is generally prohibited from excluding terrorism exposure from its primary workers compensation, individual life and group life and health policies, and is also prohibited from excluding coverage for fire losses following a terrorist event in a number of states.
Reinsurers’ obligations for terrorism-related losses under reinsurance agreements are not covered by the Act. The Company’s current reinsurance arrangements either exclude terrorism coverage or significantly limit the level of coverage.
Property and Casualty (P&C) provides standard property and casualty insurance products such as workers compensation, general and product liability, property and commercial auto coverage through traditional and innovative advanced financial risk products to a wide range of
businesses. The majority of P&C customers are small and middle-market businesses, with less than $1 million in annual insurance premiums. Most insurance programs are provided on a guaranteed cost basis; however, P&C has the capability to offer specialized, loss-sensitive insurance programs to those risks viewed as higher risk and less predictable in exposure.
P&C’s field structure consists of 68 branch locations in 63 cities. Each branch provides the marketing, underwriting and risk control expertise on the entire portfolio of products. In addition, these branches provide streamlined claim services utilizing the same regional structure. A centralized processing center for small and middle-market customers, located in Maitland, Florida, handles policy processing and accounting, and also acts as a call center to optimize customer service. The branches and processing center are all located in the United States.
Excess & Surplus (E&S) provides specialized insurance and other financial products for selected commercial risks on both an individual customer and program basis. Risks insured by E&S are generally viewed as higher risk and less predictable in exposure than those covered by standard insurance markets. E&S’s products are distributed throughout the United States through specialist producers, program agents, and P&C’s agents and brokers. The target market for these specialized programs are large accounts within Fortune 1000 businesses. E&S has specialized underwriting and claim resources in Chicago, New York, Denver and Columbus.
The combined ratio decreased 2.7 points for 2002 as compared with 2001, and underwriting results improved by $65 million as compared with the underwriting results for the same period in 2001. This change was due to decreases in the expense and dividend ratios, partially offset by an increase in the loss ratio. The loss ratio increased 3.0 points due principally to increased costs of the Company’s reinsurance programs in 2002 as compared with a significant benefit from reinsurance in 2001, including a benefit related to corporate aggregate reinsurance treaties from core operations which was recorded primarily on increased 2001 accident year losses for the workers compensation line of business.
In addition, Standard Lines had favorable prior year reserve development, primarily in the package liability and auto liability lines of business due to new claims initiatives. These new claims initiatives, which included specialized training on specific areas of the claims adjudication process, enhanced claims litigation management, enhanced adjuster-level metrics to monitor performance and more focused metric-based claim file review and oversight, are expected to produce significant reductions in ultimate claim costs. Based on management’s best estimate of the reduction in ultimate claim costs, approximately $100 million of favorable prior year reserve development was recorded in the third quarter of 2002. Approximately one-half of this favorable reserve development was recorded in accident years prior to 1999, with the remainder of the favorable reserve development recorded in accident years 1999 to 2001. Additional favorable reserve development may be recorded in the future as management continues to monitor these estimates and as additional evidence becomes available to measure the effectiveness of the claim cost containment initiatives and management’s corresponding estimate of such expected ultimate claim cost reductions. While management believes that the estimate of ultimate claim cost reductions as a result of the claim cost containment initiatives is reasonable, there can be no assurance that the ultimate expected claim cost reductions will be achieved, or that any additional favorable development will be recorded as a result of the claim cost containment initiatives described above.
Net written premiums for Standard Lines increased $1,036 million in 2002 as compared with 2001. Included in the 2001 net written premiums were $830 million of ceded premiums related to corporate aggregate reinsurance treaties, additional ceded premiums arising from both the second quarter 2001 reserve strengthening and the WTC event, and a change in estimate for involuntary market premium accruals. Excluding these 2001 significant premium items, net written premiums increased $206 million primarily as a result of strong rate increases, increased new business and lower ceded premiums.
Standard Lines achieved average rate increases of 27%, 17% and 13% in 2002, 2001 and 2000 for the contracts that renewed during these years and had retention rates of 68%, 76% and 68% for those contracts that were up for renewal.
decline in limited partnership income and increased interest expense for finite reinsurance other than corporate aggregate reinsurance treaties.
The combined ratio decreased 5.7 points in 2001 as compared with 2000, and the underwriting results improved $270 million. The change in the underwriting results and the combined ratio was driven by a decrease in the loss ratio, partially offset by increases in both the expense and dividend ratios. The loss ratio decline of 11.4 points reflects lower prior year adverse loss reserve development, excluding the second quarter 2001 reserve strengthening, and improved current year underwriting results across most lines, particularly the automobile and package lines, due to earned rate achievement and re-underwriting efforts undertaken in 2000. The expense ratio increased 4.5 points due primarily to the reduced net earned premium base in 2001, an increase in the accrual for guarantee fund assessments related to the Reliance insolvency and the decreased benefit from the change in the assessment base for certain insurance-related assessments discussed above. These declines were partially offset by lower acquisition expenses due to higher ceding commissions. The dividend ratio increased 1.2 points due primarily to adverse development in dividend reserves in 2001 compared with favorable reserve development recorded in 2000.
Net written premiums for Standard Lines decreased $906 million in 2001 as compared with 2000. Included in the 2001 net written premiums were $830 million of ceded premiums related to corporate aggregate reinsurance treaties, additional ceded premiums arising from both the second quarter 2001 reserve strengthening and the WTC event, and a change in estimate for involuntary market premium accruals. Excluding these 2001 significant premium items, net written premiums decreased $76 million primarily due to increased adverse premium development, excluding the second quarter 2001 reserve strengthening, increased ceded premiums for reinsurance treaties other than corporate aggregate reinsurance treaties and $119 million due to a change in the timing of recording written premiums for policies with future effective dates. The change for policies with future effective dates was made in conjunction with statutorily required changes in recording written premiums and had no impact on net earned premiums or net income. Partially offsetting these decreases was increased new business in the primary property and small and middle-market lines.
Professional Liability Insurance (CNA Pro) provides management and professional liability insurance and risk management services, primarily in the United States. This unit provides professional liability coverages for architects and engineers, realtors, non-Big Four accounting firms and law firms. CNA Pro also has market positions in directors and officers, employment practices, fiduciary and fidelity coverages. Specific areas of focus include privately held firms and not-for-profit organizations where CNA offers products. Products within CNA Pro are distributed through brokers, agents and managing general underwriters.
RVI is the largest monoline residual value insurer in the world, offering coverages to protect the insured against a decrease in the market value of a properly maintained asset at the termination of a lease.
Global Standard Lines is responsible for coordinating and managing the direct business of CNA’s overseas property and casualty operations. This business identifies and capitalizes on
*The 2001 adjusted underwriting loss and adjusted ratios exclude the impact of the second quarter 2001 reserve strengthening, the WTC event, both net of the related benefit of corporate aggregate reinsurance treaties, and restructuring and other related charges.
Net operating income was $28 million in 2002 as compared with a net operating loss of $329 million in 2001. The after-tax impact of the second quarter 2001 reserve strengthening on Specialty Lines was $275 million. The reserve strengthening related primarily to medical malpractice and national for-profit nursing home chains with exposure in Florida and Texas. This strengthening was necessitated by the continuing emergence of reported losses in excess of expectations and a thorough review of claim exposures. In response to these adverse trends, Specialty Lines withdrew from writing these coverages in certain states and instituted necessary rate increases. Additionally, reserve strengthening related to the marine business resulted from an increase in large claim frequency in marine cargo and hull coverages for accident years 1998 through 2000. Specialty Lines also strengthened reserves due to higher than expected losses arising from the high-hazard commercial auto business. Specialty Lines has taken rate action and reduced its exposure to unprofitable marine cargo and hull classes of business and has exited the high hazard commercial auto business.
Net operating results in 2001 were adversely impacted by $12 million of estimated losses related to the WTC event and $6 million for restructuring and other related charges. Excluding these 2001 significant items, net operating results increased $64 million for 2002 as compared with 2001. This increase was due primarily to an improvement in the 2002 underwriting results and the better alignment of premium earnings with the emergence of claims in the vehicle warranty line of business, which reduced operating results in 2001, and a $1 million after-tax reduction of the accrual for restructuring and other related charges in 2002 partially offset by a decline in net investment income, including a $13 million decline in limited partnership income.
Favorable reserve development of $13 million after-tax was recorded in 2002 in relation to the Enron exposures previously recorded as a charge of $30 million after-tax related to the bankruptcy filing of certain Enron entities in 2001. These charges consisted of $17 million after-tax of losses in connection with surety exposures, including advance payment obligations bonds and $13 million after-tax of other operating expenses in connection with collateralized debt obligations, a credit enhancement product. Additionally, the underwriting results for the London-based commercial and marine operations were unfavorable in 2001 as compared with 2002.
Approximately $50 million of the prior year unfavorable reserve development was related to long term care facilities. The development was principally recorded for accident years 1997 through 2000. The average value of claims closed during the first several months of 2002 increased by more than 50% when compared to claims closed during 2001. In response to those trends, CNA HealthPro has reduced its writings of national for-profit nursing home chains. Excess products provided to healthcare institutions and physician coverages in a limited number of states were responsible for the remaining development in CNA HealthPro. The unfavorable reserve development on excess products provided to institutions for accident years 1996 through 1999 resulted from increases in the size of claims experienced by these institutions. Due to the increase in the size of claims, more claims were exceeding the point at which these
excess products apply. The unfavorable reserve development on physician coverages was recorded for accident years 1999 through 2001 in Oregon, California, Arizona and Nevada. The average claim size in these states has increased by 20%, driving the change in losses.
Offsetting the unfavorable reserve development was favorable development in CNA Pro and for Enron related exposures. Programs providing professional liability coverage to accountants, lawyers and realtors primarily drove favorable prior year reserve development of approximately $110 million in CNA Pro. Reviews of this business completed during 2002 have shown little activity for older accident years (principally prior to 1999), which reduced the need for reserves on these years. The reported losses on these programs for accident years prior to 1999 increased by approximately $5 million during 2002. This increase compared to the total reserve at the beginning of 2002 of approximately $180 million, net of reinsurance. Additionally, favorable reserve development of $20 million was associated with the Enron settlement. The Company had established a $20 million reserve for accident year 2001 for an excess layer associated with Enron related surety losses; however the case has settled for less than the attachment point of this excess layer. Also recorded in 2001 was reserve strengthening for the London-based commercial and marine operations and losses related to Enron entities as discussed above.
Net earned premiums increased $282 million in 2002 as compared with 2001. Included in 2001 net earned premiums were $82 million related to corporate aggregate reinsurance treaties, additional ceded premiums and a change in estimate for retrospective premium accruals arising from the reserve strengthening, additional ceded premiums arising from the WTC event and a change in estimate for involuntary market premium accruals. Excluding these 2001 significant premium items, net earned premiums increased $200 million primarily as a result of the increases in net written premiums as noted above.
Specialty Lines achieved average rate increases of 26%, 13% and 5% in 2002, 2001 and 2000 for the contracts that renewed during these years and had retention rates of 76%, 78% and 78% for those contracts that were up for renewal. The retention rates above apply to Specialty Lines excluding the CNA Guaranty and Credit, Surety and Warranty businesses.
Net earned premiums increased $49 million in 2001 as compared with 2000. Included in 2001 net earned premiums were $82 million related to corporate aggregate reinsurance treaties, additional ceded premiums and a change in estimate for retrospective premium accruals arising from the reserve strengthening, additional ceded premiums arising from the WTC event and a change in estimate for involuntary market premium accruals. Excluding these 2001 significant premium items, net earned premiums increased $131 million related primarily to the reasons noted above as well as the reserve for retrospective premium increase recorded in 2000.
CNA Re’s operations also included the business of CNA Re U.K., a United Kingdom reinsurance company. On October 31, 2002, the Company completed the sale of CNA Re U.K. to Tawa UK Limited (Tawa), a subsidiary of the Artemis Group, a diversified French-based holding company. The sale includes business underwritten since inception by CNA Re U.K., except for certain risks retained by Continental Casualty Company (CCC). See the Investments section of the MD&A for further details of the sale of CNA Re U.K. CNA Re’s U.K. subsidiaries ceased new underwriting activities in the third quarter of 2001. This sale does not impact CNA Re’s on-going U.S.-based operations.
Net operating income was $65 million in 2002 as compared with a net operating loss of $622 million in 2001. The after-tax impact, net of the related corporate aggregate reinsurance treaty benefit, of the second quarter 2001 reserve strengthening on CNA Re was $346 million. The strengthening was based upon second quarter 2001 reviews that showed the emergence of higher than expected reported losses. The reserve strengthening related to a number of lines, including excess of loss liability and professional liability, in accident years 1997 to 2000.
Net operating results decreased $176 million in 2001 due to estimated losses related to the WTC event, net of related corporate aggregate reinsurance treaties benefit and $6 million for restructuring and other related charges. Excluding these 2001 significant items, net operating results improved $159 million for 2002 as compared with 2001. This increase was due to improved underwriting results and an increased benefit related to the additional cessions to CCC Cover as a result of the increase in WTC related losses recorded in the first quarter of 2002, as discussed below, partially offset by a decrease in net investment income, principally resulting from a $7 million decline in limited partnership income.
The prior year reserve strengthening recorded in 2002 was the result of an actuarial review completed during 2002 and was primarily recorded in the directors and officers, professional liability errors and omissions, and surety lines of business. Several large losses, as well as continued increases in the overall average size of claims for these lines, have resulted in higher than expected loss ratios.
Net written premiums for CNA Re increased $81 million in 2002 as compared with 2001. Included in 2001 net written premiums were $59 million related to corporate aggregate reinsurance treaties and additional ceded premiums arising from both the reserve strengthening and WTC event. These reductions in net written premiums were more than offset by $89 million of reinstatement premiums related to the WTC event. Excluding these 2001 significant premium items, net written premiums increased $111 million principally as a result of clients increasing their premium writings, achieved rate increases, an increase in new business and $25 million related to the sale of CNA Re U.K. These increases were partially offset by the 2001 decision to cease new and renewal business writings at CNA Re U.K. Net earned premiums increased $1 million in 2002 as compared with 2001.
The net operating loss was $622 million in 2001 as compared with net operating income of $92 million in 2000. Included in the 2001 results were $346 million related to the second quarter 2001 reserve strengthening, $176 million of losses related to the WTC event, net of related corporate aggregate reinsurance treaties benefit, and $6 million for restructuring and other
related charges. Excluding these significant items, net operating results decreased $186 million in 2001 as compared with 2000 due primarily to a $160 million charge to strengthen prior underwriting year reserves for CNA Re U.K. Additionally, net operating results decreased as a result of Enron-related losses of $22 million primarily for reinsurance of surety obligations, and decreased net investment income, including a $13 million decline in limited partnership income. These declines were partially offset by improved current accident year results.
Group Operations includes three principal business units: Group Benefits, Federal Markets and Institutional Markets and Other, which also includes results from businesses that CNA has exited; retail variable life and annuities and life reinsurance.
Federal Markets provided health insurance benefits to federal employees, retirees and their families, insuring nearly one million members under the National Postal Mail Handlers Union group benefits plan (the Mail Handlers Plan). On July 1, 2002, the Company sold its federal health plan administrator, Claims Administration Corporation, and transferred the Mail Handlers Plan to First Health Group. As a result of this transaction, the Company recognized a $7 million
pretax realized loss on the sale of Claims Administration Corporation and $15 million of pretax non-recurring fee income related to the transfer of the Mail Handlers Plan.
The variable products business was exited in the fourth quarter of 2001. During July 2002, the Company entered into an agreement, whereby The Phoenix Companies, Inc. acquired the variable life and annuity business of VFL through a coinsurance arrangement, with modified coinsurance on the separate accounts. The life reinsurance business was sold on December 31, 2000.
Net operating income increased by $82 million in 2002 as compared with 2001. Included in the 2001 results were $35 million related to the WTC event and $27 million related to restructuring and other related charges. Excluding these 2001 significant items, net operating results improved $20 million due primarily to growth in the disability and long term care products, increased net investment income and diminished losses due to the exit of unprofitable variable life and annuity lines of business. Net operating results also improved due to favorable reserve development relating to the WTC event of $4 million after-tax recorded in 2002. Partially offsetting these improvements was net unfavorable reserve strengthening in Group Benefits due to unfavorable mortality trends.
Net earned premiums for Group Operations decreased $66 million for 2001 as compared with 2000. Net earned premiums declined $228 million as a result of the sale of life reinsurance. This decline was partially offset by increases in Federal Markets of $138 million due to increased medical cost trends and growth in Group Benefits of $36 million, particularly in the disability and group long term care lines of business. Deposits for Group Operations decreased $296 million in 2001 as compared to 2000 due to reduced sales of GIC and S&P 500 ® contracts in Institutional Markets.
Other operations include operations in certain international markets and life settlements contract business. The Company decided to cease purchasing new life settlement policies indefinitely beginning in 2001 and ceased sale of new policies in its international operations in 2002.
*Sales volume is a cash-based measure that includes premiums and annuity considerations, investment contract deposits and other sales activities that are not reported as premiums under accounting principles generally accepted in the United States of America (GAAP).
The Corporate and Other segment is principally comprised of losses and expenses related to the centralized adjusting and settlement of APMT claims, certain run-off insurance operations and other operations.
APMT consists of the losses and expenses related to the centralized adjusting and settlement of APMT claims that were formerly included in the property and casualty segments. See the Environmental Pollution and Mass Tort and Asbestos Reserves section on the following pages for a description of APMT reserves.
Run-off insurance operations consists of personal insurance, entertainment insurance, agriculture insurance, group reinsurance and other financial lines as well as the direct financial guarantee business underwritten by CNA’s insurance affiliates and other insurance run-off operations. Run-off insurance operations also includes assumed business underwritten through a managing general agent, IOA Global, which consists primarily of certain accident and health coverages (IGI Program).
Other operations include interest expense on corporate borrowings, asbestos claims related to Fibreboard Corporation, eBusiness initiatives, CNA UniSource and inter-company eliminations.
CNA UniSource provided human resources, information technology, payroll processing and professional employer organization services. During 2002, the Company decided to exit the lines of business provided by CNA UniSource. Effective March 31, 2002, CNA UniSource ceased providing professional employer organization services. Effective December 31, 2002, CNA UniSource ceased payroll processing services.
was $837 million, including $778 million for APMT. See the Environmental Pollution and Mass Tort and Asbestos Reserves section following for a discussion of this charge. Net operating income in 2001 also decreased by $77 million of restructuring and other related charges and $17 million related to the WTC event for group reinsurance.
Net operating results declined $902 million in 2001 as compared with 2000. The after-tax impact of the second quarter 2001 reserve strengthening on the Corporate and Other segment
The Company’s ultimate liability for its environmental pollution and mass tort claims is impacted by several factors including ongoing disputes with policyholders over scope and meaning of coverage terms and in the area of environmental, court decisions that continue to restrict the scope and applicability of the absolute pollution exclusion contained in policies issued by the Company post 1989. Due to the inherent uncertainties described above, including the inconsistency of court decisions, the number of waste sites subject to cleanup, and in the area of environmental, the standards for cleanup and liability, the ultimate liability of CNA for environmental pollution and mass tort claims may vary substantially from the amount currently recorded.
CNA has structured settlement agreements with four of its policyholders for which it has future payment obligations. Structured settlement agreements provide for payments of sums certain over multiple years as set forth in each individual agreement. As to the four structured settlement agreements existing at December 31, 2002, payment obligations under those settlement agreements are projected to terminate in 2016. For these four structured settlement agreements, CNA has reserved $118 million, net of reinsurance.
issues and litigation related to coverage for asbestos exposures. Under this agreement, signatory insurers committed scheduled policy limits and made the limits available to pay asbestos claims based upon coverage blocks designated by the policyholders in 1985, subject to extension by policyholders. CIC was a signatory insurer to the Wellington Agreement. At December 31, 2002, CNA had fulfilled its Wellington Agreement obligations as to all but five accounts. With respect to the five remaining unpaid Wellington obligations, CNA has evaluated its exposure under these agreements and has established a $28 million reserve, net of reinsurance, for Wellington obligations.
At December 31, 2002, CNA’s total IBNR reserve for asbestos was $729 million, net of reinsurance. For asbestos exposure, CNA classifies its IBNR reserve as assigned or unassigned. In circumstances where CNA has executed a settlement agreement with its policyholder, CNA assigns IBNR reserve to that account to cover the projected value of the settlement. At December 31, 2002, the assigned IBNR reserve was $166 million, net of reinsurance. The unassigned IBNR reserve relates to potential development on accounts that have not settled and potential future claims for unidentified policyholders. At December 31, 2002, CNA’s unassigned IBNR reserve was $563 million, net of reinsurance.
At December 31, 2002, the Company categorized active accounts as large or small accounts. CNA defined a large account as an active account with more than $100 thousand cumulative paid losses through December 31, 2002. CNA had 150 large accounts with a collective reserve of $220 million, net of reinsurance. The Company made closing large accounts a significant management priority. Small accounts were defined as active accounts with $100 thousand or less cumulative paid losses through December 31, 2002. CNA had 939 small accounts with a collective reserve of $90 million, net of reinsurance.
On February 13, 2003, CNA announced it had resolved asbestos related coverage litigation and claims involving A.P. Green Industries, A.P. Green Services and Bigelow - Liptak Corporation. Under the agreement, CNA will be required to pay $74 million, net of reinsurance recoveries, over a ten year period. The settlement resolves CNA’s liabilities for all pending and future asbestos claims involving A.P. Green Industries, Bigelow-Liptak Corporation and related subsidiaries, including alleged “non-products” exposure. The settlement is subject to bankruptcy court approval and confirmation of a bankruptcy plan containing a channeling injunction to protect CNA from any future claims. The Company’s recorded reserves as of December 31, 2002, included reserves for this exposure.
CNA is engaged in insurance coverage litigation with Robert A. Keasbey Company (Keasbey) and associated claimants in New York state court (Continental Casualty Company vs. Robert A. Keasbey Company et al., Supreme Court State of New York - County of New York, No. 401621/02). Keasbey was a seller and installer of asbestos products in the New York and New Jersey area. CNA paid its full product liability limits to Keasbey in prior years. Claimants against Keasbey now claim CNA owes additional coverage under the operations section of policies issued to it by CNA. CNA is also a party to insurance coverage litigation between Burns & Roe Enterprises, Inc. (Burns & Roe) and its insurance carriers related to asbestos bodily injury and wrongful death claims (In re: Burns & Roe Enterprises, Inc., pending in the U.S. Bankruptcy Court for the District of New Jersey, No. 00-41610). Burns & Roe provided various engineering and related services in connection with construction projects. Burns & Roe is currently in bankruptcy. There are numerous factual and legal issues to be resolved in connection with these cases and it is difficult to predict the outcome or financial exposure represented by these matters in light of the novel theories asserted by policyholders and their counsel.
Throughout 2000, and into 2001, CNA experienced significant increases in new asbestos bodily injury claims. In light of this development, CNA formed the view that payments for asbestos claims could be higher in future years than previously estimated. Moreover, in late 2000 through mid-2001, industry sources such as rating agencies and actuarial firms released analyses and studies commenting on the increase in claim volumes and other asbestos liability developments. For example, A.M. Best released a study in May 2001 increasing its ultimate asbestos reserve estimate 63% from $40 billion to $65 billion, citing an unfunded insurance industry reserve shortfall of $33 billion. In June 2001, Tillinghast raised its asbestos ultimate exposure from $55 billion to $65 billion for the insurance industry and its estimate of the ultimate remaining asbestos liability for all industries was raised to $200 billion.
The Company experienced lower net investment income in 2001 as compared with 2000 due primarily to the decrease in limited partnership income as well as the increase in interest on funds withheld and other deposits. The decline in limited partnership income was primarily attributable to many of the same factors that impacted the broader financial markets.
The bond segment of the investment portfolio yielded 6.0% in 2002, 6.4% in 2001 and 6.7% in 2000.
Also, during 2002, CNA completed the sale of several businesses, including CNA Re U.K., the London-based reinsurer. Included in 2002 net realized investment results was a $71 million after-tax gain resulting from the sale of CNA Re U.K., which included a $39 million after-tax reduction of the previously recognized impairment loss on CNA Re U.K. The impairment loss recorded in 2001 for the sale of CNA Re U.K. and other subsidiaries was $185 million after-tax. Further details of these transactions are discussed below.
During 2002, the losses recorded in this asset class were due to changes in interest rates and certain trading for duration management purposes. Treasury bonds are used in many portfolios as duration management tools and for liquidity in the course of asset/liability portfolio management.
The security had been previously impaired and continued to be held in anticipation of proceeds from asset sales and liquidation of restaurant holdings that did not materialize.
Securities currently held have been impaired. These losses relate to trades that took place prior to impairment to reduce issuer exposure and securities with less desirable collateral.
The original holding was a private convertible preferred stock. The issuer went public and all equity holders were required to convert to the new common stock. At the time of the IPO, market conditions negatively affected the transaction as originally planned. These losses reflect the difference in the market value of the new common shares at the time of issue and the basis of the original invested securities.
Invested assets are exposed to various risks, such as interest rate, market and credit. Due to the level of risk associated with certain invested assets and the level of uncertainty related to changes in the value of these assets, it is possible that changes in risks in the near term could have an adverse material impact on the Company’s results of operations or equity.
A significant judgment in the valuation of investments is the determination of when an other-than-temporary decline in value has occurred. The Company follows a consistent and systematic process for impairing securities that sustain other-than-temporary declines in value. The Company has established a committee responsible for the impairment process. This committee, referred to as the Impairment Committee, is made up of three officers appointed by the Company’s Chief Financial Officer. The Impairment Committee is responsible for analyzing watch list securities on at least a quarterly basis. The watch list includes individual securities that fall below certain thresholds or that exhibit evidence of impairment indicators including, but not limited to, a significant adverse change in the financial condition and near term prospects of the investment or a significant adverse change in legal factors, the business climate or credit ratings.
Realized investment losses included $890 million, $129 million and $72 million of pretax impairment losses for the three years ended December 31, 2002, 2001 and 2000. The impairments recorded in 2002 were primarily the result of the continued credit deterioration on specific issuers in the bond and equity markets and the effects on such markets due to the overall slowing of the economy.
For the year ended December 31, 2000, the impairment losses recorded related primarily to corporate bonds and equities and were largely spread amongst the consumer, financial, and communications industry sectors including $14 million for Specialty Foods Corporation.
On October 31, 2002, the Company completed the sale of CNA Re U.K. to Tawa. The sale includes business underwritten since inception by CNA Re U.K., except for certain risks retained by CCC as discussed below. In October, the sale was approved in the United Kingdom by the Financial Services Authority (FSA) and by the Illinois Insurance Department. This sale does not impact CNA Re’s on-going U.S.-based operations.
The purchase price was $1, subject to adjustments based primarily upon the results of operations and realized foreign currency losses of CNA Re U.K. The final purchase price adjustments were prepared by Tawa and have been agreed to by the Company. Under the terms of the purchase price adjustment, CCC is entitled to receive $5 million from Tawa after Tawa is able to legally withdraw funds from the former CNA Re U.K. entities. CCC has also committed to contribute up to $5 million to the former CNA Re U.K. entities over a four-year period beginning in 2010 should the FSA deem those entities to be undercapitalized. The purchase price adjustment related to foreign currency losses resulted in CNA contributing additional capital to CNA Re U.K. of $11 million. As the sale and related agreements have now been completed, the Company has finalized its impairment analysis based upon the terms of the completed transactions. As such, in the fourth quarter of 2002, the impairment loss was reduced by approximately $39 million after-tax. The reduction of the impairment was included in net realized investment gains.
CNA Re U.K. had revenues of approximately $48 million, $280 million and $605 million for the three years ended December 31, 2002, 2001 and 2000. CNA Re U.K. had net losses of $22 million, $374 million and $158 million for the years ended December 31, 2002, 2001 and 2000. The assets and liabilities of CNA Re U.K., including the effects of the concurrent transactions, were approximately $2,442 million and $2,357 million at the date of sale and $2,557 million and $2,541 million as of December 31, 2001.
The following table summarizes for fixed maturity and equity securities in an unrealized loss position at December 31, 2002, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position.
The non-investment grade securities that were in an unrealized loss severity of less than 70% for longer than six months as of December 31, 2002 primarily consisted of securities in the utilities, communication and transportation sectors representing 35%, 21% and 17% of the gross unrealized loss. The non-investment grade securities that were in an unrealized loss severity of less than 70% for greater than 24 months as of December 31, 2002 primarily consisted of securities in the communications and transportation sector representing 40% and 34% of the unrealized loss. Unrealized losses in the communication sector are predominately attributable to a European leader in telecommunication services. The unrealized losses on securities held in the transportation sector are primarily comprised of debt issued from a major domestic airline.
The Company’s equity securities held as of December 31, 2002 that were in an unrealized loss position had a fair value of $206 million. The Company’s Impairment Committee, under the same process as fixed maturity securities, monitors the equity securities for other-than-temporary declines in value. In all cases where a decline in value is judged to be temporary, the Company expects to recover the book value of its investment through a recovery in the market value of the security.
The general account portfolio consists primarily of high quality (rated BBB or higher) bonds, 89% and 92% of which were rated as investment grade at December 31, 2002 and 2001. The following table summarizes the ratings of CNA’s general account bond portfolio at carrying value.
At December 31, 2002 and 2001, approximately 97% of the general account portfolio was U.S. Government agencies or was rated by Standard & Poor’s (S&P) or Moody’s Investors Service (Moody’s). The remaining bonds were rated by other rating agencies or Company management.
At December 31, 2002 and 2001, more than 99% of the separate account portfolio was U.S. Government agencies or was rated by S&P or Moody’s. The remaining bonds were rated by other rating agencies or Company management.
The carrying value of non-traded securities at December 31, 2002 was $237 million which represents 0.7% of the Company’s total investment portfolio. These securities were in a net unrealized loss position of $0.4 million at December 31, 2002. Of the non-traded securities, 78% are priced by unrelated third party sources.
The principal operating cash flow sources of CNA’s property and casualty and life insurance subsidiaries are premiums and investment income. The primary operating cash flow uses are payments for claims, policy benefits and operating expenses.
For the year ended December 31, 2002, net cash used for investing activities was $1,488 million as compared with $205 million in 2001. Cash flows used by investing activities were related principally to increased purchases of invested assets due to positive operating cash flow and cash provided by financing activities.
The Preferred Issue accrues cumulative dividends at an initial rate of 8% per year, compounded annually. It will be adjusted quarterly to a rate equal to 400 basis points above the ten-year U.S. Treasury rate beginning with the quarterly dividend after the first triggering event to occur of either (i) an increase by two intermediate ratings levels of the financial strength rating of CCC from its current rating by any of A.M. Best, S&P or Moody’s or (ii) one year following an increase by one intermediate ratings level of the financial strength rating of CCC by any one of those rating agencies. Accrued but unpaid cumulative dividends cannot be paid on the Preferred Issue unless and until one of the two triggering events described above has occurred. Beginning with the quarter following an increase of one intermediate ratings level in CCC’s financial strength rating, however, current (but not accrued cumulative) quarterly dividends can be paid.
Of the proceeds of the Preferred Issue, $250 million was used to prepay a bank term loan due in April of 2003 and $250 million was contributed to CCC to improve its statutory surplus. It is expected that the remaining proceeds will be used to repay other debt of CNAF and The Continental Corporation (Continental), a controlled subsidiary, maturing in 2003 and used for other general corporate purposes.
CNA’s estimated gross pretax losses for the WTC event were $1,648 million pretax ($1,071 million after-tax). Net pretax losses before the effect of corporate aggregate reinsurance treaties were $727 million. Approximately 1%, 73% and 20% of the reinsurance recoverables on the estimated losses related to the WTC event are from companies with S&P ratings of AAA, AA or A.
Effective January 30, 2001, the Company sold the 180 Maiden Lane, New York, facility. The sale of this property provided additional liquidity to the Company with net sale proceeds of $264 million.
The combined aggregate maturities for debt at December 31, 2002 are presented in the following table.
The Company has an existing shelf registration statement under which it may issue an aggregate of $549 million of debt or equity securities, declared effective by the SEC.
The Company pays a facility fee to the lenders for having funds available for loans under the three-year credit facility maturing April 30, 2004. The fee varies based on the long term debt ratings of the Company. At December 31, 2002, the facility fee on the three-year component was 17.5 basis points.
A Moody’s downgrade of the CNAF senior debt rating from Baa2 to Baa3 would increase the facility fee on the three-year component of the facility from 17.5 basis points to 25.0 basis points. The applicable interest rate would increase from LIBOR plus 57.5 basis points to LIBOR plus 75.0 basis points. The utilization fee would remain unchanged on the three-year facility at 12.5 basis points.
The terms of CNAF’s and CNA Surety’s credit facilities require CNAF and CNA Surety to maintain certain financial ratios and combined property and casualty company statutory surplus
As of December 31, 2002, the Company is obligated to make future payments totaling $394 million for non-cancelable operating leases expiring from 2003 through 2014 primarily for office space and data processing, office and transportation equipment. Estimated future minimum payments under these contracts are as follows: $79 million in 2003; $61 million in 2004; $56 million in 2005; $45 million in 2006; and $153 million in 2007 and beyond. Additionally, the Company has entered into a limited number of guaranteed payment contracts, primarily relating to telecommunication services, amounting to approximately $24 million. Estimated future minimum purchases under these contracts are as follows: $13 million in 2003; $9 million in 2004; and $2 million in 2005.
CNAF has provided parent company guarantees, which expire in 2015, related to lease obligations of certain subsidiaries. Certain of those subsidiaries have been sold; however, the lease obligation guarantees remain in effect. CNAF would be required to remit prompt payment on leases in question if the primary obligor fails to observe and perform its covenants under the lease agreements. The maximum potential amount of future payments that the Company could be required to pay under these guarantees are approximately $8 million at December 31, 2002.
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, 2002 that the Company could be required to pay under this guarantee is approximately $333 million. If CNA was 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.
The Company has recorded a liability of approximately $10 million for its share of estimated future operating deficits of this joint venture through 2016.
The table below reflects ratings issued by A.M. Best, S&P, Moody’s and Fitch as of February 24, 2003 for the CCC Pool, the CIC Pool, Continental Assurance Corporation (CAC) Pool and CNA Group Life Assurance Company (CNAGLA). Also rated were CNAF’s senior debt and Continental senior debt.
All rating outlooks on the above ratings are stable unless otherwise noted.
CAC and Valley Forge Life Insurance Company (VFL) are rated separately by Moody’s and both have an A2 rating.
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 Department, may be paid only from earned surplus, which is calculated by removing unrealized gains from unassigned surplus. As of December 31, 2002, CCC’s earned surplus is in a positive position, thereby enabling CCC to pay approximately $1,069 million of dividend payments during 2003 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
In June of 2001, the FASB issued Statement of Financial Accounting Standards No. 141, Business Combinations (SFAS 141). SFAS 141 requires companies to use the purchase method of accounting for business combinations initiated after June 30, 2001 and prohibits the use of the pooling-of-interests method of accounting. CNA has adopted this standard for all business combinations initiated subsequent to June 30, 2001. The adoption of SFAS 141 did not have a significant impact on the results of operations or equity of the Company.
In June of 2002, the FASB issued Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS 146). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and supercedes Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for
In December of 2002, the FASB issued Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure (SFAS 148). SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure requirements of SFAS 123, Accounting for Stock-Based Compensation, to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. CNA has adopted this standard beginning with the 2002 annual financial statements and will implement the disclosure requirements in all subsequent annual and interim financial statements. The Company has not determined if it will adopt fair value accounting in 2003.
FIN 46 defines a VIE as one in which a) the equity investment is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity, or b) the equity investors lack one or more of the following essential characteristics of a controlling financial interest i) direct or indirect ability to make decisions about the entity’s activities through voting rights or similar rights ii) the obligation to absorb the expected losses of the entity, if they occur or iii) the right to receive the expected residual returns of the entity, if they occur. The primary beneficiary of a VIE is required to consolidate the VIE.
the effects of corporate bankruptcies, such as Enron and WorldCom, on surety bond claims, as well as on capital markets, and on the markets for directors and officers and errors and omissions coverages;
the performance of reinsurance companies under reinsurance contracts with the Company;
results of financing efforts, including the availability of bank credit facilities;
man-made disasters, including the possible occurrence of terrorist attacks and the effect of the absence of applicable terrorism legislation on coverages;
Any forward-looking statements made in this report are made by the Company as of the date of this report. The Company does not have any obligation to update or revise any forward-looking statement contained in this report, even if the Company’s expectations or any related events, conditions or circumstances change.
The Consolidated Financial Statements include the accounts of CNA Financial Corporation (CNAF) and its controlled subsidiaries, which include property and casualty insurance companies (principally Continental Casualty Company (CCC) and The Continental Insurance Company (CIC)) and life and group insurance companies (principally Continental Assurance Company (CAC), Valley Forge Life Insurance Company (VFL) and CNA Group Life Assurance Company (CNAGLA)), collectively CNA or the Company. Loews Corporation (Loews) owned approximately 90% of the outstanding common stock of CNAF as of December 31, 2002.
CNA conducts its operations through five operating segments: Standard Lines, Specialty Lines and CNA Re (which comprise the property and casualty segments), Group Operations and Life Operations. In addition to the five operating segments, certain other activities are reported in the Corporate and Other segment. These operating segments reflect the way CNA manages its operations and makes business decisions.
Claim and claim adjustment expense reserves: Claim and claim adjustment expense reserves, except reserves for structured settlements not associated with environmental pollution and mass tort and asbestos (APMT), workers compensation lifetime claims and accident and health disability 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 losses; 3) estimates of losses on assumed reinsurance; 4) estimates of future expenses to be incurred in the settlement of claims; and 5) estimates of salvage and subrogation recoveries. 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. Insurance and reinsurance receivables are reported as assets in the Consolidated Balance Sheets.
Structured settlements have been negotiated for certain property and casualty insurance claims. Structured settlements are agreements to provide fixed periodic payments to claimants. Certain structured settlements are funded by annuities purchased from CAC for which the related annuity obligations are reported in future policy benefits reserves. Obligations for structured settlements not funded by annuities are included in claim and claim adjustment expense reserves and carried at present values determined using interest rates ranging from 6.0% to 7.5%. At December 31, 2002 and 2001, the discounted reserves for unfunded structured settlements were $884 million and $887 million, net of discount of $1,466 million and $1,478 million.
Deferred acquisition costs related to non-participating traditional life insurance and accident and health insurance are being amortized over the premium-paying period of the related policies using assumptions consistent with those used for computing future policy benefits reserves for such contracts. Assumptions as to anticipated premiums 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 operations when they occur. For these contracts, the amortization period is typically the estimated life of the policy.
Valuation of investments: CNA classifies its fixed maturity securities (bonds and redeemable preferred stocks) and its equity securities as available-for-sale, and as such, they are carried at fair value. The amortized cost of fixed maturity securities is adjusted for amortization of premiums and accretion of discounts to maturity, which are included in net investment income. Changes in fair value are reported as a component of other comprehensive income. Investments are written down to fair value and losses are recognized in income when a decline in value is determined to be other-than-temporary.
The Company’s limited partnership investments are recorded at fair value and typically reflect a reporting lag of up to three months. Fair value represents CNA’s equity in the partnership’s net assets as determined by the General Partner.
Cash collateral received on these transactions is invested in short term investments with an offsetting liability recognized for the obligation to return the collateral. Non-cash collateral, such as securities or letters of credit, received by the Company are not reflected as assets of the Company as there exists no right to sell or repledge the collateral. The fair value of collateral held and included in short term investments was $544 million and $912 million at December 31, 2002 and 2001. The fair value of non-cash collateral was $777 million and $413 million at December 31, 2002 and 2001.
Effective January 1, 2001, the Company accounts for derivatives and hedging activities in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133). The initial adoption of SFAS 133 did not have a significant impact on the equity of the Company; however, adoption of SFAS 133 resulted in an after-tax decrease to 2001 net income of $61 million. Of this transition amount, approximately $58 million related to investments and investment-related derivatives. Because the Company already carried its investment and investment-related derivatives at fair value through other comprehensive income, there was an equal and offsetting favorable adjustment of $58 million to stockholders’ equity (accumulated other comprehensive income). The remainder
of the transition adjustment is primarily attributable to collateralized debt obligation (CDOs) products that are classified as derivatives under SFAS 133.
A derivative is typically defined as an instrument whose value is “derived” from an underlying instrument, index or rate, has a notional amount, requires little or no initial investment and can be net settled. Derivatives include, but are not limited to, the following types of financial instruments: interest rate swaps, interest rate caps and floors, put and call options, warrants, futures, forwards, commitments to purchase securities, and combinations of the foregoing. Derivatives embedded within non-derivative instruments (such as call options embedded in convertible bonds) must be split from the host instrument and accounted for in accordance with SFAS 133 when the embedded derivative is not clearly and closely related to the host instrument. In addition, non-investment instruments, including certain types of insurance contracts, mainly CDOs and synthetic guaranteed investment contracts (synthetic GICs) that have historically not been considered derivatives, may be derivatives or contain embedded derivatives under SFAS 133.
CDOs represent a credit enhancement product that is typically structured in the form of a swap. The Company has determined that this product is a derivative under SFAS 133. Changes in the estimated fair value of CDOs, like other derivative financial instruments with no hedge designation, are recorded in realized gains or losses as appropriate. The Company did not incur any default losses in 2002. The Company incurred approximately $25 million and $13 million of default losses on these products for the years ended December 31, 2001 and 2000. The Company is no longer writing this product.
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. The policy generally prohibits the use of derivatives with a maturity greater than 18 months, unless the derivative is matched with assets or liabilities having a longer maturity. 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 repurchase transactions, to engage in derivative transactions.
The Company has exposure to economic losses due to interest rate risk arising from changes in the level of, or volatility of, interest rates. The Company attempts to mitigate its exposure to interest rate risk through active portfolio management, which includes rebalancing its existing portfolios of assets and liabilities, as well as changing the characteristics of investments to be purchased or sold in the future. In addition, various derivative financial instruments are used to modify the interest rate risk exposures of certain assets and liabilities. These strategies include
the use of interest rate swaps, interest rate caps and floors, options, futures, forwards and commitments to purchase securities. These instruments are generally used to lock interest rates or unrealized gains, to shorten or lengthen durations of fixed maturity securities or investment contracts, or to hedge (on an economic basis) interest rate risks associated with investments, variable rate debt and life insurance liabilities. The Company has used these types of instruments as designated hedges against specific assets or liabilities on an infrequent basis.
Had the Company not amortized goodwill in 2001 and 2000, net income and the related basic and diluted earnings per share amounts would have been as follows:
On April 1, 2001, the Company adopted Emerging Issues Task Force Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets (EITF 99-20). EITF 99-20 establishes how a transferor that retains an interest in securitized financial assets or an enterprise that purchases a beneficial interest in securitized financial assets should account for interest income and impairment. The adoption of EITF 99-20 did not have a significant impact on the results of operations or equity of the Company.
In June of 2002, the FASB issued Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS 146). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and supercedes Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) (EITF 94-3). CNA adopted the provisions of SFAS 146 for all disposal activities initiated after June 30, 2002. The adoption of SFAS 146 did not have a significant impact on the results of operations or equity of the Company.
guarantees, which are effective for financial periods ending after December 15, 2002. Additionally, FIN 45 outlines provisions for initial recognition and measurement of the liability incurred in providing a guarantee. These provisions are to be applied on a prospective basis to guarantees issued or modified after December 31, 2002. CNA has implemented the disclosure requirements of FIN 45 and will adopt the provisions for initial recognition and measurement for all guarantees issued or modified after December 31, 2002. The initial adoption for the recognition and measurement requirements of FIN 45 is not expected to have a significant impact on the results of operations or equity of the Company.
The unrealized gain on the Company’s position in Global Crossing, including the fair market value of the related hedge discussed in Note C, was $902 million at December 31, 2000.
Changes in Net Realized Gains and Unrealized Appreciation (Depreciation) for Global Crossing
The following tables provide a summary of investments in fixed maturity and equity securities available-for-sale.
The carrying value of fixed maturity investments that did not produce income during 2002 and 2001 was $88 million and $186 million. At December 31, 2002 and 2001, no investments, other than investments in U.S. government agency securities, exceeded 10% of stockholders’ equity.
The Company may from time to time invest in securities that may be restricted in whole or in part. As of December 31, 2002 and 2001, the Company did not hold any significant positions in investments whose sale was restricted.
Cash and securities with carrying values of approximately $1.8 billion and $2.0 billion were deposited by the Company’s insurance subsidiaries under requirements of regulatory authorities as of December 31, 2002 and 2001.
A summary of the aggregate contractual or notional amounts, estimated fair values and recognized gains (losses) related to derivative financial instruments follows.
Realized investment gains and losses from derivative financial instruments included in separate accounts assets/liabilities are not included in the Company’s realized investment gains/losses.
The effectiveness of this hedge was measured based on changes in the intrinsic value of the collar in relation to changes in the fair value of Global Crossing. Changes in the time value component of the collar’s fair value were excluded from the hedge designation and measurement of effectiveness. Up to the date of the sale, the Global Crossing hedge was 100% effective. The change in the time value component of the collar was a pretax gain of $33 million for the year ended December 31, 2001, and has been recorded as a realized investment gain in the Consolidated Statements of Operations.
The fair values of fixed maturity and equity securities were based on quoted market prices, where available. For securities not actively traded, fair values were estimated using values obtained from independent pricing services or quoted market prices of comparable instruments.
Valuation techniques to determine fair value of limited partnership investments, other invested assets and other 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.
CNA’s senior notes and debentures were valued based on quoted market prices. The fair value for other long term debt was estimated using discounted cash flows based on current incremental borrowing rates for similar borrowing arrangements.
any, equal to the federal income tax that would have been payable by the CNA Tax Group filing a separate consolidated tax return. In the event that Loews should have a net operating loss in the future computed on the basis of filing a separate consolidated tax return without the CNA Tax Group, CNA may be required to repay tax recoveries previously received from Loews. This agreement may be canceled by either party upon 30 days written notice.
Provision has been made for the expected U.S. federal income tax liabilities applicable to undistributed earnings of subsidiaries, except for certain subsidiaries for which the Company intends to invest the undistributed earnings indefinitely, or recover such undistributed earnings tax-free. Adjustments related to foreign net operating loss carry forwards reflected above pertain to those foreign subsidiaries for which no tax benefit is expected to be realized.
The deferred tax effects of the significant components of CNA’s deferred tax assets and liabilities are set forth in the table below.
CNA’s property and casualty insurance claim and claim adjustment expense reserves represent the estimated amounts necessary to settle all outstanding claims, including claims that are incurred but not reported (IBNR) as of the reporting date. The Company’s reserve projections are based primarily on detailed analysis of the facts in each case, CNA’s experience with similar cases and various historical development patterns. Consideration is given to such historical patterns as field reserving trends and claims settlement practices, loss payments, pending
levels of unpaid claims and product mix, as well as court decisions, economic conditions and public attitudes. All of these factors can affect the estimation of claim and claim adjustment expense reserves.
Catastrophes are an inherent risk of the property and casualty insurance business and have contributed to material period-to-period fluctuations in the Company’s results of operations or equity. The level of catastrophe losses experienced in any period cannot be predicted and can be material to the results of operations or equity of the Company.
The following table provides management’s estimate of pretax losses related to the WTC event on a gross basis (before reinsurance) and a net basis (after reinsurance) by line of business.
CNA’s property and casualty insurance subsidiaries have actual and potential exposures related to environmental pollution and mass tort and asbestos claims.
The following table provides data related to CNA’s environmental pollution and mass tort and asbestos claim and claim adjustment expense reserves.
During 2002, net reserves were identified relating to APMT related claim and claim adjustment expense reserves for assumed reinsurance pools, which reflects improvements in the identification of APMT activity from assumed reinsurance and pools. The inclusion of these additional APMT reserves increased the APMT reserves and decreased other reserves, resulting in no net change in the Company's overall carried claim and claim adjustment expense reserves.
Many policyholders have made claims against various CNA insurance subsidiaries for defense costs and indemnification in connection with environmental pollution matters. The vast majority of these claims relate to accident years 1989 and prior, which coincides with CNA’s adoption of the Simplified Commercial General Liability coverage form, which includes what is referred to in
A number of proposals to reform Superfund have been made by various parties. In 2002, no reforms were enacted by Congress. If there is legislation, and in some circumstances even if there is no legislation, the federal role in environmental cleanup may be significantly reduced in favor of state action. Substantial changes in the federal statute or the activity of the EPA may cause states to reconsider their environmental cleanup statutes and regulations. There can be no meaningful prediction of the pattern of regulation that would result or the possible effect upon CNA’s results of operations or equity.
As of December 31, 2002 and 2001, CNA carried approximately $517 million and $633 million of claim and claim adjustment expense reserves, net of reinsurance recoverables, for reported and unreported environmental pollution and mass tort claims. There was no environmental and mass tort net claim and claim adjustment expense reserve development for the year ended December 31, 2002. Unfavorable environmental pollution and mass tort net claim and claim adjustment expense reserve development for the years ended December 31, 2001 and 2000 amounted to $468 million and $15 million. The Company paid environmental pollution-related claims and mass tort-related claims, net of reinsurance recoveries, of $116 million, $203 million and $135 million during the years ended December 31, 2002, 2001 and 2000.
In the past several years, CNA has experienced significant increases in claim counts for asbestos-related claims. The factors that led to these increases included, among other things, intensive advertising campaigns by lawyers for asbestos claimants, mass medical screening programs sponsored by plaintiff lawyers, and the addition of new defendants such as the
distributors and installers of products containing asbestos. Currently, the majority of asbestos bodily injury claims are filed by persons exhibiting few, if any, disease symptoms. It is estimated that approximately 90% of the current non-malignant asbestos claimants do not meet the American Medical Association’s definition of impairment. Some courts, including the federal district court responsible for pre-trial proceedings in all federal asbestos bodily injury actions, have ordered that so-called “unimpaired” claimants may not recover unless at some point the claimant’s condition worsens to the point of impairment.
CNA, through its acquisition of CIC in 1995, acquired obligations under the Wellington Agreement. In 1985, 47 asbestos producers and their insurers, including CIC, executed the Wellington Agreement. The agreement intended to resolve all issues and litigation related to coverage for asbestos exposures. Under this agreement, signatory insurers committed scheduled policy limits and made the limits available to pay asbestos claims based upon coverage blocks designated by the policyholders in 1985, subject to extension by policyholders. CIC was a signatory insurer to the Wellington Agreement. At December 31, 2002, CNA had fulfilled its Wellington Agreement obligations as to all but five accounts. With respect to the five remaining unpaid Wellington obligations, CNA has evaluated its exposure under these agreements and has established a $28 million reserve, net of reinsurance, for Wellington obligations.
CNA has also used coverage in place agreements to resolve large asbestos exposures. Coverage in place agreements are typically agreements between CNA and its policyholders identifying the policies and the terms for payment of asbestos related liabilities. Claims payments are contingent on presentation of adequate documentation showing exposure during the policy periods and other documentation supporting the demand for claims payment. Coverage in place agreements may have annual payment caps. At December 31, 2002, CNA had negotiated 23 such agreements in which CNA committed coverage for payment of claims
At December 31, 2002, CNA’s total IBNR reserve for asbestos was $729 million, net of reinsurance. For asbestos exposures, CNA classifies its IBNR reserve as assigned or unassigned. In circumstances where CNA has executed a settlement agreement with its policyholder, CNA assigns IBNR reserve to that account to cover the projected value of the settlement. At December 31, 2002, the assigned IBNR reserve was $166 million, net of reinsurance. The unassigned IBNR reserve relates to potential development on accounts that have not settled and potential future claims for unidentified policyholders. At December 31, 2002, CNA’s unassigned IBNR reserve was $563 million, net of reinsurance.
On February 13, 2003, CNA announced it had resolved asbestos related coverage litigation and claims involving A.P. Green Industries, A.P. Green Services and Bigelow - Liptak Corporation. Under the agreement, CNA will be required to pay $74 million, net of reinsurance recoveries, over a ten year period. The settlement resolves CNA’s liabilities for all pending and future asbestos claims involving A.P. Green Industries, Bigelow-Liptak Corporation and related subsidiaries, including alleged “non-products” exposures. The settlement is subject to bankruptcy court approval and confirmation of a bankruptcy plan containing a channeling injunction to protect CNA from any future claims. The Company’s recorded reserves as of December 31, 2002, included reserves for this exposure.
issued to it by CNA. CNA is also a party to insurance coverage litigation between Burns & Roe Enterprises, Inc. (Burns & Roe) and its insurance carriers related to asbestos bodily injury and wrongful death claims (In re: Burns & Roe Enterprises, Inc., pending in the U.S. Bankruptcy Court for the District of New Jersey, No. 00-41610). Burns & Roe provided various engineering and related services in connection with construction projects. Burns & Roe is currently in bankruptcy. There are numerous factual and legal issues to be resolved in connection with these cases and it is difficult to predict the outcome or financial exposure represented by these matters in light of the novel theories asserted by policyholders and their counsel.
Also in the 2000 to 2001 time period, a number of significant asbestos defendants filed for bankruptcy, increasing the likelihood that excess layers of insurance coverage could be called upon to indemnify policyholders and creating the potential that novel legal doctrines could be employed, which could accelerate the time when such indemnification payments could be due.
These developments led the Company to the conclusion that its asbestos reserves required strengthening.
Unfavorable net claim and claim adjustment expense reserve development for other reserves in 2002 of $35 million was the result of analyses of several lines of business. This development
In addition, Standard Lines had favorable prior year reserve development, primarily in the package liability and auto liability lines of business due to new claims initiatives. Based on management’s best estimate of the reduction in ultimate claim costs, approximately $100 million of favorable prior year reserve development was recorded in 2002. Approximately one-half of this favorable reserve development was recorded in accident years prior to 1999, with the remainder of the favorable reserve development recorded in accident years 1999 to 2001.
Approximately $45 million of favorable reserve development was recorded in property lines during 2002. The favorable reserve development was principally from accident years 1999 through 2001, and was the result of the low number of large losses in recent years. Although property claims are generally reported relatively quickly, determining the ultimate cost of the claim can involve a significant amount of time between the occurrence of the claim and settlement.
1999. The Company expected that loss ratios for this business would be similar to its middle market commercial automobile liability business. Reviews completed during the year resulted in estimated loss ratios on the tow truck and ambulance business that are 25 points higher than the middle market commercial automobile liability loss ratios.
The unfavorable reserve development on contractors account package policies was the result of an actuarial review completed during 2002. Since this program is no longer being written, the Company expected that the change in reported losses would decrease each quarterly period. However, in recent quarterly periods, the change in reported losses has been higher than prior quarters, resulting in the unfavorable reserve development.
The gross and net carried claim and claim adjustment expense reserves for Specialty Lines were $5,668 million and $3,461 million for the beginning of the year of 2002.
The gross and net carried claim and claim adjustment expense reserves for CNA Re were $4,644 million and $3,013 million for the beginning of the year of 2002.
Unfavorable net claim and claim adjustment expense reserve development for other reserves in 2001 of $1,223 million was the result of analyses of several lines of business. This development related principally to commercial insurance coverages including automobile liability and multiple-peril, as well as assumed reinsurance and healthcare-related coverages. A brief summary of these lines of business and the associated reserve development is discussed below.
As a result of this review and changes in premiums associated with the change in estimates for loss reserves, the Company recorded a pretax reduction in premium accruals of $566 million. The effect on net earned premiums was $616 million offset by a reduction of accrued commissions of $50 million. The studies included the review of all such retrospectively rated insurance policies and the estimate of ultimate losses.
Approximately $188 million of this amount resulted from a change in estimate in premiums related to involuntary market facilities, which had an offsetting impact on net losses and therefore had no impact on the net operating results. More than one-half of the change in
estimate in premiums was attributable to accident years 1997 through 1999 with the remainder attributable to accident years prior to 1992. Accruals for ceded premiums related to other reinsurance treaties increased $83 million due to the reserve strengthening. This increase in accruals for ceded premiums was principally recorded in accident year 2000. The remainder of the decrease in premium accruals relates to the change in estimate of the amount of retrospective premium receivables as discussed above, which were principally recorded in accident years prior to 1999.
Unfavorable net claim and claim adjustment expense reserve development for other reserves in 2000 of $347 million was due to unfavorable loss experience in standard commercial lines, assumed reinsurance and accident and health lines. These unfavorable changes were partially offset by favorable development in non-medical professional liability and other casualty lines. The unfavorable development in standard commercial lines can be attributed to adverse claim experience for recent accident years in the commercial auto liability, commercial multi-peril and workers compensation lines of business. The unfavorable development in the assumed reinsurance and accident and health lines also resulted from adverse claims experience.
CNA, through assumed reinsurance contracts, provided financial guarantees to issuers of asset-backed securities, motion picture finance and money market funds. Premiums were received throughout the exposure period and were recognized as revenue in proportion to the underlying risk insured. In addition, CNA’s property and casualty subsidiaries wrote financial guarantee insurance in the form of surety bonds and also insured equity policies through August 1, 1989. These bonds represented primarily industrial development bond guarantees and, in the case of insured equity policies, typically extended in initial terms from 10 to 13 years. For these guarantees and policies CNA received an advance premium that was recognized over the exposure period and in proportion to the underlying risk insured.
As of December 31, 2002 and 2001, gross exposure on assumed financial guarantee insurance contracts, credit enhancement products, financial guarantee surety bonds and insured equity policies was approximately $7 million and $82 million. The degree of risk to CNA related to this exposure is substantially reduced through reinsurance, diversification of exposures and collateral requirements. In addition, security interests in improved real estate are also commonly obtained on these risks. Approximately 14% and 26% of the risks were ceded to reinsurers at December 31, 2002 and 2001. Total exposure, net of reinsurance, amounted to $6 million and $61 million as of December 31, 2002 and 2001. At December 31, 2002 and
2001, collateral consisting of letters of credit, cash reserves and debt service reserves amounted to $1 million and $6 million.
In 1997, CNA Reinsurance Company Limited (CNA Re Ltd.), a subsidiary of CNA Re U.K., entered into an arrangement with IOA Global, Ltd. (IOA), an independent managing general agent based in Philadelphia, Pennsylvania, to develop and manage a book of accident and health coverages. Pursuant to this arrangement, IGI Underwriting Agencies, Ltd. (IGI), a personal accident reinsurance managing general underwriter, was appointed to underwrite and market the book under the supervision of IOA. Between April 1, 1997 and December 1, 1999, IGI underwrote a number of reinsurance arrangements with respect to personal accident insurance worldwide (the IGI Program). Under various arrangements, CNA Re Ltd. both assumed risks as a reinsurer and also ceded a substantial portion of those risks to other companies, including other CNA insurance subsidiaries and ultimately to a group of reinsurers participating in a reinsurance pool known as the Associated Accident and Health Reinsurance Underwriters (AAHRU) Facility. CNA’s Group Operations business unit participated as a pool member in the AAHRU Facility in varying percentages between 1997 and 1999.
described above. As a result of these uncertainties, the results of operations in future years may be adversely affected by potentially significant reserve additions. Management does not believe that any such reserve additions will be material to the equity of the Company, although results of operations may be adversely affected. The Company’s position in relation to the IGI Program was unaffected by the sale of CNA Re U.K. in 2002. See Note P for further discussion of the sale.
In Ernestine Samora, et al. v. CCC, Case No. BC 242487, Superior Court of California, County of Los Angeles, California and Brian Wenzel v. Galway Insurance Company, Superior Court of California, County of Orange No. BC01CC08868 (coordinated), two former CNA employees, filed lawsuits in Los Angeles Superior Court on behalf of purported classes of CNA employees asserting they worked hours for which they should have been compensated at a rate of one and one-half times their base hourly wage over a four-year period. The cases were coordinated and an amended complaint was filed which alleges overtime claims under California law over a four-year period. In June 2002, the Company filed a responsive pleading denying the material allegations of the amended complaint. The Company intends to defend this case vigorously. Due to the recent commencement of discovery and the uncertainty of how the courts may interpret California law as applied to the facts of these cases, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time. Based on facts and circumstances presently known, however, in the opinion of management, the outcome will not materially affect the equity of the Company, although results of operations may be adversely affected.
CNA, along with dozens of other insurance companies, is a defendant in sixteen purported class action cases brought by large policyholders, which generally allege that the defendants, as part of an industry-wide conspiracy, included improper charges in their retrospectively rated and other loss-sensitive insurance premiums. Fourteen lawsuits were brought as class actions in state courts and two in federal court. Among the claims asserted were violations of state antitrust laws, breach of contract, fraud and unjust enrichment. In two of the cases, the defendants won dismissals on motions and, in four others, class certification was denied after hearing. Plaintiffs voluntarily dismissed their claims in four states. In the federal court case, Sandwich Chef of Texas, Inc., et al. v. Reliance National Indemnity Insurance Company, et al., Civil Action No. H-98-1484, United States District Court for the Southern District of Texas, the district court certified a multi-state class but was reversed on interlocutory appeal by the U.S. Court of Appeals for the Fifth Circuit. Due to the uncertainty of how the courts may interpret state and federal law as applied to the facts of the cases, the extent of potential losses beyond any amounts that may be accrued are not readily determinable at this time. Based on facts and circumstances presently known, however, in the opinion of management the outcome will not materially affect the equity of the Company, although results of operations may be adversely affected.
The amount subject to interest crediting on these funds withheld contracts will vary over time based on a number of factors, including the timing of loss payments and ultimate gross losses incurred. The Company expects that it will continue to incur significant interest costs on these contracts for several years.
relates to the estimated case and IBNR reserves and future policyholder benefits ceded under reinsurance contracts.
The Company attempts to mitigate its credit risk related to reinsurance by entering into reinsurance arrangements only with reinsurers that have credit ratings above certain levels and by obtaining substantial amounts of collateral. The primary methods of obtaining collateral are through reinsurance trusts, letters of credit and funds withheld balances. Such collateral was approximately $4,825 million and $3,696 million at December 31, 2002 and 2001.
CNA’s largest recoverables from a single reinsurer at December 31, 2002, including prepaid reinsurance premiums, were approximately $2,090 million, $1,456 million, $890 million, $616 million, $598 million, and $541 million from subsidiaries of The Allstate Corporation (Allstate), subsidiaries of Hannover Reinsurance (Ireland) Ltd., American Reinsurance Company, European Reinsurance Company of Zurich, subsidiaries of Gerling Global Reinsurance Corporation, and Lloyd’s Underwriters.
The Company has established an allowance for doubtful accounts to provide for estimated uncollectible reinsurance receivables. The allowance for doubtful accounts was $196 million and $170 million at December 31, 2002 and 2001.
The effects of reinsurance on earned premiums and written premiums for the years ended December 31, 2002, 2001 and 2000 are shown in the following tables.
The Company has a $250 million three-year bank credit facility with an April 30, 2004 expiration date. The Company previously had a $250 million 364-day facility with an expiration date of
April 29, 2002. An option to convert the 364-day facility to a one-year term loan was exercised in April of 2002. The term loan was subsequently prepaid on December 23, 2002.
The Company pays interest on any outstanding debt/borrowings under the three-year facility based on a rate determined using the long term debt ratings of the Company. The interest rate is equal to the London Interbank Offering Rate (LIBOR) plus 57.5 basis points. Further, if the Company has outstanding loans greater than 50% of the amounts available under the three-year facility, the Company also will pay a utilization fee of 12.5 basis points on such loans. At December 31, 2002 and 2001, the weighted-average interest rate on the borrowings under the facility, including facility fees and utilization fees, was 2.3% and 3.1%.
On September 30, 2002, CNA Surety Corporation (CNA Surety), a 64% owned and consolidated subsidiary of CNA, entered into a $65 million credit agreement with one bank, which consisted of a $35 million 364-day revolving credit facility and a $30 million three-year term loan, payable semi-annually at a rate of $5 million. The credit agreement replaced a $130 million five-year revolving credit facility that terminated September 30, 2002. The new revolving credit facility was fully utilized at inception.
The terms of the new credit facility agreement required the assumption by a second bank of $15 million of the credit risk by November 30, 2002 or CNA Surety would be required to repay $15 million to reduce the amount of the credit facility commitment from $35 million to $20 million. On November 29, 2002, CNA Surety repaid $11 million of the outstanding borrowings and arranged for the due date on the remaining $4 million to be delayed to March 31, 2003. A second bank subsequently assumed $10 million of the credit risk resulting in an additional $6 million of outstanding borrowings, leaving the credit facility commitment at $30 million. As of December 31, 2002, the revolving credit facility was fully utilized.
The terms of CNAF’s and CNA Surety’s credit facilities require CNAF and CNA Surety to maintain certain financial ratios and combined property and casualty company statutory surplus levels. At December 31, 2002 and 2001, CNAF and CNA Surety were in compliance with all restrictive debt covenants.
The Company has provided guarantees related to irrevocable standby letters of credit for certain of its subsidiaries. Certain of these subsidiaries have been sold; however, the irrevocable standby letter of credit guarantees remain in effect. The Company would be required to remit prompt payment on the letters of credit in question if the primary obligor drew down on these letters of credit and failed to repay such loans in accordance with the terms of the letters of credit. The maximum potential amount of future payments that CNA could be required to pay under these guarantees are approximately $30 million at December 31, 2002.
CNAF and certain subsidiaries sponsor noncontributory pension plans typically covering full-time employees age 21 or over who have completed at least one year of service. While the terms of the plans vary, benefits are generally based on years of credited service and the employee’s highest 60 consecutive months of compensation.
CNA’s funding policy is to make contributions in accordance with applicable governmental regulatory requirements. The assets of the plans are invested primarily in U.S. government securities with the balance in mortgage-backed securities, equity investments and short term investments.
plan or 2) to convert the present value of their accrued benefit in the pension plan to an “accrued pension account” (APA) that would be credited with interest at the 30-year Treasury rate and to receive enhanced employer contributions to the Savings and Capital Accumulation Plan (S-CAP) (see Savings Plan discussion below). Approximately 60% of eligible employees elected the latter choice, resulting in a curtailment charge of approximately $13 million pretax. Additionally, this change in benefit plan participation resulted in a reduction of the pension benefit obligation of $37 million at December 31, 2000.
services related to claims, risk control, cost management and information services, to contribute a maximum of 20% of their eligible compensation, subject to certain limitations prescribed by the Internal Revenue Service. The Company contributes matching amounts to participants, amounting to 70% of the first 6% (35% of the first 6% in the first year of employment) of eligible compensation contributed by the employee. Employees vest in these contributions ratably over five years.
The Board of Directors approved the CNA Long Term Incentive Plan (the LTI Plan) during 1999 and subsequently merged it with the CNA Financial Corporation Incentive Compensation Plan in February 2000. The LTI Plan authorizes the grant of options to certain management personnel for up to 2.0 million shares of the Company’s common stock. All options granted have ten-year terms and vest ratably over the four-year period following the date of grant. The number of shares available for the granting of options under the LTI Plan as of December 31, 2002, was approximately 0.5 million.
The fair value of granted options was estimated at the grant date using the Black-Scholes option-pricing model. The weighted-average fair value of options granted during each of the three years ended December 31, 2002, 2001 and 2000 was $3 million, $4 million and $4 million. The following weighted-average assumptions were used for the years ended December 31, 2002, 2001 and 2000: risk free interest rate of 4.0%, 4.5%, and 6.2%; expected dividend yield of 0%; and expected option life of five years. The weighted-average assumption for the expected stock price volatility was 25.2%, 26.4% and 29.2% for the years ended December 31, 2002, 2001 and 2000.
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, 2002.
lease agreements. The maximum potential amount of future payments that the Company could be required to pay under these guarantees are approximately $8 million at December 31, 2002.
In the normal course of business, CNA has obtained letters of credit in favor of various unaffiliated insurance companies, regulatory authorities and other entities. At December 31, 2002 and 2001, there were approximately $222 million and $270 million of outstanding letters of credit.
The Company has entered into a limited number of guaranteed payment contracts, primarily relating to telecommunication services, amounting to approximately $24 million. Estimated future minimum payments under these contracts are as follows: $13 million in 2003; $9 million in 2004; and $2 million in 2005.
The Company has a commitment to purchase up to a $100 million floating rate note issued by the California Earthquake Authority in the event of an earthquake during calendar year 2003 that results in California earthquake related losses greater than $4.2 billion.
The Preferred Issue is senior to CNAF’s common stock as to the payment of dividends and amounts payable upon any liquidation, dissolution or winding up. No dividends may be declared on CNAF’s common stock until all cumulative dividends on the Preferred Issue have been paid. CNAF may not issue any equity securities ranking senior to or on par with the Preferred Issue without the consent of a majority of its stockholders. The Preferred Issue is non-voting and is not convertible into any other securities of CNAF. It may be redeemed only upon the mutual agreement of CNAF and a majority of the stockholders of the preferred stock. The Preferred Issue is exempt from registration under Section 4(2) of the Securities Act of 1933.
Of the proceeds of the Preferred Issue, $250 million was used to prepay a bank term loan due in April of 2003 and $250 million was contributed to CCC to improve its statutory surplus. It is expected that the remaining proceeds will be used to repay other debt of CNAF and The Continental Corporation, a controlled subsidiary, maturing in 2003 and used for other general corporate purposes.
the rights offering amounted to $1,006 million. In connection with the rights offering, Loews purchased 38,281,644 shares.
CNA’s Board of Directors has approved the Share Repurchase Program to purchase, in the open market or through privately negotiated transactions, its outstanding common stock, as Company management deems appropriate. During 2000, CNA purchased 1,272,700 shares of its common stock for approximately $35 million. No shares of common stock were purchased during 2002 or 2001.
In 2001, CCC filed for approval with the Illinois Department of Insurance (the Department) the affiliated promissory note between CCC and Viaticus, Inc., a wholly owned subsidiary of CNAF. Review of this note was still ongoing by the Department at December 31, 2001 so, the Department granted a permitted practice that expired on June 30, 2002 to carry this note at a value of approximately $449 million as of December 31, 2001. The par value of this note at December 31, 2001 was approximately $464 million. The Department approved the note and the valuation basis in 2002.
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 Department, may be paid only from earned surplus, which is calculated by removing unrealized gains from unassigned surplus. As of December 31, 2002, CCC’s earned surplus is in a positive position, thereby enabling CCC to pay approximately $1,069 million of dividend payments during 2003 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.
During 2002, CNA underwent management changes and strategic realignment. These events have changed the way CNA manages its operations and makes business decisions and, therefore, necessitated a change in the Company’s reportable segments. The financial results for the following segment changes are reflected in the following tables in this note.
Specialty Lines provides professional, financial and specialty domestic and international property and casualty products and services through a network of brokers, managing general agencies and independent agencies. Specialty Lines provides solutions for managing the risks of its clients, including architects, engineers, lawyers, healthcare professionals, financial intermediaries and corporate directors and officers. Product offerings also include surety and fidelity bonds and vehicle and equipment warranty services. Specialty Lines includes the following business groups: Professional Liability Insurance, CNA Guaranty and Credit, Surety, CNA Global and Warranty.
Group Operations also provided life and health insurance to federal employees. During 2002, the Company sold Claims Administration Corporation and transferred the National Postal Handlers Union group benefits plan (the Mail Handlers Plan) to First Health Group Corporation. Group Operations’ revenues include $1,151 million, $2,231 million and $2,088 million in 2002, 2001 and 2000 under contracts covering U.S. government employees and their dependents. See Note P for further discussion of the Claims Administration Corporation and the Mail Handlers Plan.
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 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/losses are allocated primarily based on each segment’s net carried insurance reserves, as adjusted.
revenue and expenses eliminated at the consolidated level were approximately $130 million, $154 million and $159 million for the years ended December 31, 2002, 2001 and 2000.
In the following three tables, the caption “net operating income (loss)” is used by the Company as an operating measure of segment performance. Net operating income (loss) is calculated by deducting net realized investment gains or losses (investment gains or losses after deduction of related income taxes, participating policyholders’ and minority interests), gains or losses from discontinued operations, net of tax, and the cumulative effect of a change in accounting principle, net of tax, from net income. Net realized investment gains or losses are excluded from net operating income because net realized investment gains or losses, other than investment impairment losses, related to the Company’s available-for-sale investment portfolio are largely discretionary, are generally driven by economic factors that are not necessarily consistent with key drivers of underwriting performance, and are therefore not an indication of trends in operations.
Through December 31, 2002, 249 employees were released due to the IT Plan, nearly all of whom were technology support staff. In December of 2002, the accrual was reduced by $4 million in the Corporate and Other segment primarily related to employee termination costs.
these employees were administrative, technology or financial support staff; approximately 52% of these employees were underwriters, claim adjusters and related insurance services staff; and approximately 9% of these employees were in various other positions. During December of 2002, $8 million of accrual was reduced primarily due to successful redeployment of employees to other positions within the organization. An accrual of $1 million remained at December 31, 2002 relating to employee termination costs which will be paid in 2003.
The 2001 Plan charges incurred and accrued by CNA Re were $6 million. Costs related to employee termination and related benefit costs for planned reductions in the workforce of 33 positions gross and net, amounted to $2 million, all of which related to severance and outplacement costs. Payments of $1 million were made in 2002 for approximately 15 employees net released through December 31, 2002 due to the 2001 Plan. The remaining $4 million of charges incurred by CNA Re related to lease termination costs. Approximately $1 million was paid in 2002 related to lease termination costs. As a result of the sale of CNA Re U.K., the remaining accrual related to CNA Re of $4 million was reduced. See Note P for further discussion of the sale.
The 2001 Plan charges incurred and accrued by Group Operations were $42 million. Costs related to employee termination and related benefit costs for planned reductions in the workforce of 187 positions, gross and net, amounted to $7 million. Through December 31, 2002, 82 employees net in Group Operations were released due to the 2001 Plan. Approximately 28% of these employees were administrative, technology or financial support staff; and approximately 72% of these employees were underwriters, claim adjusters and related insurance services staff. Other costs of $35 million in Group Operations relate to a write-off of deferred acquisition costs on inforce variable life and annuity contracts, as the company believes that the decision to discontinue these products will negatively impact the persistency of the business.
At December 31, 2001, an accrual of $1 million for lease termination costs remained related to the August 1998 restructuring (1998 Plan). In December of 2002, this accrual was reduced.
As a result of this agreement, Phoenix assumed net assets of $6 million. At December 31, 2002, approximately $479 million of separate account assets and $479 million of separate account policy reserves related to the variable life and annuity business continue to be held by the Company and are reported in separate account business in the assets and liabilities sections of the Consolidated Balance Sheet. The assets and liabilities of the variable life and annuity business were $637 million (primarily separate account assets) and $637 million (primarily separate account policy reserves) as of December 31, 2001.
The variable life and annuity business’ premiums and fee income were $8 million, $11 million and $5 million for the years ended December 31, 2002, 2001 and 2000. Net loss was $5 million, $44 million and $12 million for the years ended December 31, 2002, 2001 and 2000.
Net income from Claims Administration Corporation and Mail Handlers Plan was $5 million, including the non-recurring fee income, $16 million and $6 million for the years ended December 31, 2002, 2001 and 2000.
In the first quarter of 2002, the Company completed the sale of the common stock of CNA Holdings Limited and its subsidiaries (CNA Vida), CNA’s life operations in Chile, to Consorcio Financiero S.A. (Consorcio). In connection with the sale, CNA received proceeds of $73 million and recorded an after-tax loss from discontinued operations of $35 million. This loss is composed of $37 million, net of tax, realized loss on the sale of CNA Vida and income of $2 million, net of tax, from CNA Vida’s operations for 2002.
Effective December 31, 2000, CNA completed a transaction with Munich American Reassurance Company (MARC), whereby MARC acquired CNA’s individual life reinsurance business (CNA Life Re) via an indemnity reinsurance agreement. CNA will continue to accept and retrocede business on existing CNA Life Re contracts until such time that CNA and MARC are able to execute novations of each of CNA Life Re’s assumed and retroceded reinsurance contracts.
During the second quarter of 2001, the Company announced its intention to sell certain businesses. The assets being held for disposition included CNA Re U.K. and certain other businesses. Based upon the impairment analyses performed at that time, the Company anticipated that it would realize losses in connection with those planned sales. In determining the anticipated loss from these sales, the Company estimated the net realizable value of each business being held for sale. An estimated after-tax loss of $320 million was initially recorded in the second quarter of 2001. This loss was reported in realized investment gains/losses in the Consolidated Statements of Operations.
In the fourth quarter of 2001, the Company sold certain businesses as planned. The realized after-tax loss applicable to these businesses recognized in the second quarter of 2001 was $38 million. Revenues of these businesses included in the years ended December 31, 2001 and 2000 totaled approximately $33 million and $37 million. These businesses contributed approximately $11 million and $8 million of net losses in the years ended December 31, 2001 and 2000.
net exposure to all IGI Program liabilities was assumed by CCC. Further, CCC is providing a $100 million stop loss cover attaching at carried reserves on CNA Re U.K.’s 2001 underwriting year exposures for which CCC received premiums of $25 million.
CNA shares in indemnity and claim and allocated claim adjustment expenses if payments related to losses incurred prior to October 1, 1999 on the CNA policies transferred to Allstate exceed the claim and allocated claim adjustment expense reserves of approximately $1 billion at the date of sale. CNA’s obligation with respect to unallocated claim adjustment expenses was settled at the transaction date and is therefore not subject to the sharing arrangement. CNA must reimburse Allstate for 80% of the first $40 million of payments in excess of $1 billion, and for 90% of any additional payments in excess of the first $40 million. The Company must begin to reimburse Allstate for claim and allocated claim adjustment expense payments when cumulative claim payments after October 1, 1999 on losses occurring prior to that date exceed the $1 billion. The Company’s remaining obligation valued under this loss sharing provision as of October 1, 2003, will be settled by agreement of the parties or by an independent actuarial review of the unpaid claim liabilities as of that date. Cumulative payments of indemnity and loss adjustment expenses on such policies are expected to exceed $1 billion during 2003. The Company has established reserves for its estimated liability under this loss sharing arrangement.
The following tables set forth unaudited quarterly financial data for the years ended December 31, 2002 and 2001 as previously reported before a restatement to reflect a change in the accounting for the Company’s investment in life settlement contracts. See Note T for further discussion.
On December 19, 2002, CNAF sold $750 million of a new issue of preferred stock, designated Series H Cumulative Preferred Issue (Preferred Issue), to Loews. The terms of the Preferred Issue were approved by a special committee of independent members of CNAF’s Board of Directors. See Note L for further details of this transaction.
During 2001, CNA issued and sold 40,324,363 shares of common stock for $25 per share through a rights offering to stockholders of record on August 23, 2001. The net proceeds from the rights offering amounted to $1,006 million. In connection with the rights offering, Loews purchased 38,281,644 shares. See Note L for further details of this transaction.
CNA assumes the risk for a limited amount of insurance from R.V.I. Guaranty Company, Inc. (RVI), an unconsolidated affiliate. CNA assumed approximately $0.3 million, $2 million and $11 million in written premiums from RVI during 2002, 2001 and 2000.
In March of 2003, CNAF also purchased the contractor’s outstanding bank debt for $16.4 million. Under the new credit facility, the contractor agreed to purchase from CNAF and retire the bank debt for $16.4 million, with $11.4 million of the purchase price being funded under the new credit facility and $5 million from money loaned to the contractor by its shareholders. Under its purchase agreement with the banks, CNAF is also required to reimburse the banks for any draws upon approximately $6.5 million in outstanding letters of credit issued by the banks for the contractor’s benefit that expire between May and August of 2003. Any CNAF reimbursements for draws upon the banks’ letters of credit will become obligations of the contractor to CNAF as draws upon the credit facility.
The contractor has initiated a restructuring plan that is intended to reduce costs and improve cash flow, and a chief restructuring officer has been appointed to manage execution of the plan. CNAF, through its affiliate CNA Surety, intends to continue to provide surety bonds on behalf of the contractor during this restructuring period, subject to the contractor’s initial and ongoing compliance with CNA Surety’s underwriting standards. Any losses arising from bonds issued or assumed by the insurance subsidiaries of CNA Surety to the contractor are excluded from CNA Surety’s $40 million excess of $20 million per principal reinsurance program with unaffiliated reinsurers in place in 2002. As a result, CNA Surety retains the first $60 million of losses on bonds written with an effective date of September 30, 2002 and prior, and CCC will incur 100% of losses above that retention level on bonds with effective dates prior to September 30, 2002. Through facultative reinsurance contracts with CCC, CNA Surety’s exposure on bonds written from October 1, 2002 through December 31, 2002 has been limited to $20 million per bond.
CCC provided an Excess of Loss Contract to the insurance subsidiaries of CNA Surety with the capacity to underwrite large surety bond exposures. The Excess of Loss Contract provided $75 million of coverage in excess of the $40 million of coverage provided to the insurance subsidiaries of CNA Surety in 2002 by third party reinsurers, which is in turn in excess of the $20 million of per principal losses retained by the CNA Surety insurance subsidiaries. Subsequent to September 30, 1997, CNA Surety entered into a second excess of loss contract with CCC (Second Excess of Loss Contract). The Second Excess of Loss Contract provides additional coverage for principal losses that exceed the foregoing coverage of $75 million per principal provided by the Excess of Loss Contract, or aggregate losses per principal in excess of $135 million. CCC is also obligated to act as a joint insurer, or “co-surety,” for business covered by the Excess of Loss Contract when requested by the CNA Surety insurance subsidiaries. In consideration for the reinsurance coverage provided by the Excess of Loss Contracts, the insurance subsidiaries of CNA Surety paid to CCC, on a quarterly basis, a premium equal to 1% of the net written premiums applicable to the Excess of Loss Contract, subject to a minimum premium of $20 thousand and $5 thousand per quarter under the Excess of Loss Contract and Second Excess of Loss Contract, respectively. The two Excess of Loss Contracts collectively provide coverage for losses discovered on surety bonds in force as of September 30, 1997 and for losses discovered on new and renewal business written during the term of the Excess of Loss Contracts. Both Excess of Loss Contracts commenced immediately following September 30, 1997 and continue for a period of five years from September 30, 1997 or until September 30, 2002. The discovery period for losses covered by the Excess of Loss Contracts extends until three years after the September 30, 2002 expiration date of the contracts.
CCC, effective October 1, 2002, has secured replacement excess of loss protection for new and renewal bonds for CNA Surety for per principal exposures that exceed $60 million since October 1, 2002 in two parts - a) $40 million excess of $60 million and b) $50 million excess of $100 million for CNA Surety. This excess of loss protection is primarily necessary to support new and renewal bonds for contract surety accounts with bonded backlogs or work-in-process in excess of $60 million. In consideration for the reinsurance coverage provided by the $40 million excess of $60 million contract, CNA Surety will pay to CCC, on a quarterly basis, a premium equal to $3 million. In 2002, the insurance subsidiaries of CNA Surety paid $4 million in premium to CCC in consideration of the coverage provided by the $50 million excess of $100 million.
The SEC concluded that FASB Technical Bulletin 85-4 Accounting for Purchases of Life Insurance (FTB 85-4) should have been applied to the Company’s investment in life settlement contracts. Under FTB 85-4, the carrying value of each contract at purchase and at the end of each reporting period is equal to the cash surrender value of the policy. Amounts paid to purchase these contracts that are in excess of the cash surrender value, at the date of purchase, are expensed immediately. Periodic maintenance costs, such as premiums, necessary to keep the underlying policy inforce are expensed as incurred and included in other
Amounts previously reported have been revised to reflect the presentation of CNA Vida as a discontinued operation. See Note P for further discussion.
Also, as discussed in Note A to the consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill and indefinite-lived intangible assets and in 2001 the Company changed its method of accounting for derivative instruments and hedging activities.