exploration, production and marketing of natural gas and oil (including condensate and natural gas liquids), (HighMount Exploration & Production LLC (“HighMount”), a wholly owned subsidiary);
commercial automobile liability, workers’ compensation, general liability, medical, professional liability, other professional liability coverages, assumed reinsurance run-off and products liability. Short-tail exposures include property, commercial automobile physical damage, marine and warranty. CNA Specialty and CNA Commercial contain both long-tail and short-tail exposures. Other Insurance contains long-tail exposures.
For other more complex products where the above methods may not produce reliable indications, CNA uses additional methods tailored to the characteristics of the specific situation.
Net income increased $239 million in 2010 as compared with 2009. This improvement was driven by significantly improved net investment results of $943 million ($551 million after tax and noncontrolling interests), partially offset by the loss associated with the Loss Portfolio Transfer. See the Investments section of this MD&A for further discussion of net realized investment results and net investment income. Favorable net prior year development of $594 million and $208 million was recorded for 2010 and 2009. Further information on net prior year development for the year ended December 31, 2010 and 2009 is included in Note 8 of the Notes to Consolidated Financial Statements included under Item 8. Net earned premiums decreased $206 million in 2010 as compared with 2009, driven by a $176 million decrease in CNA Commercial and an $18 million decrease in CNA Specialty. See the CNA Segment Results section of this MD&A for further discussion. Net loss from discontinued operations increased $18 million in 2010 as compared to 2009, due to the loss associated with the Loss Portfolio Transfer.
CNA Specialty’s average rate was flat for 2011, as compared to a decrease of 2.2% in 2010 for the policies that renewed in each period. Retention of 86.1% and 85.7% was achieved in each period.
The combined ratio improved 1.5 points in 2010 as compared with 2009. The loss ratio improved 2.9 points, primarily due to increased favorable net prior year development, partially offset by the impact of a higher current accident year loss ratio. The expense ratio increased 1.2 points primarily related to higher underwriting expenses and higher commission rates. Underwriting expenses were unfavorably impacted by higher employee-related costs and IT costs.
In addition, under its insurance policy that expires on May 1, 2012, Diamond Offshore carries marine liability insurance covering certain legal liabilities, including coverage for certain personal injury claims, with no exclusions for pollution and/or environmental risk. Diamond Offshore believes that the policy limit for its marine liability insurance is within the range that is customary for companies of its size in the offshore drilling industry and is appropriate for Diamond Offshore’s business. Diamond Offshore’s deductibles for marine liability coverage, including for personal injury claims, are $10 million for the first occurrence and vary in amounts ranging between $5 million and, if aggregate claims exceed certain thresholds, up to $100 million for each subsequent occurrence, depending on the nature, severity and frequency of claims which might arise during the policy year, which under the current policy commences on May 1 of each year.
(b) Includes $507 million, $524 million, $524 million and $324 million for the years 2012 to 2015, attributable to contracted operations offshore Brazil.
Operating expenses increased $74 million in 2010 as compared with 2009. This increase was primarily driven by a $47 million increase in fuel consumed due to the pipeline expansion projects and higher natural gas prices. There was a $24 million increase in depreciation and property taxes due to a larger asset base from the pipeline expansion projects and a $10 million increase in operation and maintenance expenses due to an increase in major maintenance projects. The 2009 period was unfavorably impacted by $8 million of pipeline investigation and retirement costs related to the East Texas Pipeline. Interest expense increased $19 million due to higher debt levels in 2010 and lower capitalized interest due to the completion of Boardwalk Pipeline’s pipeline expansion projects.
Dividends of $76 million and $122 million on the 2008 Senior Preferred were declared and paid for the years ended December 31, 2010 and 2009.
The fixed maturity investment portfolio provided a pretax effective income yield of 5.5%, 5.6% and 5.7% for the years ended December 31, 2011, 2010, and 2009. Tax-exempt municipal bonds generated $240 million, $263 million and $381 million of net investment income for the years ended December 31, 2011, 2010 and 2009.
For asset-backed securities included in fixed maturity securities, the Company recognizes income using an effective yield based on anticipated prepayments and the estimated economic life of the securities. When estimates of prepayments change, the effective yield is recalculated to reflect actual payments to date and anticipated future
The Company’s carrying value of investments in limited partnerships is its share of the net asset value of each partnership, as determined by the General Partner. Certain partnerships for which results are not available on a timely basis are reported on a lag, primarily three months or less. These investments are accounted for under the equity method and changes in net asset values are recorded within Net investment income on the Consolidated Statements of Income.
Reinsurance contracts that do not effectively transfer the economic risk of loss on the underlying policies are recorded using the deposit method of accounting, which requires that premium paid or received by the ceding company or assuming company be accounted for as a deposit asset or liability. CNA had $18 million and $23 million recorded as deposit assets at December 31, 2011 and 2010, and $123 million and $114 million recorded as deposit liabilities at December 31, 2011 and 2010. Income on reinsurance contracts accounted for under the deposit method is recognized using an effective yield based on the anticipated timing of payments and the remaining life of the contract. When the anticipated timing of payments changes, the effective yield is recalculated to reflect actual payments to date and the estimated timing of future payments. The deposit asset or liability is adjusted to the amount that would have existed had the new effective yield been applied since the inception of the contract.
Deferred acquisition costs related to accident and health insurance are amortized over the premium-paying period of the related policies using assumptions consistent with those used for computing future policy benefit reserves for such contracts. Assumptions are made at the date of policy issuance or acquisition and are consistently applied during the lives of the contracts. Deviations from estimated experience are included in results of operations when they occur. For these contracts, the amortization period is typically the estimated life of the policy. At December 31, 2011, deferred acquisition costs were presented net of Shadow Adjustments of $412 million.
Supplementary cash flow information - Cash payments made for interest on long term debt, net of capitalized interest, amounted to $526 million, $494 million and $442 million for the years ended December 31, 2011, 2010 and 2009. Cash payments for federal, foreign, state and local income taxes amounted to $322 million, $378 million and $219 million for the years ended December 31, 2011, 2010 and 2009. Investing activities exclude $14 million of accrued capital expenditures for the year ended December 31, 2011. For the years ended December 31, 2010 and 2009, investing activities include $51 million and $235 million of previously accrued capital expenditures.
CNA performs the discounted cash flow analysis using stressed scenarios to determine future expectations regarding recoverability. For asset-backed securities, significant assumptions enter into these cash flow projections including delinquency rates, probable risk of default, loss severity upon a default, over collateralization and interest coverage triggers and credit support from lower level tranches.
The corporate and other bonds in a gross unrealized loss position by ratings distribution are as follows:
The largest exposures at December 31, 2011 as measured by gross unrealized losses were several separate issues of Puerto Rico sales tax revenue bonds with gross unrealized losses of $80 million. All of these securities are rated investment grade.
Limited partnerships representing 11.7% and 9.1% at December 31, 2011 and 2010 were invested in private debt and equity. The remaining were invested in various other partnerships including real estate. The ten largest limited partnership positions held totaled $1.3 billion and $1.4 billion as of December 31, 2011 and 2010. Based on the most recent information available regarding the Company’s percentage ownership of the individual limited partnerships, the carrying value reflected on the Consolidated Balance Sheets represents approximately 4.1% and 4.2% of the aggregate partnership equity at December 31, 2011 and 2010, and the related income reflected on the Consolidated Statements of Income represents 3.9%, 3.5% and 4.4% of the changes in partnership equity for all limited partnership investments for the years ended December 31, 2011, 2010 and 2009.
Favorable development was recorded for property coverages. Favorable catastrophe development was driven by the favorable settlement of several claims primarily in accident years 2005 and 2007, and better than expected frequency and severity on claims in accident year 2008. Favorable non-catastrophe development primarily related to large property and marine coverages in accident years 2007 and 2008. Favorable development was recorded in CNA’s European property, cargo, and personal accident and travel businesses driven by both frequency and severity emerging favorably to prior expectations, particularly in accident years 2007 and 2008.
(c) During 2010, HighMount reclassified 208 Bcfe of proved undeveloped reserves to a non-proved category due to certain wells reaching their five year maturity as a result of reduced drilling activity in 2009 and 2010. Additionally, HighMount reduced its proved developed and proved undeveloped reserves by 346 Bcfe as a result of higher production declines on its producing wells than previously anticipated.
The Company recorded stock-based compensation expense of $10 million, $11 million and $13 million related to the Loews Plan for the years ended December 31, 2011, 2010 and 2009. The related income tax benefits recognized were $4 million, $4 million and $4 million. At December 31, 2011, the compensation cost related to nonvested awards not yet recognized was $12 million, and the weighted average period over which it is expected to be recognized is 2.3 years.
CNA’s non-core operations are managed in two segments: Life & Group Non-Core and Other Insurance. Life & Group Non-Core primarily includes the results of the life and group lines of business that are in run-off. Other Insurance primarily includes certain corporate expenses, including interest on corporate debt, and the results of certain property and casualty business primarily in run-off, including CNA Re and A&EP.