property and casualty subsidiaries adversely impacted by these charges. A summary of the capital plan, related actions, and other significant 2003 business decisions is discussed below:
Net earned premiums increased $925 million in 2002 as compared with 2001. The increase in net earned premiums was primarily attributable to decreased ceded premiums related to corporate aggregate and other reinsurance treaties, strong rate increases, increased new business and decreased unfavorable premium development. The 2001 unfavorable net prior year premium development was primarily due to a change in estimate for retrospective premium accruals and a change in estimate for involuntary market premium accruals. Partially offsetting the improvements in net earned premiums was 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.
the number and outcome of direct actions against the Company; and
In 2001, the Company entered into a one-year aggregate reinsurance treaty related to the 2001 accident year covering substantially all property and casualty lines of business in the Continental Casualty Company pool (the CCC Cover). The loss protection provided by the CCC Cover has an aggregate limit of approximately $761 million of ceded losses. The ceded premiums are a percentage of ceded losses. The ceded premium related to full utilization of the $761 million of limit is $456 million. The CCC Cover provides continuous coverage in excess of the second section of the Aggregate Cover discussed above. During 2003, the CCC Cover was fully utilized. Under the CCC Cover, interest charges on the funds withheld generally accrue at 8% per annum. The interest rate increases to 10% per annum if the aggregate loss ratio exceeds certain thresholds. If the aggregate loss ratio would exceed these certain thresholds, then additional interest charges on funds withheld would be approximately $27 million in 2004.
The Terrorism Risk Insurance Act of 2002 (the Act) established a program within the Department of the Treasury under which the federal government will share the risk of loss by commercial property and casualty insurers arising from future terrorist attacks. The Act expires on December 31, 2005. Each participating insurance company must pay a deductible, ranging from 7% of direct earned premiums from commercial insurance lines in 2003 to 15% in 2005, before federal government assistance becomes available. For losses in excess of a company’s deductible, the federal government will cover 90% of the excess losses, while companies retain the remaining 10%. Losses covered by the program will be capped annually at $100 billion; above this amount, insurers are not liable for covered losses and Congress is to determine the procedures for and the source of any payments. Amounts paid by the federal government under the program over certain phased limits are to be recouped by the Department of the Treasury through policy surcharges, which cannot exceed 3% of annual premium.
The unfavorable net prior year development on contractors account package policies was the result of a 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.
Additionally, acquisition expenses increased as a result of a $44 million increase in certain insurance-related assessments recorded in 2003 as compared with a $30 million reduction in accruals for certain insurance-related assessments resulting from changes, due to legislation, in the basis on which the assessments were recorded in 2002. Also increasing the expense ratio was approximately $62 million of expenses related to eBusiness in 2003. The 2002 eBusiness expenses were included in the Corporate and Other segment.
A $238 million underwriting benefit was recorded for the corporate aggregate reinsurance treaties in 2001, comprised of $443 million of ceded losses and $205 million of ceded premiums for accident year 1999.
CNA Pro, through CNA HealthPro, also offers insurance products to serve the healthcare delivery system. Products are distributed on a national basis through a variety of channels including brokers, agents and managing general underwriters. Key customer segments include long term care facilities, allied healthcare providers, life sciences, dental professionals and mid-size and large healthcare facilities and delivery systems. Additionally, CNA HealthPro offers risk management consulting services to assist customers in managing quality of care risks associated with the delivery of healthcare. Claim services are provided to manage and resolve claims.
The following net prior year development was recorded in 2003 as a result of the elimination of deficiencies and redundancies in reserve positions within the segment. An additional $50 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development was recorded related to medical malpractice and long term care facilities. Partially offsetting this unfavorable claim and allocated claim adjustment expense reserve development was a $25 million underwriting benefit from cessions to corporate aggregate reinsurance treaties. The benefit was comprised of $56 million of ceded losses and $31 million of ceded premiums for accident years 2000 and 2001.
Net income decreased $113 million in 2003 as compared with 2002. The decrease in net income was primarily related to the decline in underwriting results, decreased net investment income due primarily to a reduction of invested assets resulting from the sale of CNA Re U.K., increased interest expense of $8 million after-tax ($12 million pretax) related to additional cessions to the corporate aggregate reinsurance treaties, and decreased net realized investment results. See the Investments section of this MD&A for further discussion on net investment income and net realized gains (losses).
CNA Re. Losses have continued to show large increases for accident years in the late 1990s and into 2000 and 2001. These increases are greater than the increases indicated by patterns from older accident years and have a similar effect on several lines of business. Approximately $67 million unfavorable net prior year development recorded in 2003 was related to proportional liability exposures, primarily from multi-line and umbrella treaties in accident years 1997 through 2001. Approximately $32 million of unfavorable net prior year development recorded in 2003 was related to assumed financial reinsurance for accident years 2001 and prior and approximately $24 million of unfavorable net prior year development related to professional liability exposures in accident years 2001 and prior.
Federal Markets provided health insurance benefits to federal employees, retirees and their families, insuring nearly one million members under 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.
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, ceased providing professional employer organization services and ceased payroll processing services.
subrogation continues to be collected on these types of claims, thereby reducing estimated future losses net of anticipated reinsurance recoveries.
At December 31, 2003, the carrying value of the general account fixed maturities was $28,678 million, representing 75% of the total investment portfolio. The net unrealized gain of this fixed maturity portfolio was $1,114 million, comprising gross unrealized gains of $1,237 million and gross unrealized losses of $123 million. Gross unrealized losses were across various sectors, the largest of which was corporate bonds. Within corporate bonds, the largest industry sectors were financial, consumer-cyclical and consumer-non-cyclical, which as a percentage of total gross unrealized losses were 33%, 18% and 17%. Gross unrealized losses in any single issuer was less than 1% of the carrying value of the total general account fixed maturity portfolio.
For the year ended December 31, 2003, the impairment losses recorded related primarily to corporate bonds in the airline, healthcare and energy industries.
The general account portfolio consists primarily of high quality (rated BBB or higher) bonds, 93% and 89% of which were rated as investment grade at December 31, 2003 and 2002. The following table summarizes the ratings of CNA’s general account bond portfolio at carrying value.
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 75.0 basis points. Further, if the Company has outstanding loans greater than 50% of the amounts available under the three-year facility, the Company will also pay a utilization fee of 12.5 basis points on such loans. At December 31, 2003 and 2002, the weighted-average interest rate on the borrowings under the facility, including facility fees and utilization fees, was 2.3%.
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 to CNA Surety arising from bonds issued to the contractor or assumed 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 October 31, 2003 has been limited to $20 million per bond. For bonds written subsequent to November 1, 2003, and for bonds CNA Surety may write in 2004, CNA Surety’s exposure is limited to $14.5 million per bond subject to an aggregate limit of $150 million under all such reinsurance contracts. Effective January 1, 2004, CCC and CNA Surety entered into a $40 million excess of $60 million reinsurance contract that provides coverage to CNA Surety exclusively for the contractor. This reinsurance will be in effect through December 31, 2004. The premium for this contract is $3 million, plus an additional premium if a loss is ceded under it. Effective January 1, 2004 through December 31, 2004, CNA Surety and CCC also entered into a $50 million excess of $100 million contract that provides coverage to CNA Surety for the contractor, as well as other CNA Surety risks. The premium for this contract is $6.0 million plus an additional premium if a loss is ceded to this contract.
The Institutional Markets business unit of Group Operations, which was not included in the sale of CNA’s group benefits business to Hartford and provides investment products to pension plan sponsors and other institutional customers, would be significantly impacted by a downgrade of CAC/VFL.
and the individual life insurance business as described below. In addition, Loews committed to an additional $150 million by March 31, 2004, in a form to be determined, to support the statutory capital of CCC in the event of additional shortfalls in relation to business and asset sales.
Surplus notes are financial instruments with a stated maturity date and scheduled interest payments, issued by insurance enterprises with the approval of the insurer’s domiciliary state. All payments of interest and principal on these notes are subject to the prior approval of the Illinois Insurance Department. Surplus notes are included as surplus for statutory accounting purposes, but are classified as debt instruments under GAAP, as reflected in the Consolidated Balance Sheet.
unrealized losses and the related fair value of investments with unrealized losses for securities that have been in an unrealized loss position for less than 12 months and separately for those that have been in an unrealized loss position for over 12 months, by investment category. The Company has adopted the disclosure requirements in these financial statements. Further discussion on the meaning of other-than-temporary impairments for EITF 03-1 is expected at a future EITF meeting.
on December 31, 2003, resulting in an after-tax realized investment loss on the sale of $130 million during 2003. See Note P for further information.
As part of the capital plan, Loews purchased $346 million of CCC surplus notes in February of 2004. See Note L for further information.
Future policy benefits reserves: Reserves for traditional life insurance products (whole and term life products) and long term care products are computed using the net level premium method, which incorporates actuarial assumptions as to interest rates, mortality, morbidity, persistency, withdrawals and expenses. Actuarial assumptions generally vary by plan, age at issue and policy duration, and include a margin for adverse deviation. Interest rates range from 2.3% to 9.4%, and mortality, morbidity and withdrawal assumptions are based on Company and industry experience prevailing at the time of issue. Expense assumptions include the estimated effects of inflation and expenses to be incurred beyond the premium paying period. Reserves for interest-sensitive contracts are equal to the account balances that accrue to the benefit of the policyholders. Interest crediting rates ranged from 3.9% to 6.5% for the three years ended December 31, 2003.
Reinsurance: Amounts recoverable from reinsurers are estimated in a manner consistent with claim and claim adjustment expense reserves or future policy benefits reserves and are reported as receivables in the Consolidated Balance Sheets. The cost of reinsurance is 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.
Deferred acquisition costs are recorded net of ceding commissions and other ceded acquisition costs. The Company evaluates deferred acquisition costs for recoverability; adjustments, if necessary, are recorded in current results of operations.
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 $430 million and $544 million at December 31, 2003 and 2002. The fair value of non-cash collateral was $505 million and $777 million at December 31, 2003 and 2002.
During 2002, the Company completed its initial goodwill impairment testing and recorded a $64 million pretax, or $57 million after-tax, impairment charge. In accordance with SFAS 142, the impairment charge, which consisted of a $51 million pretax, or $48 million after-tax, charge in Specialty Lines, a $12 million pretax, or $8 million after-tax, charge in Life Operations, and a $1 million pretax, or $1 million after-tax, charge in Corporate and Other, was recorded as a cumulative effect of a change in accounting principle as of January 1, 2002. Any impairment losses incurred after the initial application of this standard are reported in operating results.
In December of 2002, the FASB issued SFAS 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 No. 123, Accounting for Stock-Based Compensation, to require prominent disclosures in both annual and interim financial statements about the
The Company’s investments in limited partnerships contain withdrawal provisions that typically require advanced written notice of up to 90 days for withdrawals. The carrying value of these investments reported as a separate line item in the Consolidated Balance Sheet is $1,117 million and $1,060 million at December 31, 2003 and 2002.
Also, offsetting the unfavorable net prior year development was a $216 million underwriting benefit from cessions to corporate aggregate reinsurance treaties recorded in 2003. The benefit is comprised of $485 million of ceded losses and $269 million of ceded premiums for accident years 2000 and 2001.
During 2003, as a result of the unfavorable net prior year development recorded related to accident years 2000 and 2001, the $500 million limit related to the 2000 and 2001 accident years under the first section was fully utilized and losses of $500 million were ceded under the first section of the Aggregate Cover. In 2001, as a result of reserve additions including those related to accident year 1999, the remaining $500 million limit related to the 1999 accident year under the first section was fully utilized and losses of $510 million were ceded under the second section as a result of losses related to the WTC event. The aggregate limits for the Aggregate Cover have been fully utilized.
The Company’s pension plan weighted-average asset allocation at December 31, 2003 and 2002, by asset category are as follows:
As noted above, during 2000, CCC employees were required to make a choice regarding their continued participation in CCC’s defined benefit pension plan. Employees who elected to forego earning additional benefits in the defined benefit pension plan and all employees hired by CCC on or after January 1, 2000 receive a Company contribution of 3% or 5% of their eligible compensation, depending on their age.
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, 2003, was approximately 0.1 million.
publications of the NAIC as well as state laws, regulations and general administrative rules. The Company’s insurance subsidiaries followed one significant permitted accounting practice at December 31, 2002, related to discounting of certain non-tabular workers compensation claims. The impact of this permitted practice was to increase statutory surplus by approximately $24 million at December 31, 2002. This practice was followed by an acquired company, and CNA received permission to eliminate the effect of the permitted practice over a period of years, which ended in 2003.
The assets and liabilities of Claims Administration Corporation and the Mail Handlers Plan were $352 million and $350 million at December 31, 2001. The revenues of Claims Administration Corporation and the Mail Handlers Plan were $1,151 million and $2,231 million for the years ended December 31, 2002 and 2001.
CNA Re U.K. had revenues of approximately $48 million and $280 million for the two years ended December 31, 2002 and 2001. CNA Re U.K. had net losses of $22 million and $374 million for the years ended December 31, 2002 and 2001. 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.